Will the Trump trade fade?

Since Donald Trump won the US election markets have been desperately searching for an investment narrative to build their investment strategies upon. Given the unprecedented situation we find ourselves in, with a character like Donald Trump, market participants have sought shelter by forming a consensus view of how things will pan out during the Trump administration. This has given rise to the Trump trade (or Trumpflation trade).

What is the Trumpflation trade?

The narrative is fairly straightforward:

• Out of all the sound bites Donald Trump gave during the election campaign the one that the market sees as most credible, for now anyway, is his promise to spend $500bn on infrastructure. While the figure is plucked from the air the consensus view is that the man who says he 'builds great structures' will build a lot of things, whether you include the Mexican wall or not
• Donald Trump has also pledged to cut taxes
• Both measures start to fall under the fiscal stimulus category. If you recall monetary stimulus (printing money) is what central banks do. Like monetary stimulus, fiscal stimulus usually boosts economic growth
• If the economy grows then this will create inflation
• The US Federal Reserve will then need to raise rates to keep inflation under control. By the way, the market has already priced in a 94% probability that the Fed will increase rates in December.

The Trumpflation trade:

• If the Trump win means higher inflation and higher interest rates then bonds (with their fixed interest rates) become unappealing. So investors would be best served dumping bonds, especially those with long duration (something I spoke about before the election)
• That means rotating out of bonds and into equities
• However not equities that are bond-like. Bond-like equities include those unexciting defensive companies that pay dependable dividends (such as utility companies)
• If the interest rate on a currency is likely to go up then it becomes more appealing to hold. That means its price will go up. So buying the dollar becomes the consensus trade.

There are moves in other markets, especially involving currencies but the above pretty much summarises what's been happening in the last couple of weeks.

Best and worst performing fund sectors since the US election

The table below shows how the fund sectors have fared since the US Election result was announced

Name	Total Return since the election
North American Smaller Companies	8.41
North America	4.26
UK Smaller Companies	2.23
Technology & Telecoms	1.38
Japan	1.2
UK All Companies	0.73
Global	0.72
UK Equity Income	0.56
Cash	0
Targeted Absolute Return	-0.17
Flexible Investment	-0.19
UK Equity & Bond Income	-0.21
Global Equity Income	-0.27
Mixed Investment 40%-85% Shares	-0.3
Mixed Investment 20%-60% Shares	-0.57
Sterling High Yield	-0.59
China/Greater China	-0.73
Mixed Investment 0%-35% Shares	-0.82
Sterling Strategic Bond	-0.88
Property	-0.94
Sterling Corporate Bond	-1.06
UK Gilts	-1.51
Specialist	-1.53
Japanese Smaller Companies	-1.56
Europe Including UK	-1.81
Asia Pacific Including Japan	-1.88
European Smaller Companies	-2.18
Asia Pacific Excluding Japan	-2.18
UK Index - Linked Gilts	-2.29
Europe Excluding UK	-2.3
Global Bonds	-2.4
Global Emerging Markets	-4.58
Global Emerging Market Bond	-5.1

This table shows how the market thinks that Trump will be good for US equities yet bad for bonds and other risk assets, especially in emerging markets (the latter due to his protectionist views). The rising dollar vs yen has been good for Japanese equities because when the yen falls the export-heavy Japanese stock market rallies.

The Trump trade is uneven

Yet the table above masks the fact that the Trump trade has been far from even. The table below shows that the Trump trade is industry specific. The logic being that higher interest rates are good for bank's profit margins. On the flipside it's been bad for dividend stocks (property, consumer staples and utilities) as they look less attractive in a higher interest rate world.

Sector	Stock price move
Financials	10.7%
Industrials	5.1%
Consumer discretionary	3.2%
Health care	3%
Materials	2.3%
S&P 500	2.2%
Energy	1.6%
Information technology	-0.2%
Real estate	-3.5%
Consumer staples	-4%
Utilities	-5.9%

Even within sectors the Trump trade is uneven. Biotech stocks have performed well on the assumption that the promised tax cuts would allow these companies to repatriate cash from overseas. Donald Trump also said that he wouldn't cap prescription prices. Conversely large tech companies like Facebook and Amazon which would usually rally alongside biotech companies have instead slumped. This is because Donald Trump said during his campaign that Silicon Valley was 'going to have such problems' if he got elected. The point is that the Trump trade is based upon sound bites from Trump's erratic mind.

Will the Trump trade fade or strengthen?

The strength of the recent market moves have been surprising. The US stock market is near all-time highs while the bond market has experienced the biggest rout in 16 years. The end of the 30 year bull market has been predicted for a long time so many investors were happy to find a reason to sell. Although Donald Trump hasn't taken office yet there's still plenty of time for him to continue to promise the earth before he is forced to make good on his promises. In addition the market is convinced the Fed will raise interest rates in December which is bad for bonds and good for the dollar, although this has pretty much been priced in already. From a technical viewpoint the bullish trend for the S&P 500 is also strengthening as the great rotation from bonds to equities is playing out.

However, it's important to give the Trumpflation trade some perspective. If you set aside the speculative nature of the underlying narrative the rally in US equities is largely being driven by financials, in the hope of lighter regulation from Trump. It's certainly not a broad risk-on rally. Also the bond market is showing signs of being oversold. The Relative Strength Index (RSI) is a momentum measure that measures the speed and change of price movements. RSI is given a score between 0 and 100 and is used as an indicator of whether an asset is considered overbought or oversold. This week the RSI indicated that US Treasuries were the most oversold since 1990. Most of the time this has preceded a reversal of a bond sell-off i.e bonds starting to rally. Of course the RSI is an indicator and not a crystal ball. During the infamous taper tantrum in 2013 when the Fed first hinted that it might start tapering its money printing programme, the RSI flashed 'oversold' and the market continued downwards. Interestingly the RSI also suggests that the dollar is now overbought. So there are signs that the Trump trade could soon run out of steam or at least take a breather.

The Trumpflation narrative doesn't make a lot of sense anyway. The dollar is also a haven asset which people buy during uncertain times. In its role as a risk indicator the strengthening dollar usually suggests people would be moving out of risk assets (such as equities) and into safer assets (such as bonds) but the opposite is currently happening. If fear grips the market then investors will go back to old behaviours and buy bonds once more.

Also bear in mind that a strong dollar will eventually start to hit the earnings of the large US companies with overseas earnings, which will be bad for their share price and US equities. That's currently being ignored by the Trump trade. The market has the ability to suspend reality for considerable amounts of time, which it has done since the financial crisis. The Trumpflation trade is built upon speculation and has been sharp and sudden. That makes it particularly prone to a pullback or reversal if the market narrative changes or indeed if Donald Trump changes his own narrative, which he is prone to doing.

Does what happens between now and when Trump takes office tell us anything?

Even if we ignore all of the above, has the performance of equity markets between a President's election win and his inauguration had any bearing on how well the market performed once he'd taken office? According to history the answer is no. For example, when Barack Obama won the US election markets fell but his actual term in office has coincided with a huge bull market. So history tells us that the knee-jerk reaction in the aftermath of previous elections doesn't set the tone for how to profit once the president-elect takes office.