The Trump Trade Is Alive. The Reflation Trade Is All But Dead.by
Peso battered, U.S. stocks outperforming, small caps on top
Lack of upward pressure on headline inflation weighs on yields
The Trump trade is undergoing a revival, rising from the ashes of the flailing reflation trade.
U.S. stocks are once again beating emerging markets, the dollar is up and Mexico’s peso is floundering, all signs that betting on President Donald Trump is regaining popularity -- a rebuke to pessimists who predict he won’t be able to get his policies through Congress. Meanwhile, the somewhat-related reflation trade -- wagering that global stocks and bond yields will both climb -- is in retreat on the view that consumer-price increases may already have peaked.
The divergence shows that while investors are seeing a brighter outlook for the U.S. administration’s efforts to push through stimulus measures and tax cuts, they’re also cognizant that some policy planks would adversely affect other nations and damp global growth.
Here’s where the shift can be seen in markets:
The Peso Is Falling Again
The Mexican peso is weakening again as the Trump administration embarks upon a trade enforcement drive, levying tariffs against Canadian softwood lumber imports and encouraging a probe into allegations of dumping by Chinese steel producers.
While Wednesday’s sharp depreciation in the peso, linked to reports a U.S. announcement to exit Nafta was imminent, was somewhat reversed on Thursday after Trump said he was looking to renegotiate the accord, Mexico’s currency has been trending weaker since April 17.
American (Equities) First
The initial market response to Trump’s victory mirrored his “America First” campaign pledge as U.S. stocks trounced their emerging-market peers.
Inaction -- both on fiscal stimulus and protectionist measures -- fostered an abrupt reversal in this trade, with investors falling back in love with developing-nation assets in the first quarter.
But emerging-market outperformance ceased in late March as the Trump administration shifted its attention from health-care policy to tax reform. A basket of high-tax stocks compiled by Goldman Sachs Group Inc. began a bout of modest outperformance relative to their lower-taxed counterparts on the view Trump’s ideas might come to fruition.
On a related note, riskier small-cap stocks are also getting renewed attention from investors. The Russell 2000 Index is sitting at all-time highs -- unlike the Dow Jones Industrial Average, which remains within spitting distance of fresh records after trailing the smaller-cap index’s advance over the past seven weeks.
BAT Trades Strike Out
To be sure, a number of the Trump trade’s initial facets have lost their allure -- and their fundamental underpinning. Retail stocks, which underperformed amid the overhang of a potential border adjustment tax, no longer face that headwind (but Amazon’s still out there!) Since March 21, the SPDR S&P Retail ETF is also beating the Standard & Poor’s 500 Index. The diminished likelihood of a BAT is also seen in the spread between Brent and West Texas Intermediate futures that expire in December 2017, 2018, and 2019, which are on a widening trend again.
A BAT would have incentivized U.S. production relative to bringing in oil from overseas. On the other end of the spectrum, tempered expectations surrounding a U.S. infrastructure binge have caused a basket of stocks linked to that theme to lag the broad market.
Bonds Bounce Back
Sovereign bond yields had been moving higher well before the U.S. election -- in fact, that trend started shortly after the Brexit vote in late June 2016. However, expectations for fiscal stimulus stateside helped catalyze a fierce spike in yields after the election, at the same time as economic data had been surprising to the upside all over the world.
But the Bank of America Merrill Lynch Global Government Index has since staged a notable rebound off its December lows, aided by a decline in the bond market’s estimates for inflation over the next five years. The year-end rally in crude has reversed amid rising rig counts and production in the U.S., reducing inflation pressures.