TACO: Tariffs Always Create Opportunity

The article discusses the "TACO" (Trump Always Chickens Out) trade, a pattern of market sell-offs on tariff announcements followed by rallies on subsequent trade deal news, and examines whether this pattern will persist. It notes that while bearish sentiment is increasing and options trends suggest renewed skittishness, the market has remained resilient, potentially emboldening Trump to maintain tariffs without market repercussions. The analysis suggests focusing on domestic producers like MP Materials (MP) and steel stocks (CLF, STLD) as potential beneficiaries if trade tensions escalate, while also highlighting options strategies to capitalize on volatility regardless of directional moves.

Analysis

The market is currently navigating a period of heightened volatility characterized by the "TACO" (Trump Always Chickens Out) phenomenon, where initial sell-offs on tariff announcements are often followed by rallies upon news of lighter trade deals. Despite recent tariff rhetoric, including new steel tariffs on the EU and re-engaged tensions with China, major indices like the S&P 500 have shown resilience, retaking its year-to-date breakeven and the 6,000 level, while the Cboe Volatility Index (VIX) has fallen in six of the last seven sessions. This market strength, even as a July 9 EU tariff deadline looms, questions whether the conditions for a classic TACO trade – specifically a market dip to buy – will materialize. Investor sentiment, however, is showing signs of increasing caution; the American Association of Individual Investors (AAII) survey indicates bearish sentiment rose to 41.4% from 36.7% in late May, and options data reveals skittishness, with approximately 20% of SPX components exhibiting a 10-day put/call ratio above 1.0 and significant SPY put activity. The article suggests that if markets remain elevated, President Trump might feel emboldened to maintain tariffs, potentially shifting focus to domestically producing sectors. MP Materials Corp. (MP), a U.S. rare-earths producer, exemplifies this sensitivity, experiencing significant price swings ($29.72 high to $18.75 low within a month) tied to U.S.-China trade relations and rare-earth export policies; despite a Morgan Stanley upgrade to "overweight" with a price target hike to $34, the stock recently declined after China granted temporary export licenses for auto manufacturers Ford, General Motors, and Stellantis. MP Materials also has 20% of its float sold short, indicating potential for a short squeeze. Conversely, domestic steel producers like Cleveland-Cliffs Inc. (CLF) and Steel Dynamics Inc. (STLD) saw substantial gains of 23% and 10.3% respectively on a single Monday, positioning them as potential beneficiaries should U.S. protectionist measures solidify.

Key Decisions for Investors

• Investors should monitor key sentiment indicators, such as the AAII bearish sentiment figures and options market put/call ratios, as a significant increase in negativity may be required to create the dip necessary for a traditional 'TACO' trade.
• Consider exposure to domestic producers, particularly in sectors like U.S. steel (e.g., CLF, STLD, X) and rare earths (e.g., MP Materials), which could benefit from escalating trade tensions and protectionist policies, while being mindful of the inherent volatility and event-driven nature of these stocks, as seen with MP Materials' reaction to Chinese export licenses and its high short interest.
• For those seeking to capitalize on the anticipated market whiplash without a strong directional bias, exploring volatility-focused options strategies such as straddles, strangles, or iron condors could be a prudent approach to navigate the uncertainty stemming from tariff rhetoric and geopolitical developments.