Understanding the "Trump Trade"
Althea Spinozzi
Head of Fixed Income Strategy
Summary:
- The recent assassination attempt on Donald Trump has increased the likelihood of his victory in the upcoming U.S. election. Markets are currently grappling with the concept of the "Trump Trade," which implies deregulation, tax cuts, and increased fiscal spending.
- During Trump's previous presidency, the "Trump Trade" led to a rally in U.S. equities, especially in technology and financial sectors, rising Treasury yields, tightening corporate bond spreads, a stronger U.S. dollar, and a surge in industrial metals.
- A Trump victory could imply that the Federal Reserve may remain cautious about cutting interest rates, as a pro-business environment might re-accelerate the American economy and increase inflation.
- The Trump Trade prompts investors to increase exposure to domestic equities, favor shorter-duration bonds, implement hedging strategies against a strong dollar, and diversify into safe-haven assets.
What is the “Trump Trade”?
Following the assassination attempt on Donald Trump, the odds for a Trump victory have increased, prompting market participants to evaluate the potential consequences of his win in the upcoming U.S. presidential elections. Central to this discussion is the "Trump Trade."
The "Trump Trade" refers to the market movements and investor behaviors that emerge in response to the economic policies and political actions associated with a Donald Trump presidency. This term gained prominence particularly after his election in November 2016, when markets reacted to his promises of deregulation, tax cuts, and increased infrastructure spending. The Trump Trade primarily reflects the expectation of a pro-business environment and a significant boost to the American economy through fiscal stimulus.
To understand this concept and what markets anticipate, we need to reflect on market behaviors during Trump's previous presidency. This analysis aims to provide insights into those past market dynamics and their implications for the future.Market impacts of the "Trump Trade" Pre-COVID
- Equities:
- Rally in Domestic Stocks: U.S. equities, particularly in sectors such as technology, financials, industrials, and energy, saw significant gains. The Tax Cuts and Jobs Act of 2017, which reduced corporate tax rates, was a major boon for tech companies, many of which had large cash reserves held overseas. The repatriation of these funds allowed for increased investments, stock buybacks, and dividends, further boosting stock prices. The S&P rose by 62% since Trump was elected president until the beginning of the COVID pandemic.
- Healthcare Volatility: Healthcare stocks had a more mixed performance during Trump's presidency. While some segments, like biotechnology and pharmaceuticals, saw gains, others, such as health insurance companies, faced more challenges. The sector was heavily influenced by policy debates and legislative efforts related to healthcare reform. The attempts to repeal and replace the Affordable Care Act (ACA) created uncertainty for healthcare providers and insurers.
- Fixed Income:
- Rising Yields: Expectations of increased government spending, higher growth prospects and a hawkish Federal Reserve led to a rise in Treasury yields for two years following Trump’s election. The yield on the 10-year U.S. Treasury rose by 138bps from 1.85% in November 2016 to 3.25% in November 2018. By the end of 2018, yields began to drop as markets fear the risk of a recession due to tight monetary policies.
- Corporate Bonds: The improved economic outlook significantly boosted corporate bond markets, especially high-yield bonds, as investors gained confidence in the creditworthiness of companies. During the first two years of Trump's presidency, junk bond credit spreads tightened by 176 basis points, dropping to 308 basis points over Treasuries, the lowest level since 2007. At the same time, Investment grade corporate bonds tighten by 43bps dropping to 84bps over US Treasury by early 2018, the lowest since 2007.
- Currencies:
- Strong Dollar: The U.S. dollar appreciated significantly against major currencies due to expectations of higher interest rates and stronger economic growth.
- Commodities:
- Mixed Reactions: Industrial metals like copper surged on the anticipation of increased infrastructure spending, while oil prices showed resilience due to expectations of deregulation in the energy sector. Gold prices saw an initial rise as investors sought safe-haven assets amid uncertainties surrounding Trump's policy changes, geopolitical tensions, and the potential for inflation due to fiscal stimulus and tax cuts. In 2018-2019 Gold prices became volatile as the Fed continued to hike rates putting pressure on non-yielding assets.
“Trump Trade” Implications on Monetary Policies
In response to the anticipated boost to the American economy, the Federal Reserve implemented the following policies:
- Rate Hikes: With stronger economic growth and inflation expectations, the Federal Reserve was more inclined to increase interest rates to prevent the economy from overheating. This was a shift from the ultra-low interest rate environment that prevailed post-2008 financial crisis.
- Balance Sheet Reduction: The Fed also began considering reducing its balance sheet, which had ballooned due to years of quantitative easing. This marked a significant shift towards monetary tightening.
“Trump Trade” Geopolitical Implications
The Trump Trade wasn't confined to economic policies; it had substantial geopolitical ramifications:
- Trade Policies: Trump's protectionist stance, exemplified by tariffs on Chinese goods and renegotiations of trade agreements like NAFTA (now USMCA), created uncertainties in global trade. This led to volatility in markets dependent on international trade.
- Global Tensions: The administration's unpredictable foreign policy, including confrontations with North Korea and strained relations with traditional allies, added to geopolitical risks. Markets often reacted to news of these tensions, reflecting the global interconnectedness of economic and political stability.
- Investment Shifts: Emerging markets, particularly those with strong trade ties to the U.S., faced increased risk premiums. Investors started to reassess their allocations towards safer, more stable regions.
“Trump Trade” Portfolio Implications
For an investor's portfolio, the Trump Trade meant reassessing and rebalancing to align with the new economic landscape:
- Equity Allocation: Increased exposure to domestic equities, especially in sectors benefiting from deregulation and tax cuts, became favorable.
- Fixed Income Strategy: A cautious approach to long-term bonds due to rising yields and a preference for shorter-duration bonds to mitigate interest rate risk.
- Currency Considerations: Hedging strategies became more critical for portfolios with significant foreign exposure to protect against the strong dollar.
- Geopolitical Hedging: Diversifying into assets less sensitive to U.S. political shifts and incorporating safe-haven assets like gold or Japanese yen became prudent.
Conclusion
The Trump Trade encapsulated a significant shift in market dynamics driven by expectations of a more business-friendly environment, substantial fiscal stimulus, and deregulation. These changes reverberated across asset classes, influencing monetary policies and global geopolitics. For investors, understanding and adapting to these shifts is crucial to optimizing portfolio performance and mitigating risks associated with increased market volatility and geopolitical uncertainty.