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 -1%, the NASDAQ 100 dropped almost -3%, and the “Magnificent 7” were down -4%.

On the other hand, U.S. small caps popped another +3.5%, mid-caps by +2%, and the Japanese yen finally posted considerable gains against the U.S. dollar.

Nvidia is now in its own bear market (down -20% from its all-time high), but regional banks have finally recovered their losses from the U.S. mini banking crisis in March 2023.

Fixed income markets are feeling their own shift. Two-year yields have dropped at a faster rate than their 10-year counterpart. This kind of yield curve steepening is typical around the start of rate cutting cycles.

Indeed, last week’s first look at Q2 GDP showed the U.S. economy grew at a +2.8% annualized rate (faster than the 2.0% Street expectations). The Purchasing Managers’ Index surveys for July also confirmed robust activity across economies. Growth is holding up, and inflation is no longer threatening. That should allow central banks to ease policy rates. Although a Fed cut doesn’t look likely this week, markets suggest a 100% chance of a September rate cut. A similar story is true for the Bank of England, but whether that first cut comes on Thursday or in September is a closer call. That is as strong a signal as any that it is time to consider stepping out of excess cash.

Now, we would forgive you for not noticing the moves in markets. The U.S. election is already taking up a lot 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 might 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).