How will rising gilt yields affect your clients?

Summary

Donald Trump’s return to the White House this week has major implications for people’s money. Whether that’s investments in the stock market, government bonds, cash in the bank or even holiday money, his policies have far-reaching consequences.

Trump’s election victory has already had an impact on stocks, bonds and currencies and we’re likely to see further action once he is inaugurated today.

The US stock market initially responded favourably to the election result last November, but recent headwinds have curtailed some of the Trump-related gains. The S&P 500 index of US shares is now trading 1.2% higher than election day, while the more tech-focused Nasdaq index is up 3.7%.

Initial euphoria was driven by investors locking onto the fact Trump is pro-business and is expected to cut taxes and have looser regulation, potentially giving a boost to corporate profit margins and driving greater share buybacks. There is a big risk that investors have now priced in a lot of potential good news and that markets don’t do as well once Trump is back in power.

How have markets performed under previous Republican presidents?

Analysis by AJ Bell of market performance during previous campaigns since 1949 finds that US equities can be slow movers in the first year of a Republican president, rising just 2% on average.

The second and third years are much better, rising by 11.8% and 14.8% on average respectively, with only a 0.2% gain in year four.

How have bond markets reacted?

The bond market appears to be less optimistic, given how Treasury prices have fallen amid concerns that Trump will borrow more money, putting further pressure on his government’s finances. The US budget deficit is expected to have been $1.9 trillion in 2024, an already sky-high figure, so the prospect of it getting even bigger is a worry.

Bond yields rise when prices fall, and the 10-year US Treasury yield now stands at 4.791% compared to 4.286% on the day of the 2024 US presidential election. That’s quite a jump in such a short period and provides a headwind for the equity market as it influences the cost of borrowing.

Rising bond yields create headwinds for equities because they increase companies’ cost of raising capital. They affect swap rates, which are estimates of future interest rates and are what financial institutions pay to acquire funding for lending. If the cost for lenders goes up, the rates they charge to customers will also increase.

Also starting to weigh on investors’ minds is the fact that Trump’s policies, particularly around immigration and tariffs, could drive up inflation. A clampdown on immigration could lead to higher labour costs if the pool of individuals willing to do certain jobs shrinks.

Tariffs: the big unknown

Tariffs are the big unknown with regards to Trump. We still don’t have precise detail on which sectors and countries will be targeted and the rates to be imposed. Two weeks ago, investors were hoping Trump’s bark could be worse than his bite, with market chatter that the incoming US President’s tariffs might only be applied to critical imports. Such a move would be positive not just for global trade but also for the US economy as it could dilute prospects for inflation to rear its ugly head.

However, Trump quickly appeared to throw cold water over this suggestion. The latest speculation is that Trump’s economic team might consider a ramp-up in trade tariffs rather than going straight in guns a-blazing. Markets would like such an approach as it gives companies on the receiving end of tariffs more time to consider their options, and it could also mean a slower increase in inflation.

How have the dollar and the pound performed?

The dollar has been on a run over the past few months as markets expect Trump’s policies to accelerate economic growth, keep interest rates higher for longer, and in recognition of the US economy already being in a better shape than many other regions such as the UK, Eurozone and China.

The US dollar index – a relative measure of the dollar against a basket of six foreign currencies including the euro, pound and yen – has increased by just under 6% since Trump won the election.

The pound has weakened by 5.9% against the US dollar since the election, meaning UK holidaymakers going to the US will find their money doesn’t go as far. For example, £1 will buy you $1.2189 today versus $1.2954 on 5 November 2024 when the election was held. Someone buying £3,000 worth of dollars for their holiday will now get $3,656 excluding FX commission – that’s $230 less than on election day ($3,886), which is a substantial drop.

How have ‘Trump trade’ stocks performed?

Investors could have made good money through investing in the obvious ‘Trump trades’ ahead of his inauguration. Nearly all of the obvious winners from his policies are trading higher since the election was called:

• Prison companies - Big gains have been recorded in shares of for-profit operators of prisons and immigration detention centres in anticipation of Trump’s clampdown on illegal immigration, including a 103% share price gain on Geo Group and a 62% gain from CoreCivic. Investors may be expecting these companies to see an increase in occupancy numbers and win new government contracts as the administration enacts a policy of mass deportation and potentially more aggressive policing practices.
   

• Tesla - Being in Trump’s inner circle has elevated Elon Musk’s profile on the world stage and encouraged investors in his electric vehicle company to believe Tesla will get preferential treatment from the new administration. While Trump comes across as an anti-green leader, he is also expected to loosen regulations and that could benefit Tesla’s quest to roll out self-driving technology. Trump is expected to cut federal subsidies for electric vehicles – at face value, that’s not good for Tesla, but it could be even worse for its smaller, weaker competitors.
   

• Cryptocurrencies- Bitcoin has rocketed since Trump’s appointment, given he has promised to make America ‘the crypto capital of the planet’ and to build a strategic reserve of bitcoin. Business information group MicroStrategy has been a popular way for UK investors to play this theme and its shares have gone up by 44% since the election result. Most people wouldn’t have a clue what MicroStrategy does as a day-to-day business, but that hasn’t stopped them buying the shares. The key attraction is MicroStrategy’s massive holding in bitcoin which makes its share price highly leveraged to the cryptocurrency.
   

• Banks - The US banking industry should benefit from Trump’s return to the White House in multiple ways, and that explains why shares in the sector have strengthened, including a 14% gain from Citigroup since 5 November 2024. Banks had faced the prospect of having to hold more capital in reserve under Biden. While the Federal Reserve recently watered down those plans, Trump is expected to further dilute them so as to free up money for banks to lend and drive greater economic activity. This could also drive higher returns for shareholders through greater dividends and share buybacks. We may also see increased M&A activity among banks if there is reduced regulatory scrutiny.
   

• Oil producers and explorers - Trump loves using the slogan, ‘drill, baby, drill’, and his election win gave a spark to US oil producers on the stock market. Trump has talked about increased drilling on federal land and awarding more permits for LNG exports. Shares in US oil and gas producers were initially in demand after the election result as their industry backdrop should benefit from looser regulation under the new president. However, global oil and gas prices are heavily influenced by production from the Middle East which means Trump’s return to the White House isn’t necessarily a free ticket to greatness for the sector. If anything, greater production from the US could even push oil and gas prices lower if it adds significantly to global output. The oil and gas sector has been volatile of late and that’s evident by US major Chevron now only up 1% on the stock market since the election result and pureplay US producer Devon Energy down 7% over the same period.
   

• Defence contractors - Trump has implied he wants to strengthen America’s defences, which theoretically creates more opportunities for defence companies. However, defence stocks haven’t enjoyed a sustained rally since the election as investors are worried about possible budget cuts. For example, American defence group Northrop Grumman is down 8% since 5 November 2024. There is a big difference between wanting to do something and having the funds to make it happen – so it might be that we see a shift in defence spending, with some areas losing out to others.
   

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