The Fade of the Trump Trade

What is (or was) the Trump Trade?

Posted: 26th June 2017

By: Saurav Risbud

Overview

The Trump Trade was the simultaneous surge in U.S. stocks, Treasury yields and the US dollar following Donald Trump’s unexpected win on November 8 2016 in the US Presidential Election. The Dow Jones industrials index reached a record above the 21000 level. Volatility fell to its lowest point since 1965. Yet, all this occurred despite below-average measures of market breadth, that is, a relatively small number of stocks were fuelling the upwards trend.

However, on election night itself, markets cratered as the unpredictability of Trump’s economic position scared investors. The broad scaled effects of disruptive political events are well documented. After Brexit in June 2016 the S&P 500 and the Dow both wiped out all their gains for 2016, while the Nasdaq fell by over 4% -the biggest one-day drop since 2011. Similarly, during the Tiananmen Square protests in 1989, the Hang Seng fell 22% in a single day, and lost 37% from its peak.

This sort of response is typical of investor behaviour, as politically destabilising events inevitably create anxiety, leading to market volatility. However, these short-term fluctuations rarely lead to long-term trends. In the words of Giles Keating, former head of research at Credit Suisse, “the most profitable strategy has usually been the contrarian one of buying into price falls caused by such incidents”. Stocks bounced back almost immediately after Brexit, as shown in the chart below, while the Hang Seng climbed back to its peak over the year after the Tiananmen Square protests.

Source: https://www.businessinsider.com.au/stock-markets-after-trump-election-2016-12?r=US&IR=T#/#stocks-have-climbed-to-a-record-but-1

The chart below shows how quickly stock markets recovered following Trump’s election.

Source: https://www.businessinsider.com.au/stock-markets-after-trump-election-2016-12?r=US&IR=T#/#stocks-have-climbed-to-a-record-but-1

Rather than worrying about uncertainty, investors focused on the benefits of Trump’s protectionist agenda to “Make America Great Again” through the prospects of lower corporate tax, the removal of red tape and an eye-watering $1 trillion USD expenditure on infrastructure. Republican control of both executive and legislative branches of the US government increased the chances of these measures passing into law.

As mentioned above, measures of market breadth were underwhelming, with specfic sectors particularly benefitting from Trump’s election. Banks were some of the biggest winners, as deregulation was expected to boost profits. The promise of massive infrastructure spending boosted stocks of select construction and materials companies. Biotech stocks also swung sharply upwards, as Hillary Clinton had been critical of pharmaceutical companies, with her defeat suggesting a more lenient regulatory environment for drug companies. However, a few days later, in a TIME Magazine interview, Trump said he was ‘going to bring down drug prices”, leading to a drop-off in stock prices. Lastly, the USD also surged as analysts expected the Administration’s fiscal policies to push the dollar higher due to higher economic growth. Proposals to encourage companies holding money overseas to bring profits back to the US could also increase demand for the USD.

Source: https://www.businessinsider.com.au/stock-markets-after-trump-election-2016-12?r=US&IR=T#/#stocks-have-climbed-to-a-record-but-1

Bond yields also rose sharply after the election, threatening to end a multi-decade bull market in bonds. The yield on the ten-year Treasury bond jumped from 1.73% to 2.36% at one point, whereas the yield on the two -year bond jumped from 0.78% to 1.12% (Bond prices fall as yields rise). The rationale for this shift was again, the belief that Trump’s policies would boost economic growth, allowing the Fed to hike up interest rates.

Was it all because of Trump?

No. The Trump Trade was boosted by a host of other factors. In late 2016, economic data was better than forecast, especially regarding key indicators such as U.S. consumer sentiment, global trade volumes and industrial output in the EU. Simultaneously, oil prices, which had reached record lows in 2016 due to a glut in world markets, were recovering as a result of OPEC production cuts. Stronger growth and higher prices were bringing an end to the lower than desired inflation that had plagued countries since the Global Financial Crisis. While Trump’s shock election did have a considerable impact, these other factors certainly had their own effects.

Why has there been a fade?

Multiple political crises in the Administration have undermined investor confidence in Trump’s ability to convert his goals into legislation, despite Republican majority in both Houses. The Administration’s initial failure to repeal Obamacare raised doubts over Trump’s ability to pass his other legislative objectives such as tax reform, deregulation and infrastructure spending. This has been reflected in a sector rotation away from the beneficiaries of Trump’s agenda. Bank of America Merrill Lynch strategist Savita Subramanian noted that the Trump trade peaked towards the end of last year, led by financials, energy and telecoms. In 2017, these leaders have trended in the opposite direction, as the likelihood of Trump’s campaign promises coming to fruition faded.

Source: https://www.ft.com/content/0b8a221c-3b5d-11e7-821a-6027b8a20f23

On top of this, the policies that were likely to be passed were seen as detrimental to certain areas of the economy such as the border adjustment tax (essentially an import tariff) that would drive costs up for retailers. According to CBS News, an index of the stocks that this tax would most negatively affect has fallen by more than 10% since late November, more than reversing post-election gains. With the optimism fading away, investors sought the safety of government bonds pushing the yield on the ten-year bond 10 basis points lower to 2.22%.

Impeach trade?

In mid-May memos were revealed that suggested Trump had obstructed justice. This new information, along with the appointment of a special counsel to investigate the President’s links with Russia raised the possibility that Trump may be impeached. Impeachment is the process by which charges are formally levelled by the legislature against a high-ranking official, such as the US president, and is the first step towards removal from office. Naturally, this spooked investors, with the S&P 500, the Dow Jones Industrial Average, the Nasdaq and the Russell 2000 all recording their biggest one day declines since before the election. Since the news, the greenback has given up all the gains it made following the election.

For now, what’s seen as bad for Trump is seen as bad for the markets, that is we are not yet a point where markets are anticipating impeachment. However, when that changes, the markets will be sending a clear signal: investors expect an end to his presidency, and they are optimistic about it.

What to take away

Politics and the markets are closely intertwined. While money managers have traditionally said to look past the squabbling of geopolitics, investors seem to suggest the opposite- that politics is the new economics. When investing and trading, it is important to understand the political environment, however, it is perhaps even more vital to look at the fundamentals. Although Trump’s election and talk about his impeachment have undoubtedly swayed markets, a variety of other economic factors have been at play.