By Lewis (JO:LEWJ) Krauskopf

NEW YORK (Reuters) – A U.S. stock rally fueled by Donald Trump’s election victory is stumbling, as investors contend with renewed inflation worries and uncertainty over the impact of the president-elect's policies.

The S&P 500 fell 2% in the past week, erasing more than half its gains from a post-election surge driven by optimism over pro-growth policies central to Trump’s economic platform.

Though the index remains near record highs and is up 23% this year, some enthusiasm has waned.

Concerns that Trump’s policies may ignite inflation and complicate further interest rate cuts pushed the benchmark U.S. 10-year yield to its highest level in over five months on Friday, which could be unwelcome for stocks.

Fears regarding Trump’s cabinet selections and his plans for cutting bureaucratic excess have negatively impacted shares in pharmaceutical companies and government contractors, leaving Wall Street uncertain about the timeline and scope of the president-elect's agenda.

Despite the market's initial excitement over Trump’s economic policies, Paul Nolte, a senior wealth adviser and market strategist, expressed skepticism about the ease of positive outcomes.

A Trump spokesperson did not immediately comment.

Trump’s trade policies, which suggest hefty tariffs on goods from China and allies like the European Union, are intended to rejuvenate American manufacturing and alleviate deficit fears.

EYES ON YIELDS

Rising yields remain a significant concern as they provide competition for equities and increase capital costs for companies and consumers. The benchmark 10-year yield, which usually aligns with interest rate expectations, surged approximately 90 basis points since mid-September as investors revised their expectations regarding Federal Reserve rate cuts amidst strong growth that could lead to inflation.

Until recently, stocks appeared resilient to rising yields, but many of Trump's policies—tax cuts and tariffs—are seen as inflationary, causing yields to potentially exceed the 4.5% level flagged by some investors as a potential trigger for market unrest. The yield touched 4.5% on Friday before settling lower.

“I think it will become a problem because it will basically translate into a tighter monetary environment,” said Irene Tunkel, chief U.S. equity strategist at BCA Research.

Fed Chair Jerome Powell stated that there is little urgency in cutting rates, given solid economic growth and inflation exceeding the central bank’s 2% target, which negatively impacted stocks and raised bond yields.

As bond yields rise, the attractiveness of equities relative to U.S. government bonds, deemed risk-free if held to term, has diminished by some measures. The equity risk premium, comparing S&P 500 earnings yield to the 10-year Treasury yield, is at its lowest since mid-2002.

POLICY UNCERTAINTY

Uncertainty surrounding the timing and impact of Trump’s policies has increased. Shares of Pfizer (NYSE:PFE), Moderna (NASDAQ:MRNA), and other drugmakers fell after Trump appointed vaccine skeptic Robert F. Kennedy Jr. to lead the Department of Health and Human Services. Defense and government contractor stocks, such as Leidos Holdings (NYSE:LDOS) and General Dynamics (NYSE:GD), also fell amid investor concerns about a new efficiency entity led by Tesla CEO Elon Musk.

Kennedy's confirmation by Senate lawmakers remains pending, and the extent of cuts from the efficiency entity is unclear. This uncertainty has prompted some investors to “sell first, ask questions later,” according to King Lip, chief strategist at BakerAvenue Wealth Management.

Strategists from BofA Global Research indicated that the risks to their 2.3% economic growth forecast for next year are “very large in either direction,” considering the ambiguity about which aspects of Trump’s policies will be prioritized. Growth could exceed 3% if the administration emphasizes fiscal easing and deregulation; however, a shift toward tariffs could incite a trade war and push the economy into recession.

Some “Trump trades” continue to prosper, with Tesla shares up 28% since Election Day due to expectations of beneficial relations with the president-elect. Bitcoin also surged over 30% amid hopes of crypto deregulation.

Historically, stocks perform well at year-end, with the S&P 500 averaging a 3.3% increase in the last two months of presidential election years since 1952, which provides a glimmer of optimism, alongside strong corporate earnings and a robust growth backdrop, according to Ross Mayfield, investment strategist at Baird Private Wealth Management.

“There is a lot else working for the market,” Mayfield stated.