It’s probably safe to say that “skepticism” re: the feasibility of the Trump administration’s agenda has reached a post-election peak.
And indeed it’s easy to understand why. “Repeal and replace” was a disaster. “Build that wall that Mexico’s definitely going to pay for” has turned into “maybe let’s hold off for a minute and when we finally do get started, taxpayers will have to front the money.” “Phenomenal,” “massive” tax reform ended up being a double-spaced one-pager that looks like it walked out of a high school student’s Trapper Keeper, and despite its amorphous character, it’s still unlikely to fly on Capitol Hill. And most recently, Trump only narrowly avoided an embarrassing government shutdown.
Meanwhile, the President has flip-flopped on all manner of bombastic campaign rhetoric including NATO being “obsolete” and China being a currency manipulator.
Oh, and “America first” has turned into “Syria first” and then “North Korea second” and then maybe “America third.”
Finally, “drain the swamp” turned into “fill up the swamp with Goldman bankers.”
So it’s easy to understand why the market – near record highs on every benchmark notwithstanding – has aggressively faded virtually every Trump trade that was put on so vigorously post-election.
Earlier today, we asked (twice) whether the “Trump trade fade” might be overdone. You can read those posts here:
- Does This Chart Show The Market Is Too Negative On Tax Reform?
- Trader: The “Only Option” Is To Be Optimistic
But it occurred to us that given the above-mentioned enthusiasm at the (equity) index level, it might not be readily apparent to most investors just how aggressively the “Trump trade” has in fact been faded. In the interest of illustrating things, we present the following out Friday afternoon from Goldman…
In mid-December risk appetite reached the highest level since the early 1990s as markets were getting increasingly optimistic on global ‘reflation’ – since then risk appetite has generally declined (Exhibit 1). As we discussed in our February GOAL, very bullish sentiment and positioning alone is no reason to turn bearish but it increases the risk of disappointment. Indeed, up until this week, risk appetite generally declined towards neutral territory – this has been true across asset classes but was led by equity volatility, with equities and bonds following (Exhibit 2). However, after the first round of the French elections, risk appetite rebounded across assets.
This is particularly true underneath the index level. The ‘reflation’ optimism has faded since the end of January owing to a combination of concerns, which we discuss in more detail below. The fade of the ‘reflation trade’ becomes particularly evident when looking at style performance within equities – cyclicals vs. defensives and financials vs. staples have both reversed significantly (Exhibit 3). And this has generally been a global theme with cyclicals underperforming defensive across regions (Exhibit 4). The only exception is EM, which managed to decouple from DM in part because it lagged in the global ‘reflation trade’ last year and arguably has most to gain from more anchored rates and a less strong US dollar. Also there has been a small reversal in Europe post the French elections.
The sharp increase in risk appetite last year happened in two phases (Exhibit 10): (1) a strong search for yield, or TINA (There Is No Alternative), stabilised risk appetite at very low levels in 1H 2016. During this period global 10-year yields headed towards their cycle lows pushing investors up the risk curve and credit led the increase in risk appetite. And after a short ‘reflation flirtation’ in 2Q markets embraced phase (2), ‘reflation infatuation’, in 2H 2016. As markets repriced deflation risk from low levels it boosted risk appetite driving a strong outperformance of equities vs. bonds in 2H 2016. This phase peaked at the end of January this year – we have entered a ‘reflation pausation’. We think this is the result of a combination of worries: (1) Disappointing hard data vs. soft data so far, in particular core CPI, (2) commodity recovery fading and base effect on headline inflation rolling off, (3) Trump optimism fading, (4) European politics moving into the hot phase, and (5) first signs of growth momentum slowing.
Most of the beneficiaries of higher inflation expectations have reversed part of their gains from ‘reflation infatuation’ during the ‘reflation pausation’. Equities are the odd one out – they performed well during both the ‘infatuation’ and the ‘pausation’ phases (Exhibit 11). We think this is because equities are continuing to benefit from still strong growth and TINA owing to lower bond yields. But looking at performance underneath the index level reveals that the key ‘reflation trades’ within equities in 2H 2016 have already reversed. MSCI Value vs. Growth has already reversed more than half of its gains – global financials vs. staples are still up materially. Beyond equities, on a cross-asset basis, gold has been the big winner, reversing most of its losses from last year, in part a result of elevated political uncertainty and lower yields.
CFTC futures positioning in bonds and FX is broadly consistent with the US reflation trend moderating – with net shorts in bonds and net longs in the Dollar coming off. After Treasury positioning had been the most bearish in history, it has now come back materially, with US 10-year positioning closer to neutral and other maturities retreating as well but at a slower pace, suggesting some expectation of bear flattening (Exhibit 13). US Dollar long positioning has also materially declined, particularly against the euro and yen, which are the currencies likely to weaken with US reflation (Exhibit 14).