Trade idea of the day: The Trump trade keeps giving
President Donald Trump likes to think of himself as the U.S. stock market’s best friend. Amongst other things, his Twitter feed is infamous for multiple tweets celebrating U.S. stock market milestones. The so-called Trump Trade has favoured some sectors more than others though. And originally, only highly established ‘value’ sectors were regarded as being in the basket, like the S&P 500’s Financials sector, up 40% since the November 2016 election. However, it has since become evident that the technology sector’s 55% advance means lower-yielding ‘growth’ shares are just as eligible.
Hedged and outright
Regardless of underlying cause, it is just as remarkable that among these relative sectoral performances, several trends have persisted since November 2016. For instance, the S&P 500’s booming Information Technology sector has outshone the ailing Consumer Staples sector throughout the last 18 months. The latter was still the worst-performing S&P 500 group at last look, down 1.8% for the year. Telecom Services was also still underperforming, having inched just 0.2% higher. Real Estate and Utilities were relatively weak too, both posting measly gains of about 6%. Compare that with the next worst-performing sector, Energy, which was 17% higher. Hence, with the S&P 500 fresh from turning positive again for the year last week, well-established inter-sector differentials may offer attractive risk/reward. Alternatively, a hedge strategy can be just that: a means of offsetting potential losses in another trade, rather than a standalone strategy.
Buy and sell
A classic hedge trade will look to exploit well defined divergences like those outlined above. For instance, we might look to trade a stock or basket of stocks as proxy for one of the S&P 500 sectors with the least healthy trends, Consumer Staples or Telecom Services. We would then select another stock or basket as proxy for an ‘over-performing’ sector, like Information Technology or Financials. The basic strategy would be to buy the stock in the outperforming sector whilst simultaneously selling the stock in the losing sector. For example, buying Netflix at the start of the year and selling SPDR’s Consumer Staples Select Sector Fund would have provided exposure to the streaming giant’s 64% rise since early January and the consumer ETF’s 12% slide.
Of course, hedge strategies are not risk-free, the first risk to consider being the cost of the trade. Fees must be weighed against collateral and expected reasonable returns to judge whether the trade makes financial sense. The risk that losses from one leg of a hedge could deplete or completely nullify the return from the other must also be faced. At worst, in theory, both legs of the hedge could produce losses. Put another way, the hedge may fail to produce sufficient profits over the length of time the trader is comfortable keeping the trade open. These risks underscore the need for careful consideration before executing such a strategy and strict management once in the trade.