Donald Trump’s election to the U.S. presidency late last year started what has been termed the “Trump reflation trade,” or the “Trump Trade” for short, in the financial markets. The Trump Trade is focused on the idea that the incoming president would spur economic growth and inflation with his stances on fiscal, regulatory and trade policies, which would lead to higher equity prices, higher interest rates/lower bond prices and a stronger U.S. dollar. The market’s initial reaction to the Trump Trade was strong – yields on the 10-year Treasury increased 80 basis points (bps) to north of 2.6%, the U.S. Dollar Index (DXY) rose 6.5% to 103, and the S&P 500 Index rallied 15% to 2400 at the highs. Since hitting their post-election highs, however, only equities have kept momentum from the rally as the markets question the president’s ability to push his agenda through a divided Congress. At the time of this writing, the 10-year Treasury yield and DXY are down to 2.4% and 99.5, respectively, while the S&P 500 Index sits at 2,400.
Today’s chart shows investor’s net positioning in futures contracts tied to the 10-year Treasury, DXY, and S&P 500 Index since Election Day. Futures positioning in 10-year Treasuries and DXY show investors have decreased long positions on the U.S. dollar and turned bullish on Treasuries, effectively unwinding the Trump Trade. On the contrary, equity positioning remains bullish. With Treasury markets and the U.S. dollar signaling the Trump Trade is over (or at the very least, taking a pause until more clarity comes out of Washington D.C.), why are U.S. equities still reaching new all-time highs?
First, shorting Treasuries in an upward sloping yield curve is a negative carry trade, which means the investor loses money over time if markets remain unchanged. A long equity position, where the investor is collecting dividends, has stronger staying power. Second, low realized equity index volatility has resulted in systematic investors, such as Commodity Trading Advisors (CTAs) and risk-parity funds, increasing their equity exposure due to stronger risk-adjusted returns. Hedge funds have also reduced their short positions and net positioning across the hedge fund industry is approaching neutral. A third reason investors are staying in equities is because they are better positioned than credit at this late stage in the cycle due to higher leverage to positive growth and less duration risk heading into the Federal Reserve’s rate normalization. Finally, the rotation within stocks from value to growth this year, evidenced by the outperformance of FAANG stocks (Facebook, Amazon, Apple, Netflix and Google), suggests the Trump Trade has been unwound in equities, as well.
Key Takeaway:Despite the recent unwinding of the Trump Trade, equities can continue to grind higher in absence of a catalyst (geopolitical risks, poor economic data) and lack of better alternatives if credit spreads remain firm and interest rates fail to breakout higher.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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