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Investment Strategy

Is the Trump Trade a good deal?

Rotation woes

Investors have spurned some of their favorite trades in favor of laggards for another week. The S&P 500 fell almost -2%, the NASDAQ 100 dropped -3.5%, and the “Magnificent 7” fell over -4.5%.

On the other hand, US Small Caps popped another +2%, Biotech spiked by over +5%, and the Yen finally gained against the US Dollar.

Nvidia is now in its own bear market (down over -20% from its all-time high), but Regional Banks are finally higher than where they were when the U.S. mini banking crisis hit in March 2023.

Fixed income markets are feeling their own shift. 2 year yields have dropped by -8 basis points while the 10 year yield was flat. This kind of yield curve steepening (short term yields moving down faster than long term yields) is typical around the start of rate cutting cycles.

Indeed, last week’s first look at 2Q GDP showed the U.S. economy grew at a +2.8% annualized rate (faster than the 2.0% Street expectations). Growth is holding up, and inflation is no longer threatening. That should allow the Fed to ease policy rates. Futures markets suggest a 100% chance of a September rate cut. That is as strong a signal as any that it is time to step out of excess cash.

Now, we would forgive you for not noticing the moves in markets. The U.S. election is already taking up most of the airtime after all. In this week’s spotlight, we examine the extent to which the moves we are seeing in markets are being driven by changing perceptions of the U.S. election outcome.

The “Trump trade”

Since 1950, there have been 18 Presidential elections and 10 transitions in the White House between Democrats and Republicans. Over those 74 years, U.S. GDP growth has averaged a 3.2% annual pace, and the S&P 500 has compounded at 9.4% per year. 

Despite the long-term trends, elections can introduce short-term volatility. Most of the focus this time has revolved around what a Trump/Vance victory mean for markets given that the 2016 election caused notable moves across asset classes, and that most investors currently perceive Trump to be the favorite to win the White House.

What is the Trump Trade? The Trump trade is a view that less regulation, lower taxes, less immigration, and higher tariffs could benefit certain sectors and industries, and have important implications for inflation and bond yields.  

What happened in 2016? An important piece of context for the 2016 election is that President Trump’s victory was a surprise. It wouldn’t be this time. In 2016, investors quickly shook off initial fears that a protectionist agenda would hurt stocks, and instead embraced the prospect for corporate tax cuts and a focus on pro-growth policies like infrastructure investment.

The first “Trump trade” was most prominent in the month following the election. Before the 2016 election, the market was focused on sluggish growth, low inflation, and low interest rates (aka “secular stagnation”). Trump’s policies were viewed as stimulative to nominal growth, and policymakers actually welcomed upward pressure on below target inflation.

The first Trump trade was characterized by small caps (which outperformed large cap equities by nearly 8%), the energy sector (which outperformed the broader index by over 10%), the 10 year Treasury bond (yields rose by almost 100bps), and the 2 and 10-year yield curve (which steepened by 17bps).

Yields of 10-year Treasuries soared after Trump’s 2016 win

10-year U.S. Treasury bond yields, %

This chart shows yields of 10-year U.S. Treasury bonds from July 2015 to June 2017. In July 2015, the 10-year Treasury yielded 2.4%. In November 2015, the 10-year Treasury yielded 2.3%. In March 2016, the 10-year Treasury yielded 1.8%. In July 2016, the 10-year Treasury yielded 1.3%. In November 2016, the 10-year Treasury yielded 1.7% before jumping to 2.6% in December 2016 after Donald Trump won the Presidential election. In March 2017, the 10-year Treasury yielded 2.5%. In June 2017, the 10-year Treasury yielded 2.3%.
Source: Bloomberg Finance L.P. Data as of June 30, 2017
Past performance is no guarantee of future results. It is not possible to invest directly in an index.
How are markets responding to the prospect of Trump 2.0?According to Real Clear Politics, betting markets gave President Trump a 47% chance to win the 2024 US Presidential election on May 31st. That rose nearly 19 percentage points to a peak of 66% on July 15th. Since President Biden has dropped out of the race, Trump’s odds have fallen about 10 points to 56%. We look at the rise and fall of Trump's winning odds over those periods and how the Trump 1.0 trades fared this time around.

