By Ian Salisbury

President-elect Donald Trump's win sent the stock market soaring -- but bondholders got a gut-check. Investors who own classic, diversified portfolios many want to consider adjustments so they aren't burned by higher interest rates in the long term.

The Dow Jones Industrial Average jumped more than 3% Wednesday, following news Trump defeated Vice President Kamala Harris to win the White House. But bonds took it on the chin, with yields on 10-year Treasury notes jumping 0.15 percentage points to 4.435%. (Bond prices move in the opposite direction to interest rates.)

That means for investors with classic 60/40 stock-bond portfolios the day was a mixed bag. The Vanguard Balanced Index Fund, a popular mutual fund that follows the strategy, gained 1.5%.

What gives? Wall Street was relieved the election ended with a clear-cut winner and was excited about Trump's promise to cut the corporate tax rate to 15% from 21%.

But while lower taxes could boost the economy, that growth, along with other Trump initiatives, could lead to another bout of inflation, hurting bond investors.

Trump's proposed tax cuts are unfunded, meaning they would likely add trillions to the deficit. New tariffs and plans to deport undocumented workers could also spur inflation, which economists have estimated to could end up anywhere from about half of one percentage point over the baseline to more than 6%.

In other words, Trump's win means investors need to take advantage of the potential for growth, without taking on too much interest rate risk.

While stocks rallied Wednesday, not all sectors benefited equally. The S&P 500's biggest winner was financials, with the Financial Select Sector SPDR rising 6%. Shares of JPMorgan Chase jumped 12%. Goldman Sachs was up 13%.

Wall Street had long been predicting a Trump win would favor investment banks, given Republicans' light regulatory touch, especially when it comes to mergers and acquisitions. But banks can also thrive during inflationary periods, since higher interest rates make loans more profitable.

By contrast, the worst performing sector of the S&P 500 Wednesday was real estate, down 2.7%. Mortgage rates, which closely follow the 10-year Treasury yield, have already ticked up in the past month as investors priced in an increasingly-likely Trump win.

A harder case is whether to bet on small-company stocks. The small-cap focused Russell 2000 was up 5.8% Wednesday. These stocks could be poised to rally if the Trump tax cuts spark growth, since the companies, which have weaker balance sheets and business models, are more sensitive to economic conditions. The flip side is that, with lower credit ratings, they are also more sensitive to rising interest rates.

"We still have an emphasis on large caps over small caps, even though on a shorter-term basis, small caps are likely to outperform," wrote Keith Lerner, Truist market strategist, in a note Wednesday. "On a longer-term basis, the asset class remains in a tug of war between a resilient economy and higher interest rates."

Bond investors, who have been looking forward to the tailwind of declining interest rates, need to consider their options if that catalyst fails to materialize. The Federal Reserve, scheduled to announce its next interest-rate move on Thursday, is still expected to cut interest rates by a quarter-point. But whether the central bank will follow the same plan for steady cuts into next year is an open question.

Bets on long-term Treasuries, popular earlier this fall, might look too risky. Investors have poured billions into the iShares 20+ Year Treasury Bond ETF in recent weeks, but the fund has stumbled. It posted a negative 2.6% return over the past month through election day, and declined another 2.7% Wednesday.

A better bet may be intermediate-term Treasuries or bonds that offer more attractive yields in exchange for some credit risk, such as investment-grade corporate bonds. The iShares iBoxx $ Investment Grade Corporate Bond ETF also declined Wednesday, but by a much more modest 1%

"We are neutral long-term U.S. Treasuries and prefer medium-term maturities and some quality credit for income -- but expect yields to rise over time as investors seek more compensation for the risk of holding bonds," wrote iShare parent BlackRock in a note Wednesday.

Write to Ian Salisbury at ian.salisbury@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

November 06, 2024 20:03 ET (01:03 GMT)

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