Investors have grown increasingly skeptical of President Trump’s aggressive trade rhetoric, adopting what’s known in the market as the “TACO trade” — an acronym for “Trump Always Chickens Out.” This strategy, popularized by Financial Times columnist Robert Armstrong, hinges on the belief that Trump’s bold tariff threats and controversial trade policies are ultimately bluffs that will be softened or reversed when financial markets react negatively. But is this confidence in Trump’s capitulation misplaced? At Extreme Investor Network, we believe it’s time to rethink the TACO trade and prepare for a more volatile and uncertain trade environment ahead.
The Illusion of the TACO Trade: Why It Might Backfire
This year, investors have been rewarded for buying the dip whenever Trump escalated trade tensions. When tariff announcements triggered market sell-offs—like the significant drops in stocks and bonds in April—Trump appeared to back down, pausing tariffs and abandoning extreme proposals such as firing Federal Reserve Chair Jerome Powell. These market reactions served as a de facto check on his trade policies.
However, Ben Inker, co-head of asset allocation at GMO, warns that this dynamic may be shifting. The muted market response to Trump’s recent tariff threats—like the proposed 25% tariffs on Japan and South Korea, 50% tariffs on Brazil, and 35% on Canada—signals a dangerous complacency. The S&P 500 and Nasdaq recently hit all-time highs despite these escalating threats, suggesting investors are no longer pricing in the downside risks of a full-blown trade war.
Inker points out that Trump’s renewed aggressiveness, especially the steep 50% tariffs on Brazil, reflects a new assumption: without strong market pushback, he may feel emboldened to push his agenda further. Unlike earlier this year, when bond markets reacted violently and forced a retreat, the current market calm may remove the financial brakes that previously restrained Trump’s trade ambitions.
What This Means for Investors: High Valuations and Rising Risks
The complacency in the markets comes at a time when valuations are already stretched. According to Inker, the S&P 500 is likely close to 40% overvalued, trading at levels not seen outside the dot-com bubble era. This overvaluation, combined with the potential for escalating tariffs, creates a precarious situation for investors who continue to rely on the TACO trade as a safe bet.
Moreover, the U.S. market’s premium valuation relative to global markets is near an all-time high. This valuation gap suggests that investors might be underestimating opportunities outside the U.S., especially in developed markets where valuations are more attractive.
Unique Insight: The Hidden Opportunity in Emerging Market Commodities
While much of the focus has been on U.S. and developed markets, savvy investors should also look toward emerging market commodities as a hedge against trade tensions. For instance, Brazil, targeted by the proposed 50% tariffs, is a key exporter of iron ore and agricultural products. Disruptions in trade could lead to volatility in commodity prices, presenting unique trading and investment opportunities.
A recent report from the International Monetary Fund (IMF) highlighted that emerging market economies with commodity exports could see significant shifts in capital flows and currency valuations amid rising protectionism. Investors positioning themselves in commodity-focused ETFs or stocks with strong exposure to emerging markets might find both risk mitigation and growth potential.
What Should Investors and Advisors Do Differently Now?
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Reassess the TACO Trade Strategy: Don’t assume Trump will always back down. Prepare for scenarios where tariffs escalate further without immediate market punishment.
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Trim U.S. Equity Exposure: Given the high valuation risks, consider reducing exposure to overvalued U.S. stocks, especially those vulnerable to trade disruptions.
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Diversify Globally: Increase allocations to developed markets outside the U.S., where valuations are more reasonable and growth prospects are solid.
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Explore Commodity Plays: Look into emerging market commodities and related sectors as a potential hedge and growth area amid trade tensions.
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Monitor Market Sentiment Closely: Watch bond markets and volatility indices as early warning signals. A sudden spike could indicate that markets are finally reacting to trade risks, prompting a swift reassessment.
What’s Next?
The next few quarters could reveal whether the TACO trade remains a viable strategy or if investors have been lulled into a false sense of security. With trade tensions escalating and markets potentially underpricing risks, volatility is likely to increase. Investors who act now by diversifying, hedging, and staying vigilant will be better positioned to navigate the uncertain terrain ahead.
For those seeking deeper insights, keep an eye on GMO’s evolving asset allocation views and reports from global economic authorities like the IMF and OECD. At Extreme Investor Network, we’ll continue to bring you exclusive analysis and actionable advice to help you stay ahead of these critical market shifts.
Sources: Business Insider, GMO, Financial Times, International Monetary Fund
Source: How the TACO trade could end up backfiring on investors