Trump’s odds of victory spiked and receded

PredictIt market implied odds of a 2024 Trump Presidential victory

This chart shows the betting odds for a Trump victory in the 2024 Presidential election from January 2024 to the present. In January, the odds were at 40. By May, they had risen to 50 after a long period of plateauing. They rose throughout June to end the month at 56. The odds spiked in July, reaching a high of 69 before falling to their present value of 55 as of July 24th.
Source: Bloomberg Finance L.P., PredictIt. Data as of July 24, 2024.
Past performance is no guarantee of future results. It is not possible to invest directly in an index.
  • Small caps: Small cap stocks rose by 4.6% as Trump’s odds were improving, mirroring the “1.0” trade. However, over the same period, large caps returned 6.7%. Interestingly, small caps have started to outperform large caps despite the decline in Trump’s odds. This suggests that there is more to small cap outperformance than just the election. Interest rates and valuations are the more likely the drivers of small cap returns. As our Asset & Wealth Management Chairman of Investment Strategy Michael Cembalest noted in his latest piece, more than 40% of the small cap index is unprofitable. That makes them reliant on debt capital markets for financing. Therefore, the prospect of lower interest rates has a large impact on small caps. Small caps have benefitted from the view that inflation has finally turned the corner and that the Fed will start cutting rates in September.
  • Energy: The energy sector rallied in 2016 based on optimism around less onerous regulations and more independent U.S. energy production. Eight years later, the U.S. is now the world’s dominant oil producer. While less regulation could bring even more production, an oil glut could put downward pressure on prices and negatively impact energy company earnings. This time around, the energy sector declined while Trump’s odds were increasing.

The United States produced more Crude in 2023 than any country, ever

Crude oil including lease condensate production (Mb/d)

This chart shows the average daily production of crude oil of Russia, Saudi Arabia, and the United States from 2016 to 2023.
Source: U.S. Energy Information Administration, International Energy Statistics. Data as of December 31, 2023.
  • Bond yields: This time, bond yields across the curve have declined since President Trump’s odds have increased, but the yield curve has steepened. Said differently, shorter term interest rates are moving lower faster than longer term interest rates. To us, that suggests that central bank policy expectations are the primary driver of bond yields, and not the election. This is perhaps the biggest difference between 2016 and today. Then, the central bank was desperate for any signs of inflation that would allow them to raise rates above nearly 0%. Today, the central bank is desperate for confirmation that inflation is low enough to allow them to lower rates from 20 year highs. The key risk for bond markets is that protectionist economic policy like increased tariffs and less immigration will reduce growth and increase inflation at the same time that the extension of tax cuts will increase the deficit. The good news right now is that it seems like bond yields are taking their cues from the growth, inflation, and central bank policy outlook. 

Overall the Trump Trade 2.0 seems relatively inconclusive. Instead, it seems like markets are reacting more to the increasing likelihood that the Fed will be lowering interest rates with a backdrop of relatively decent underlying economic growth. However, certain sectors and industries may be more sensitive to changing election perceptions. Regional banks, for example, have reacted positively to an increase in Trump’s odds. Meanwhile, clean energy and Chinese stocks have been negatively impacted. The bottom line for investors is that we believe the growth, inflation, and policy backdrop will be the primary driver of market moves, but the election will matter underneath the surface.

What does history have to say about Election years?

Election years tend to bring similar levels of equity market volatility until October, when there is a noticeable uptick in the VIX. But, since 1984 there has only been one election year where the market was lower 12 months after the election, that was in 2000 amid the tech bubble. Notably, implied equity market volatility falls relatively quickly after the new composition of government is confirmed and on average equities are higher 12 months after the election. 

Markets tend to focus on prevailing fundamentals

S&P 500 performance around elections since 1984, indexed to Election Day

This chart shows the performance of the S&P 500 in the 18 months before and 12 months after U.S. Presidential elections from 1984 to 2020.
Source: Bloomberg Finance L.P. Analysis as of January 16, 2024.
Past performance is no guarantee of future results. It is not possible to invest directly in an index.

TAGS

The information presented is not intended to be making value judgments on the preferred outcome of any government decision or political election.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

The VIX Index is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index call and put options. 

All market and economic data as of July 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

RISK CONSIDERATIONS

  • Past performance is not indicative of future results. You may not invest directly in an index.
  • The prices and rates of return are indicative, as they may vary over time based on market conditions.
  • Additional risk considerations exist for all strategies.
  • The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
  • Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.

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We assess whether the ‘Trump trade’ is real and what it could mean for investors.
Published Jul 29, 2024

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