Investors in the ‘TACO trade' should study the other side of the menu, strategists say

Strategists warn investors relying on the 'TACO trade' (Trump always chickens out) to buy dips during tariff threats may be enabling President Trump to use market volatility as leverage. While this strategy has historically led to market rallies and recent record highs for the S&P 500 and Nasdaq, renewed tariff threats against Brazil and Canada caused recent market weakness, with the Dow down 1.2% and S&P 500 down 0.4% for the week. Despite this policy-driven uncertainty, market focus remains on the U.S. economy and corporate earnings, suggesting diminishing impact on overall confidence.

Analysis

A prevalent market strategy, dubbed the 'TACO trade' (Trump Always Chickens Out), where investors buy dips following tariff threats, is facing new scrutiny. According to analysis from TS Lombard, this behavior has effectively sold President Trump a 'call option' on the market, allowing him to leverage financial market volatility to extract trade concessions whenever equities are strong. This dynamic is cited as a source of inevitable, policy-driven volatility. Recent events support this view, as new tariff threats against Brazil and Canada on August 1st precipitated a market downturn, with the Dow Jones Industrial Average falling 1.2% for the week and the S&P 500 declining 0.4%. This occurred immediately after the S&P 500 and Nasdaq reached new record highs of 6,280.46 and 20,630.66, respectively. Despite this trade-induced weakness and a U.S. dollar that has fallen 9.8% year-to-date, strategists suggest the market impact of policy uncertainty may be diminishing, with investor focus increasingly shifting toward the underlying strength of the U.S. economy and corporate earnings.

Key Decisions for Investors

• Investors should anticipate continued policy-driven volatility, as the 'TACO trade' may be encouraging the use of market disruption as a negotiating tactic, thus increasing the risk of buying dips on trade news.
• Note the divergence in index performance, where the Dow's 1.2% weekly loss indicates greater sensitivity to industrial trade disputes compared to the more resilient S&P 500 and Nasdaq, suggesting a need for sector-specific risk assessment.
• While trade headlines will drive short-term moves, portfolios should be positioned for a market environment where U.S. economic fundamentals and corporate earnings are re-emerging as the primary long-term drivers of investor confidence.
• Given the U.S. Dollar Index has declined 9.8% year-to-date, U.S. investors should assess currency risk in their portfolios, particularly in assets sensitive to a weaker dollar or further trade policy shifts.