What exactly is the "Trump Trade," and is the market very certain?

Wall Street is starting to have divergent views on the "Trump Trade".

The so-called "Trump Trade" actually refers to a series of investment operations that investors conduct based on expectations of Trump's policies, usually including shorting long-term government bonds, going long on cryptocurrencies, and investing in higher-risk stocks such as small caps. The logic behind it is that Trump's policies such as tax cuts, deregulation, and trade protectionism will have different impacts on different asset classes.

Cooling Down of the Trump Trade

Although the "Trump Trade" theoretically sounds reasonable, investors seem to be skeptical. On Monday, the US capital markets did not continue the trend of the "Trump Trade": the US Treasury yield curve flattened, the US dollar fell, and although the Russell 2000 still closed slightly ahead of the S&P 500, this also indicates that there are divergent views on the "Trump Trade" within Wall Street.

Some analysts point out that there are still 4 months until the US November election, during which investors will have to digest a large number of US stock earnings reports and two Federal Reserve meetings. There will be a lot of variables before the election results are announced, and continuing to speculate on the "Trump Trade" now will be full of great uncertainties.

As Howard Marks, the founder of Oaktree Capital, pointed out in the latest investment memo on July 17:

During the 2016 presidential election, almost everyone believed two things: 1. Hillary Clinton would win. 2. If Trump won unexpectedly, the US stock market would collapse.

However, the result was that Trump won, and then the US stock market rose by over 30% in the following 14 months.

This fully proves: 1. People actually cannot predict the direction of things; 2. Nor do they know how the market will react after things happen.

The current US election is even more uncertain: from the undecided Democratic presidential candidate to uncertainties in Federal Reserve policies, geopolitical issues, and US stock valuations, all make investments more complicated.

This also leads to significant differences in views among Wall Street analysts and economists on how Trump's election as president will affect the financial markets.

Divergence on Wall Street

The biggest divergence on Wall Street comes from the fact that the impact of the policies promoted by Trump's campaign may be contradictory. For example, his most popular tax reduction policy may push up inflation and interest rates, while his signature policy of imposing tariffs may suppress consumer spending and have a dampening effect on inflation. This contradiction makes it difficult for the market to form a consensus on the "Trump Trade".

A survey by Bank of America shows that nearly three-quarters of the investors surveyed believe that if Trump wins a landslide victory in the election, it will push up bond yields. However, Bank of America's strategist Michael Hartnett disagrees with this outcome. In a report last Thursday, he pointed out that one should not overly believe in this explanation of the Trump Trade, as no government would want prices to keep rising. The reality of the election is that voters consider inflation to be their top concern Alpine Macro's Chief Strategist Chen Zhao also pointed out that although tax cuts will push up long-term interest rates, another policy that Trump favors - imposing tariffs, often has the opposite effect by squeezing consumer spending.

My view is: Trump's tax cut policy will be negative for long-term bonds, while imposing tariffs will be positive for bonds. But if Trump does both things at the same time, that would be a big mistake.

Regarding the outlook for the US dollar and bond yields, most strategists, including Deutsche Bank, Alpine Macro, and Barclays Bank, believe that Trump's presidency will boost the US dollar. After all, investors tasted this flavor in Trump's first term. When Trump won the election, the dollar initially surged along with bond yields until his trade policies dampened economic optimism.

However, economists at Jefferies believe that if Trump exerts political pressure on the Federal Reserve, the attractiveness of the dollar as a wealth reserve may diminish (the dollar may weaken).

Lindsay Rosner, Head of Fixed Income Investments at Goldman Sachs, stated that in any case, if Harris eventually becomes the Democratic nominee and continues Biden's policies, the yield curve may steepen.

Neither candidate has discussed any form of fiscal restraint, which has already been priced into the yield curve. Many things have changed, so anchoring your investment portfolio to a specific outcome is not a prudent approach.

Brian Jacobsen, Chief Economist at Annex Wealth Management, pointed out that the most certain trade now is to invest in small-cap stocks, mainly because small-cap stocks are undervalued. Regardless of the political outcome, this is a good bet.

Therefore, in this complex situation, trading should not rely solely on political headlines, but should involve a comprehensive analysis of macroeconomic data and Federal Reserve policies.

Wolf von Rotberg, Stock Strategist at J. Safra Sarasin, said: "What really matters is the macro data we currently have, which may change significantly before the November election. We are seeing a slowing economic cycle. This will determine the interest rate space, which will in turn affect the stock market, having a more substantial impact on the market than politics."

As Howard Marks said: The most important job for investors is risk management, because we never know what the future holds