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Portfolio Update

Has the Trump Trade Peaked?

By Elliott H. Gue, on Apr. 13, 2017

Following the US presidential election last November, talk of a Trump Trade became ubiquitous on Wall Street.

The basic idea: A combination of lighter touch regulation, tax cuts and infrastructure spending would boost US economic growth, lift corporate earnings and drive inflation and interest rates higher.

Under the Trump Trade scenario, you should expect fixed income (bonds and bond-like investments) to underperform due to rising interest rates, while financials, select commodities and cyclicals outperform.

In addition, when US economic growth is weak, growth stocks tend to outperform value stocks. That’s because earnings for a true growth stock are driven by secular themes, such as a popular new product or technology, that don’t need strong economic growth to continue.

In contrast, many value stocks are more cyclical in nature. These names tend to need economic tailwinds to see strengthening earnings growth.

Last year, prior to the November election, the market was pricing in a slow growth, low inflation scenario. Bonds generally outperformed stocks with the iShares 20+ Year Treasury Bond (TLT) exchange traded fund (ETF) jumping nearly 10 percent compared to a gain of around 6.7 percent for the S&P 500. Utilities, a safe-haven choice, was the second-best performing sector in the S&P 500, returning 16.5 percent in the first 11 months of 2016.

Investors also gravitated to pure growth plays, such as Information Technology (IT), that could still generate earnings without overall economic growth. The overall S&P 500 IT Index beat the broader market by 600 basis points in this pre-election period.

Through most of the election cycle, the consensus on Wall Street held that Hillary Clinton would win the presidential election and the Democratic Party would likely take the US Senate. So, when President Donald Trump prevailed and the GOP retained control of both the House and Senate, the market reacted quickly and the leaders and laggards changed virtually overnight.

The Trump Trade is most evident from the time of the Presidential Election until roughly the end of February. Over this time frame, financials were the best-performing market sector, returning more than double the 11.2 percent gain in the S&P 500.

That reflects the trend, outlined in Rising Rates: Buy Financials and Value, that rising interest rates boost net interest margins for banks while stronger economic growth tends to support loan growth. Industrials and materials stocks–two groups that tend to benefit from strengthening economic growth, tax cuts and infrastructure spending–also outperformed the broader market over this roughly four-month time frame.

Treasury Bonds, the biggest winners through most of 2016, were the big losers in the months following the election. More defensive groups, such as Utilities and Consumer Staples, managed to eke out gains, though they significantly underperformed the broader market.

Since the end of February, the market has reverted to its pre-election trading pattern: The S&P 500 is down slightly, led by the Financials and Industrials, while growth-oriented IT companies and Treasury bonds have generally gained ground.

Investors suffer from what psychologists call a recency bias, the tendency to project short-term trends into the future. That bias, coupled with the financial media’s desire to create excitement out of the dullest markets, has resulted in a profusion of headlines declaring the death of the Trump Trade.

We disagree: The Trump Trade has simply paused.

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