In the Wake of the Election

We recently sat down with Dominic Nolan, CEO of Aristotle Pacific Capital, to get his insights into the initial post-election impacts on markets, the underrated U.S. economy, the Fed and interest rates, and fixed-income opportunities. We finished up with a random round of questions and personal reflection.

Market Performance: Total Return

Let's start with markets. Bank loans ended up positive, but everything else ended October in the red. What happened?

October was a pretty benign month for equities. The S&P 500 Index was down 1% for the month (but still up almost 21% for the year), the Russell 1000 Growth Index dropped a fraction, and the Russell 2000 Value Index was down 1.5%. It was a different story on the fixed income side as rates moved higher on the long-end of the curve. Investment-grade bonds dropped 2.5%. High yield was down a half-percent. Bank loans, the non-rate sensitive instrument, was up 85 basis points, which is around coupon, and once again among the leaders in fixed income. Performance was driven, largely, by two headwinds: 1) The markets were waiting the results of the election; and 2) The increase in the 10-year Treasury rate, which was driven by the expectation of inflationary policies.

10-Year Treasury Yields Remain Range Bound

How are they related?

Beginning near the first week of October, the prediction markets started to see increasing amounts of money put on a Trump victory, pushing the chances of him winning from 49% to over 60%. These markets provide a much different look at the election than polls do, and I think equity and bond markets started to buy in and process the likelihood of a Trump victory and GOP strength. The market is a discounting mechanism, and the belief became Trump is going to win. The money in the prediction markets was right, and that is the takeaway.

Magnificent 7: Concentrated Performance

How did the Magnificent 7 do?

It was a mixed bag. NVIDIA was up 9%, but four of the Magnificent 7 were negative in October. NVIDIA now has a market cap of almost $3.6 trillion—that would be 13% of the U.S. GDP. Just incredible.

Economic Dashboard: GDP, Inflation, Jobs and Consumer Spending

What about the economy?

Inflation is now in the 2.5% to 3% range. It doesn't seem to be heading much lower, but inflation has moderated. Real GDP growth is healthy at around 2%. Job growth is slower, but I think companies may have been waiting for the election results before adding employees. In addition to all this, consumer confidence is higher this year than last. What perplexed me during the election campaigns was all the rhetoric about how bad the economy is. Most measures show a relatively healthy economy when most believed not too long ago that we were going to be in a recession.

Fed Futures: Accelerating Timing of Rate Cuts (Cuts Expected into July 2025)

The Fed lowered rates by 25 basis points this month, the second cut in 2024. What’s next?

The Fed is expected to cut rates again in December. It's really a question of how many times do they cut next year? That's going to be the dilemma they face, assuming some of the Trump policies the market is expecting start to flow through. Base case is another two to three cuts next year, which would take us 100 or 125 basis points lower, putting us in that 3.5% range. Inflation expectations will a major factor with how this all plays out.

End of the Inversion?

The yield-curve inversion, normally a predictor of recessions, has ended for now. What’s this signaling?

The bond market is indicating the economy is on decent track. It seems to be the end of the inversion and given market expectations on policy and impacts of a Trump administration, I would expect the 10-year Treasury yield to stay elevated.

Market Performance: 1-Day Total Return

How did the markets do the day after the presidential election?

Wall Street in general was thrilled with the result. I'll say the reasons behind that are the hope for lower taxes and less regulation. The S&P 500 rallied 2.5% for the day. The Russell 2000 Value Index, which is made up of smaller companies, gained 6%. We saw rates increase. The market is telling you it believes there's going to be more economic growth. At the same time on the bond side, it’s expecting more inflation. For the 10-year Treasury, it started October at 3.73% and moved to 4.43% the day after the election.

Sector Performance: 1-Day Total Return

How did sectors react to the news of another Trump presidency?

Financials were the big winner, up over 6% on the hopes of less regulation, increased M&A, much of which stalled under the Biden administration. Other sectors that performed well the day after the election include industrials, consumer discretionary and energy. Driven in large part by growth expectations and onshoring elements. On the flip side, real estate is a very rate-sensitive asset class. Between rates and asset prices going up, home affordability just went down substantially. Consumer staples also took a hit with increased tariffs coming into play. Other sectors to watch are healthcare (it looks like Robert F. Kennedy Jr. is going to have a significant voice in the Trump administration, so expect volatility on the pharma side), and in the utilities sector, clean energy is expected to take a hit.

Market Expects Inflation: 10-Year Treasury Yield

Thoughts on the increased tariffs advocated by President-elect Trump?

The incentive for tariffs is to put more manufacturing back in the U.S. If you’re a job seeker, that sounds great. If you're a consumer, prices are going up.

Should we be concerned about the federal deficit with all the spending?

Should we be concerned? Long-term, yes. Are we concerned? I’m don’t think we have ever acted on anything that really addresses this structurally, so I would say Americans are not concerned. The reality is since we started accumulating deficits, we have seen nothing but rates going down and the dollar has remained strong for years. In theory, deficits make the currency weaker, which makes inflation higher. We’ve had a little bit of that during the pandemic, but we also printed trillions of dollars, so I don't know how concerned Americans should be about the deficit in the short-term. , At some point, it does meaningfully take away from our allocation to other areas. It's a long slow burn

Has your outlook on markets changed?

I think most of the Trump trades are already in. My outlook is now it's about relative value moving forward. There is an expectation the economy grows, so there's less value in the market today because many positives have been baked in. Bonds are more attractive than a month ago.

Fixed-Income Yields and Year-to-Date Returns

Let's turn to opportunities in fixed income. Where do you see them?

