The Stock Market's TACO Trade May Be About to Backfire

Investors' reliance on the 'TACO trade'—the belief that President Trump will back down from extreme trade policies due to market pressure—is being challenged as recent aggressive tariff threats, including 50% on Brazil and 25% on Japan/South Korea, have met with muted market reactions. GMO's Ben Inker warns that this lack of significant market sell-off removes a key check on Trump, potentially emboldening him to escalate trade wars further. With the S&P 500 at all-time highs and US valuations appearing stretched, Inker suggests investors are not adequately pricing in downside risks, indicating better opportunities in deep value or non-US developed markets.

Analysis

The prevailing investor strategy of buying market dips following tariff announcements, known as the 'TACO' (Trump Always Chickens Out) trade, is facing increased risk. According to Ben Inker of GMO, the market's role as a check on aggressive trade policy is diminishing. Recent threats, including potential tariffs of 50% on Brazil and 25% on Japan and South Korea, have elicited a muted market response compared to the significant sell-offs in April that previously prompted policy reversals. This lack of a strong negative market reaction could embolden the administration to escalate protectionist measures without fear of financial backlash. This dynamic unfolds in a context of high US equity valuations, with the S&P 500 near all-time highs and, by Inker's measure, approximately 40% overvalued and at a record valuation premium to global markets. The combination of investor complacency and reduced market deterrence suggests that downside risks associated with escalating trade disputes are not being adequately priced into US equities.

Key Decisions for Investors

• Investors should reconsider the 'buy the dip' strategy on tariff-related news, as the absence of a strong market sell-off may increase the probability of policy escalation and heighten tail risk.
• Given that US equity indices are near all-time highs and considered significantly overvalued, it is prudent to review and potentially trim exposure to broad US market benchmarks.
• Consider reallocating capital towards areas identified as more attractively valued, specifically deep value stocks and developed-market equities outside of the US, to mitigate concentration risk in expensive US assets.