The Trump Trade Returns
Slowly but surely it seems, the “Trump trades” of earlier this year appear to be gaining traction once again.
It’s not too late to jump aboard.
What are the Trump trades? They’re based on the view that the combination of US monetary policy tightening from Janet Yellen and fiscal stimulus from Donald Trump would spark not only a further leg up in the global equity rally, but also underpin rising bond yields and the US dollar. In a sense, it’s akin to what America witnessed under Ronald Reagan in the early 1980s: tax cuts from a business friendly President and interest rate hikes from a hawkish and inflation-wary Federal Reserve.
Thanks to exchange traded funds (ETFs), moreover, it never been easier for local investors to tap into these global macro investment themes.
Of course, the Trump trades were supposed to play out earlier this year – but so far this year only one of the three markets has followed the script. US equities are up, but bond yields and the $US are down.
Bond yields have fallen because US inflation has tended to surprise on the downside, meaning the Federal Reserve has not needed to raise interest rates as quickly as feared. There’s also been disappointment that Trump had not focused on tax cuts and infrastructure spending as quickly as traders hoped. In turn, a patient Fed and simmering talk of policy tightening in Europe have helped weaken the US dollar.
Wall Street, of course, has managed to shrug off disappointment with Trump’s fiscal plans because lower bond yields and a more competitive $US have supported both equity valuations and corporate earnings.
Up until recently, the $US dollar had become very unloved. From a technical perspective it appeared “oversold” with the weekly relative strength index (RSI) dropping to around 30 – its lowest level in six years.
The yield on US 10-year bonds, meanwhile, also fell - but according to the RSI indicator, US bonds are not as obviously “overbought” as yet as they were back in mid-2016. Of course, it’s still quite possible yields will rise from year, for the reasons I’ll now outline.
For starters, the Fed has surprised markets over the past week by reiterating its intention to raise interest rates again in December – even though the market had lowered the risk of this to only around 40%. Fed chair Janet Yellen appears to have concluded that even though US inflation remains below America’s 2% target level, rates should nonetheless continue to gradually “re-normalise” given they’re still very low and the US labour market is becoming very tight.
Not only are US rates destined to rise again in December, the Fed is still clinging to its view they’ll rise another three times in 2018 – twice more than the market had recently been expecting.
Meanwhile, US President Donald Trump has finally placed some flesh on the bones of this tax policy, pledging to cut the corporate tax rate from 35% to 20%. He’s also still keen to encourage US global heavy weights to bring some of their billions in foreign earnings back into the country – through a tax incentive. Of course, there’s still a long way to go before anything passes Congress, but it’s enough to get markets excited again – and Republicans will likely be keen to pass something after their failures to do anything on health care so far this year.
All this bodes well for an overdue rebound in the unloved $US and a belated lift in US bond yields. Of course, it’s still possible equities can also continue to rise in this environment, given the fact that America’s economy and corporate earnings are still travelling well – and the prospect of tax cuts, and profit repatriation from offshore (which could help fund share buybacks) only adds to the positive outlook.
So how can we profit from these trends? Investors keen on seeking exposure to the rising US dollar can do so through currency based exchange traded funds, such as USD and YANK. Rising US bond yields also helps improve the interest margins of global banks, exposure to which is possible through the global banks ETF, BNKS. Last but not least, the prospect of even better US growth and share buybacks fuelled by profit repatriation is particularly positive for a growth orientated index such as America’s tech and health-care heavy NASDAQ-100 Index, exposure to which is possible through the NDQ ETF.
The Trump train is leaving the station. Time to jump aboard.
David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.