Why ‘Trump Trade’ ETF Winners Are Fading – Insights on Financial Markets

Introduction

Last week, Donald Trump’s remarkable political resurgence, alongside a Republican majority in Congress, triggered immediate rallies in U.S. stock markets and other risk-driven assets. However, merely a week later, the initial post-election enthusiasm has begun to wane as investors express concerns about the sustainability of this ‘honeymoon’ phase. With apprehensions that Wall Street might be left grappling with an overvalued stock market under an unpredictable Trump policy framework, a reassessment of investment strategies is underfoot.

The Shifting Focus of Investors

As Troy Donohue, head of Americas portfolio trading at BTIG, observed, investors are currently reassessing the practical effects of the recent election. “Now investors are looking back and analyzing what the actual impact of the election is, and they make their time to redo their portfolios and calls with the right sectors and international allocations that they need,” he said. This transition suggests that while the initial sentiment heightened asset prices, the market is now stabilizing as investors reposition themselves accordingly.

The Role of Trump’s Economic Plans

The primary impetus for buying into the so-called Trump trade was the expectation that Trump’s second term would bolster the U.S. economy and corporate growth. Many investors speculate that his policies could lead to tax relief, increased tariffs, and reduced financial regulations. However, the flip side of these policies could potentially result in escalating fiscal deficits and a resurgence of inflation, which would adversely impact government debt securities and push interest rates upward once again.

Small-Cap ETFs: Stars That Are Losing Shine

Exchange-traded funds (ETFs) focused on U.S. small-cap stocks enjoyed an impressive rally last week, exemplified by the iShares Russell 2000 ETF (IWM) which surged by 8.8%, marking its strongest week in more than four years. The surge was attributed to the anticipation that Trump’s tax cuts and focus on domestic supply chains would benefit smaller, domestically-oriented firms.

However, this momentum is now showing signs of turbulence; the IWM has fallen over 2.5% in the past week, while the Vanguard S&P Small-Cap 600 ETF (VIOO) has experienced a drop exceeding 2%. According to FactSet data, rising Treasury yields have placed pressure on these small-cap stocks. The 10-year Treasury note yield, hovering around a four-month high, suggests potential inflation linked to expected Trump administration policies.

Cody Slach, senior managing director at Gateway Group, indicated that the direction of the 10-year yield will play a crucial role in determining small-cap performance moving forward. Nevertheless, Jan Szilagyi, CEO of Reflexivity, cautioned against overreacting to the small-cap selloff, attributing it more to typical volatility than a definitive shift in investor sentiment.

Big Tech and Tesla-Related ETFs See Declines

Along with small-caps, other ETF beneficiaries of the Trump trade, particularly in the technology sector, have also faded. The Roundhill Magnificent Seven ETF (MAGS), which comprises major technology stocks such as Apple Inc., Microsoft Corp., Alphabet Inc., Amazon.com Inc., Nvidia Corp., Meta Platforms Inc., and Tesla Inc., has dropped nearly 1% this week after an impressive 8% gain the week prior.

Tesla has particularly led the decline with its stock tumbling more than 3% this week, following an astounding 30% advance last week due to expectations that the new administration would favor electric vehicle (EV) manufacturers. On one day alone, Tesla shares plummeted 5.8% amid concerns that the Trump administration might retract EV tax credits.

As Donohue noted, the quick-cycling interest in Tesla suggests that while short-term trading remains robust, the market’s overall direction may lack definitive clarity. Both the Direxion Daily TSLA Bull 2X Shares ETF (TSLL) and the GraniteShares 2X Long TSLA Daily ETF (TSLR) initially surged over 60% last week before ceding ground this week.

Conclusion

In summary, the excitement surrounding the ‘Trump trade’ may have reached a plateau as investors look inward and recalibrate their portfolios amidst economic uncertainties. The need to analyze potential inflationary pressures alongside Treasury yields has risen in importance, especially in the small-cap segment. For large tech players and ETFs tied to them, the future remains uncertain as reactions to policy shifts will dictate the market’s trajectory. As the political landscape continues to evolve, one thing remains evident: thorough reassessment of market strategies is key to navigating the complexities presented by changing administrations.