Dow Jones Upside Tempered by Trumpflation Risks

The stock market surged following Donald Trump's election win, but the potential risk of higher inflation driven by the expectation of economic expansion raises concerns about sustained higher rates, which could eventually curtail equity gains due to high valuations.​

Time for a Price Check

The upcoming October CPI release is the main focus for markets this trading week. However, investors may look beyond the data and toward an impending shift in the economic paradigm. President Trump is widely expected to implement a range of policies that could influence inflation. Even the Fed acknowledged last week that the transition period conflicted with forecasting.

Analysts expect headline CPI to accelerate to an annual rate of 2.6% from 2.4% previously, primarily driven by higher fuel prices. The core rate, which is more relevant for monetary policy, is projected to remain above the target at 3.3%. In September, CPI showed a rebound from the bottom reached in August. Investors may be concerned that a higher-than-expected reading could reignite speculation that the Fed might not cut rates in December, as currently expected by the market. This is despite Fed Chair Jerome Powell's commitment to focus on the data before the next meeting.​

Rising Into Storm Clouds

Along with other indices, the Dow Jones reached new record highs following Trump's election victory. However, the yields on Treasury bonds also increased as investors realised that new policies would lead to higher inflationary pressures. Traders must weigh the potential benefits of a more relaxed regulatory environment and lower taxes against the forecasted impact of higher interest rates and the Dow's sensitivity to consumer demand.

Traditionally, the Dow has been less affected by monetary policy than other major indices due to its high concentration of industrial and significant consumer companies. However, the recent addition of Nvidia has bolstered its technology bona fides. Still, recent gains have made the Dow vulnerable, as it is currently trading at a price-to-earnings (PE) ratio of 27.8x, well above the 20-year PE average of 16.1x. With high valuations supported by accommodative monetary policy and many analysts expecting higher inflation and interest rates over the next four years, the index may not only struggle to make further gains but could also experience a correction, particularly once the post-election euphoria wears off.​

Dow Jones Trend Intact

The Dow Jones has extended towards its measured-move projection of 44400, following the correction from 41400 to the 40000 handle. Despite a recent pullback to 41650, prices remained above the upper channel trendline, suggesting a potential move to the 45000 round resistance if bulls sustain the 43330 swing high during a potential decline.

Source: SpreadEx / Wall Street

Key Takeaways

The stock market surged following Donald Trump's election on increasing expectations of economic expansion. However, concerns arise about sustained higher inflation rates potentially curtailing equity gains due to high valuations. While the upcoming CPI data would typically be the main focus, investors may look towards an impending economic paradigm shift under Trump's policies and weigh the benefits of a more relaxed regulatory environment and lower taxes against the forecasted impact of higher interest rates. With the Dow's high PE ratio well above the 20-year average and analysts expecting higher inflation and rates, the index may struggle to make further gains.