(Bloomberg) -- After a post-election risk-taking binge, stock investors sobered up this week as Jerome Powell’s go-slow message on interest-rate cuts cooled the Trump trade euphoria that drove Wall Street to records.
With the world’s most important central banker in no hurry to ease monetary policy thanks to a still-robust labor market and strong economic data, bond yields once again rose and dragged stocks lower in their wake. Down 2% over five sessions, the S&P 500 erased half of its trough-to-peak gains since the election. Combined with losses in corporate credit and commodities, the week rounded out a pan-asset retreat that by one measure was the worst in 13 months.
Unbridled investor optimism over President-elect Donald Trump’s business-friendly policies, including tax cuts and deregulation, is easing and cooler heads are prevailing. One worry: the Republican’s fiscal agenda threatens to rekindle inflation and, thereby, may force the Federal Reserve to cut interest rates less than expected.
Another: elevated valuations. The current market setup leaves little room for error should growth disappoint, or inflation pick up again. A Bloomberg model that adjusts the S&P 500 earnings yield and 10-year Treasury rates for inflation shows pricing for the world’s two most-watched assets is historically stretched. In fact, cross-asset valuations in real terms are now higher than 88% of the time in data going back to in 1962.
“The market is expensive,” said John Davi, chief investment officer at Astoria Advisors. “Powell’s speech last night basically saying that Fed officials don’t need to rush to lower rates, that’s probably the main reason why we’re selling off.”
At an event Thursday, Fed Chair Powell said the US economy has been “remarkably good,” giving central bankers room to lower interest rates at a careful pace. In turn, 10-year Treasury yields hit an intraday four-month high as traders pared back bets on December rate cuts, with many emboldened by the stronger-than-expected data on retail sales and firm inflation.
The RPAR Risk Parity ETF, which tracks everything from Treasuries to stocks and commodities, tumbled 3.2%, the most since October 2023.
Stocks slipped, with the S&P 500 failing to hold gains above the 6,000 level. The Russell 2000 index of small-caps, a major plank of the Trump trade, dropped 4% for its worst week in more than two months. The Nasdaq 100 sank ahead of next week’s widely watched earnings from Nvidia Corp., a chipmaker at the center of the artificial intelligence boom.
For a fifth straight week, stocks and Treasury yields moved in opposite directions, signaling anxiety around inflation and the central bank’s response. It marked a subtle departure from the previous four weeks, when rising yields were taken as evidence of a resilient economy, something that bodes well for risky assets like equities.
Now with Treasury rates rising despite the Fed’s easing cycle and the inflation threat back on traders’ radars, the risk-on appetite that swept Wall Street in the aftermath of Trump’s victory is showing signs of easing.
“With the market extrapolating resilient growth and firmer inflation now into a future that has upside risks to both growth and inflation under the Trump administration, the result is a more hawkish outlook on policy rates and the curve as a whole,” said Garrett Melson, a portfolio strategist at Natixis Investment Managers Solutions. “In that tug of war between a reflation optimism and rates, rate uncertainty seems to be winning out and keeping risk appetite in check.”
While the moves were jarring, particularly Friday, when the Nasdaq 100 tumbled more than 2%, the week’s reversals were barely a blip in a year that has showered trillions of dollars of fresh wealth on American equity owners. A paring back of election euphoria may also have been inevitable after a week that saw the S&P 500’s biggest gain in a year and the fastest runup in small caps since 2020.
Over at JPMorgan Chase & Co., strategists including Nikolaos Panigirtzoglou compared prices and fund flows across various assets to those during the first eight weeks following Trump’s presidential win in 2016. On that historic basis at least, they conclude the Trump trade has further room to run. And the optimism is shared by the firm’s sales and trading team led by Andrew Tyler.
The ramifications from a resilient economy “appear to be a truncated easing cycle for the Fed, but this is not a bad thing for stocks,” Tyler wrote in a note to clients. “While the repricing in yields may lead to some short-term negative reactions to stocks, the strength of the underlying economy continues to support our tactical bullish view in stocks till year-end.”
Heading into this week, skepticism has been in short supply. Big money managers have boosted holdings in US equities to an 11-year high, according to the latest Bank of America Corp. survey. And day traders scooped up shares at the fastest pace since March 2022 in the week through Wednesday, data compiled by JPMorgan show.
While Bitcoin has extended its price gains past 30% from the election day, Thursday marked the first time over the stretch that crypto-tracking exchange-traded funds had outflows, data compiled by Bloomberg show. The digital coin has been on a tear, propelled by Trump’s pledge to implement a game-changing regulatory agenda in favor of digital assets while creating a strategic US stockpile of Bitcoin.
Not all aspects of the Trump trade tired out. The US dollar has climbed for seven weeks in a row, hitting a two-year high, in part because of the president-elect’s protectionist promises. Rising bond yields have long been seen as a likely byproduct of his fiscal ambitions, a source of stress in markets where a lot of good news is priced in, according to Scott Chronert, Citigroup Inc.’s head of US equity strategy.
“There is a lot of pressure on macros and fundamentals to deliver, which may explain some recent profit taking after a rapid post-election run,” he wrote in a note. “Market action reflects how participants feel: exhausted.”
