(Bloomberg) -- Wall Street has a sorry record trying to predict – and trade — pivotal elections at the best of times. Now as Joe Biden’s withdrawal upends the US presidential race, the danger of investing based on the latest political headlines has been thrown into sharp relief.
For weeks, a list of “Trump trades” was starting to take shape as Republican odds rose: Short Treasuries, especially on the long end. Long crypto and riskier stocks like smallcaps and banks. Yet as the events of this weekend show, trades put in place four months before the election results become clear — never mind its meaning for the economy — are long shots at best.
Anyone requiring a lesson on the danger of front-running big national polls need look no further back than 2016, when virtually all of Wall Street was braced for market turmoil in the event of a Donald Trump victory. That view lasted all of four hours before optimism over tax cuts and deregulation kicked in, catapulting the S&P 500 up some 20% over the next 12 months.
Fast forward eight years and the implications for markets by most measures are harder to assess, with uncertainty swirling around who the Democratic candidate will be — and everything from Federal Reserve policy to geopolitics and market valuations complicating the speculative picture.
“Wall Street analysts and economists have pushed wildly divergent ideas on how a Trump presidency would affect financial markets,” wrote Anatole Kaletsky, co-founder of Gavekal Research. “Would Trump winning mean a stronger dollar because tariffs would narrow the US trade deficit, or a weaker dollar because the US would deliberately devalue?”
Some of the so-called Trump trades reversed slightly Monday. The Treasury yield curve flattened and the dollar slipped. The S&P 500 was outperforming the Russell 2000 as of early New York trading.
But even before Biden quit the race, the consensus around how Trump might sway markets was starting to crack.
The conventional wisdom was that his policies would boost inflation and interest rates. Three-quarters of investors polled by Bank of America Corp. said a clean election sweep would push up bond yields, and the Treasury curve also noticeably steepened after Biden’s disastrous debate and the assassination attempt on Trump.
But the bank’s own strategists argued against putting too much faith in that interpretation, saying no government is likely to want higher consumer prices. “Electoral reality is voters say ‘inflation’ is what they care about most,” the Bank of America team led by Michael Hartnett wrote in a Thursday note, adding that is bullish for bonds.
At Alpine Macro, Chief Global Strategist Chen Zhao points out that while tax cuts will push up inflation, Trump’s other favorite policy — tariffs — tend to have the opposite effect by squeezing consumer spending.
“My take is this: domestic tax cuts bearish for bonds on the long end of the curve, tariffs bullish,” he said. “If he does both at the same time, it’s a big nothing.”
Investors had a taste of that with Trump’s first term. The dollar initially jumped with bond yields after the election, until his trade war dampened economic optimism.
It all goes back to working through the impact of Trump’s conflicting proclamations, including tax cuts, higher tariffs, a clampdown on immigration, deregulation, a more pliable central bank and dollar devaluation.
For instance, most strategists including Deutsche Bank AG, Alpine Macro and Barclays Plc say Trump’s policies will boost the dollar. Jefferies quants, however, say the greenback’s appeal as a store of wealth might be eroded if he piles political pressure on the Fed.
It’s also been hard to disentangle these trades with other market factors. Most notably, a weaker-than-expected inflation report has boosted certainty the Fed will cut rates in September.
And the yield curve might be set to steepen anyway assuming Kamala Harris ends up as the Democratic nominee and continues Biden’s policies, says Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management.
“Neither candidate is discussing any kind of fiscal restraints and that is being priced in to the back end of the curve,” she said. “A lot has happened, so it doesn’t feel prudent to position your portfolio on a specific outcome.”
At Annex Wealth Management, chief economist Brian Jacobsen says his surest Trump trade is rotating into small-caps, though mostly because cheap valuations make it a good bet, regardless of politics.
There’s been little agreement on how Trump might sway stock indexes, though most of Wall Street agrees he will be better for heavily regulated banks, gun stocks, energy firms and corporate mergers.
Until November, investors will also have to digest a barrage of earnings and two more Fed meetings. While Trump’s first term began after the first US rate hikes since the global financial crisis, the next president will likely take office at the start of an easing cycle.
“What really matters is the macro data which we are currently having, and this may change quite a bit until the elections in November,”’ Wolf von Rotberg, equity strategist at Bank J. Safra Sarasin, told Bloomberg Television. “We are seeing a slowing cycle. That will define the rates space and there will be a read across for the equity markets coming from rates, which will have a much more material impact on the market than just politics.”
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