The stock market is riding a "red wave" with policy risks, analysts say

Market analysts say the stock market's momentum following the 2024 election could continue, driven by steady economic growth, strong corporate earnings and expectations for further interest rate cuts by the Federal Reserve. But concerns remain that a shift in policies could affect inflation rates.

The U.S. market typically rises after presidential elections regardless of which party wins, and it surged after former President Donald Trump won another term and Republicans took control of the U.S. Senate. The Dow Jones Industrial Average, the S&P 500 and the tech-focused Nasdaq Composite closed at record highs last week, with most stocks edging upward this week following a pause on Tuesday. On Wednesday, the GOP won enough seats to control the U.S. House.

Sam Stovall, chief investment strategist at CFRA Research, said the "red wave period" is “the best scenario for a Republican president (when it comes to the stock market)." Stovall cited historical data showing that during similar "red wave" periods, the stock market gained an average of nearly 13% annually and increased 75% of the time.

In apparent response to the GOP wins, small-cap stocks, along with financial and traditional energy sectors — including oil, gas and coal — performed particularly well following the election and may continue to benefit from anticipated new policies, such as corporate tax cuts, reduced regulatory oversight for financial institutions and fewer environmental restrictions on fossil fuel production.

However, certain policy proposals may pose economic risks. Trump has repeatedly pledged to impose a 60% tariff on Chinese-made goods and a 10% to 20% tariff on imports from other countries, a position he used to court voters in the manufacturing sectors. Economists have warned that such tariffs could drive up consumer prices as companies pass on higher costs, potentially worsening inflation and putting further interest rate cuts on hold. Columbia Sportswear recently told the Washington Post it is set to raise prices due to potential tariff impacts.

Inflation has already been a major concern for U.S. consumers, reaching a peak of 9.1% in June 2022 due to pandemic-related supply chain disruptions. Although it has since moderated, inflation remains a key issue for voters, with many citing dissatisfaction with rising prices as a factor in their support for Trump.

Industries such as automotive, electronics and apparel retail could face significant pressures under his proposed tariffs, according to a report by asset management company Janus Henderson. Trump’s proposed immigration policy, which includes mass deportations, could further strain the economy by tightening labor markets, driving up wages and adding to inflationary pressures, analysts have said — particularly in low-wage industries like agriculture, construction and food service.

The Peterson Institute for International Economics forecasts that, combined with steep tariffs and mass deportation, these measures could lead to lower national income, reduced employment and inflation rates between 6% and 9.3% by 2026.

Despite these risks, market experts suggest investors should focus on the economic environment and company fundamentals, as political factors tend to have a short-lived impact on the stock market and policy changes require time to be implemented.

“Our data have shown us over time, it’s really still about the economy, and earnings growth is a much bigger driver than merely election outcomes or who’s in control,” said Rob Haworth, senior investment strategy director for U.S. Bank Asset Management.

The U.S. economy grew at a healthy 2.8% annualized rate in the third quarter, driven by robust consumer spending, which expanded at a 3.7% pace. This, combined with modest business investment spending, serves as the foundation for a favorable earnings environment, Haworth said.

Major tech companies such as Alphabet, Microsoft, Meta Platforms, Amazon and Apple reported strong third-quarter earnings, with revenue exceeding expectations across the board.

In a move to boost the economy as inflation cools, the Federal Reserve on Nov. 7 cut its benchmark interest rate by 25 basis points as expected, following a September rate cut. Another rate reduction is anticipated in December.

These factors collectively make equities more appealing than fixed-income investments like bonds, analysts say. Technology stocks, in particular, are expected to drive future gains, fueled by growth potential in artificial intelligence.

“A lot of people like to use a baseball analogy. Some say we’re in the early innings. Well, our analysts think we’re still in batting practice, meaning we are not even in the game yet,” CFRA’s Stovall noted.

While pointing out the stock market traditionally performs the best from November through April, typically gaining about 7%, Stovall cautioned about a potential decline in 2025. Since the beginning of the bull market in late 2022, the market has grown 70%, meaning many stocks are now trading at premiums, which could make further growth in its third year more challenging, he added.