Fading the Trump trade

January 27, 2017 01:00 PM
Is it time to take the other side of the Trump rally?

Forget Hillary Clinton, the biggest losers on election day may have been the economists and market forecasters who predicted a rout in the event of a Donald Trump victory--unlikely as that may have seemed at the time--because, of course, the S&P 500 and Dow Jones Indexes pushed to new highs as traders rushed to take advantage of what some termed “the Trump trade.”

After an initial selloff, financials and industrials soared while promises of a new infrastructure program sent Treasury yields to their highest levels in more than a year. The net result was more than $50 billion of new assets flowing into ETFs in November--more than $20 billion of that into just four funds--pushing some to extreme levels. All of that has us left wondering if it’s time to think about taking the other side of the trade. 

Long/short traders looking for an easy way to profit off of a faltering Trump rally would do well to focus on a handful of small funds in the banking and defense sectors that have seen strong inflows as investors anticipate the new reality of President-elect Trump. Formerly troubled mega-banks like Bank of America (BOA) and Citigroup (C) may have soaked up the headlines, but small and micro-cap bank stocks were the biggest winners as a steepening yield curve and hopes for a repeal of some elements of the Dodd-Frank Act have a much bigger impact on their bottom lines. Given that Republicans have only a small hold on the Senate, and with memories of the 2008 economic collapse relatively fresh, we have to wonder how sweeping any revisions to Dodd-Frank might be. Small-cap banks might be a natural starting point for traders looking for shorting opportunities. While reducing onerous Dodd-Frank provisions on smaller banks has been the most talked about post-election reform by analysts, big banks have a way of getting the bulk of rewards when policies shift. 

The First Trust Nasdaq ABA Community Bank Index Fund (QABA) was up 19.6% in the 17 trading days after the election, slightly lagging several other bank stock funds, but investors found a lot to love in the micro-cap fund as they increased its assets by more than 117% in November and pushed valuations to record levels.
A price-to-book ratio of 1.4 might not sound that impressive, but that’s currently the highest for any pure bank fund, not to mention the highest level QABA has ever traded at with its trailing P/E of 16.83 not far behind. 

Every short needs a long and there is no shortage of candidates with Treasuries or gold miners; and even technology stocks having felt the lash of the Trump trade months before he took office. But the best fund for the job might be waiting south of the border wall construction site (see “Trump correction trade” below). News that Trump won the White House sent the iShares Mexico Capped ETF (EWW) down more than 18% in less than a month, although you wouldn’t know it from our behavioral models or fund flow data, as EWW produced a 141% increase in its assets in November. The fund has clearly seen weaker price momentum, but a surge in its short interest as traders rushed to hog pile onto an easy victim while the getting is good. 

The question is how long can that last for?

While President-elect Trump made an early deal with Carrier to keep some positions from shifting south, even business friendly publications like the Wall Street Journal have called his deal-making skills and commitment to free markets into question while expecting a radical shift in trade policies ignores one major data point: Mexico is America’s third largest trade partner and second largest export market with more than $236 billion in U.S. goods and services sold there in 2015. Anyone expecting a quick end to NAFTA, and more brutality for Mexican stocks, might be in for a rude awakening.

About the Author

Matt Litchfield is content editor for ETF Global (ETFG.com) and is responsible for all posts and new product updates on ETFG.com. @ETF_Global