If you’ve been reading these monthly interviews, this will be no surprise: I continue to think bank loans are an undervalued asset class, which is up 7.5% for the year. We have been constructive on this asset class for over two years now, while many on Wall Street have been advocating for duration because “rates are going down.” Well, so far Wall Street's been wrong. I continue to expect outflows for the bank-loan asset class, but it has outperformed with substantially less volatility. We’ve been advocating a barbell strategy: bank loans and investment-grade corporate bonds, which have had better returns (more than 5%) than most bond investments this year.

Volkswagen closing factories in Germany.

Strategically, many automakers went heavy into EVs, which is market where you have a dominant player—Tesla—with operating efficiencies and a large head start. Musk has done nothing but make it harder for them. He has reduced prices, increased efficiency, and added to an already industry leading charging network. These internal combustion-engine manufacturers wanted strategically to be in the electric-vehicle space, but they probably got a little over their skis.

Nvidia replacing Intel in the Dow Jones Industrial Average.

I think it's ironically awesome.

Starbucks and its new CEO are unveiling some new initiatives. I'm going to hit you with four of them. First, enforcing a return-to-office policy.

I'm okay with that.

Simplified menu.

It’s no surprise to me he was going to do that. It had gotten unwieldly.

More staffing.

Because you're simplifying your menu, you want to make sure you don't lose your efficiency. They’re choosing to offset some of the service changes with more people.

Going back to using Sharpies to write names on coffee cups instead of computer printouts.

I'm indifferent. I guess for some customers, they would appreciate that kind of personal touch.

Best team in college football.

I'm a West Coast guy, so I've seen more of Oregon, and they're really good. But I can't decide if Oregon, Texas, Ohio State or Georgia is the best team. The playoffs will be very interesting this year.

Last question. Deep-fried vs. oven-roasted turkey for Thanksgiving?

I have oven-roasted turkey 90% of the time, but I love a deep-fried turkey.

Can you give us a personal reflection related to the U.S. presidential election?

There's a wide continuum of emotions given what's happened this week with the election. Many are going to view this through a winners-and-losers lens. For those whose candidate won, it is time to be gracious. And for those that lost, it's time to be supportive. We need to remind ourselves that we’re all Americans in this, and to anchor there. Now is the time to either be supportive or gracious. We’ll all benefit from that, as well as our country.

Definitions

The 2-year Treasury yield is the interest rate the U.S. government pays to borrow money for two years.

The 10-year Treasury yield is the interest rate the U.S. government pays to borrow money for a decade.

Bank loans (or floating-rate loans) are financial instruments that pay a variable or floating interest rate. A floating-rate fund invests in bonds and debt instruments whose interest payments fluctuate with an underlying interest rate level.

Basis points, otherwise known as bps or bips, are a unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument. One basis point is equivalent to 0.01% (1/100th of a percent) or 0.0001 in decimal form.

The Bloomberg US Aggregate Bond Index (Agg) is composed of investment-grade U.S. government bonds, invest-ment-grade corporate bonds, mortgage pass-through securities, and asset-backed securities, and is commonly used to track the performance of U.S. investment-grade bonds.

The Bloomberg US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government-related bond markets.

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.

A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity.

The effective yield is the return on a bond that has its interest payments (or coupons) reinvested at the same rate by the bondholder.

Fed funds futures are a tool used by traders and institutions to hedge or bet on changes in the federal funds rate, which is key to U.S. monetary policy.

The federal funds rate is the target interest rate set by the Fed at which commercial banks borrow and lend their extra reserves to one another overnight.

The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve System that determines the direction of monetary policy.

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period. The nominal GDP growth rate compares the year-over-year (or quarterly) change in a country’s economic output to measure how fast an economy is growing. Real GDP is GDP adjusted for inflation.

GDPNow is a forecasting model that provides a "nowcast" of GDP growth.

High-yield bonds are debt securities, also known as junk bonds, that are issued by corporations.

An inverted yield curve occurs when the yield on 2-year Treasuries is higher than the yield on 10-year notes.

Investment grade refers to the quality of a company's credit. To be considered an investment grade issue, the company must be rated at 'BBB' or higher by Standard and Poor's or Moody's.

Leverage refers to using debt (borrowed funds) to amplify returns from an investment or project.

The price-to-book (P/B) ratio is an evaluation metric that is used to compare the current market price of a company's stock to its book value.

The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-value ratios and higher forecasted growth values.

The Russell 2000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell1000 companies with lower price-to-book ratios and lower expected growth values.

The S&P 500 Index is a stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States.

The S&P 500 Equal Weight Index is the equal-weight version of the widely used S&P 500 Index, which is a stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States.

Spread is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, represented by treasury bonds. Spread income refers to the additional income from this difference.

Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security.

Yield is the income returned on an investment, such as the interest received from holding a security.

A yield curve plots the interest rates of bonds that have equal credit quality but different maturity dates.

Yield-to-worst is the lowest potential yield that can be received on a bond without the issuer defaulting.

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Any performance data quoted represent past performance, which does not guarantee future results. Index performance is not indicative of any fund’s performance. Indexes are unmanaged and it is not possible to invest directly in an index. For current standardized performance of the funds, please visit www.AristotleFunds.com.

The views expressed are as of the publication date and are presented for informational purposes only. These views should not be considered as investment advice, an endorsement of any security, mutual fund, sector or index, or to predict performance of any investment or market. Any forward-looking statements are not guaranteed. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. The opinions expressed herein are subject to change without notice as market and other conditions warrant.

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