Dow Deja Vu: 'Trump Trade' Regains Favor -- Update

By Akane Otani Features Dow Jones Newswires

The "Trump trade" is making a comeback, reflecting investors' renewed belief in the strength of the U.S. economy and fresh hopes for business-boosting policy from Washington.

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U.S. stocks keep chugging higher. The S&P 500 has risen 3.6% from June 30 through Thursday's close, putting it on track for its eighth consecutive quarterly gain. The Dow Jones Industrial Average has added 4.8% in the third quarter and is up 13% year to date.

In a throwback to the early days after President Donald Trump was elected, shares of U.S. banks and industrial companies are climbing and small-capitalization stocks are in record territory, while Treasury bonds and their stock-market proxies have fallen out of favor. The U.S. dollar, beaten down for much of 2017, is rebounding.

Underlying those trades are a combination of business fundamentals, economic data and policy expectations. Corporate earnings remain strong, and some say such results support a rally regardless of policy changes. But renewed expectations that the Federal Reserve will continue to raise interest rates are making bank stocks more attractive to investors. And while there is some skepticism that the Republicans' tax overhaul will pass, the fact that a plan was put forth this week has tantalized investors with the prospect of improved earnings.

The developments could give investors fresh reason to believe stocks trading near records can keep rallying, despite concerns over pricey valuations and rising bond yields. Still, nascent signs of an inflation uptick and the outline of tax changes are no guarantee the bets will pay off.

Such wagers helped drive major U.S. stock indexes to records following the November election, but faltered early this year. Uneven economic data cast doubt on the strength of the U.S. recovery, while congressional gridlock led many investors to downgrade expectations for policy change in Washington. By the end of the president's 100th day in office, the Trump trade looked done, many investors and analysts said.

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"In the last month, the market seems to have completely changed its mind about what's going to happen," said Omar Aguilar, chief investment officer for equities at Charles Schwab Investment Management. He believes sectors that tend to do well in stronger economic conditions, like industrial and financial stocks, are poised to outperform.

Those who are buying stocks now say a tax cut could prompt investors to sell bonds to buy other things.

Bank shares have gained due to expectations of rising rates, with the KBW Nasdaq Bank Index of large U.S. commercial lenders rising 6.1% in September compared with the S&P 500's 1.6% increase. Shares of industrial companies in the S&P 500 have risen 3.6%. The Russell 2000 index of small-capitalization companies, perceived to be some of the biggest beneficiaries of a tax overhaul because of their relatively heavy tax burden, has climbed 5.9%.

That follows a period of underperformance for the Russell 2000. After rising for 15 consecutive trading days in November, notching several fresh highs, the index fell behind the S&P 500 for months and is now back at records. Banks and industrial stocks also lagged behind in early 2017 following sharp gains after the election.

Goldman Sachs Group said in a research note Monday that its economists believe a tentative Senate budget deal has increased the likelihood that tax reform will be passed by 2018. Every percentage point reduction in the tax rate could boost the per-share earnings of the S&P 500 by a dollar, according to Goldman. The bank added that its basket of stocks with the highest tax rates rallied in the two weeks ended Sept. 22 after underperforming the S&P 500 for most of the year.

J.P. Morgan equity analysts opined similarly, saying in a research note earlier in September that "now is a good time to position for tax reform." The bank's analysts added that they expect investors to move from emerging-market stocks to U.S. stocks, from multinational to domestic companies and from large to small-capitalization companies if Congress makes headway on taxes.

Others attribute the market's about-face to growing consensus that the Federal Reserve will raise interest rates once more this year.

A measure of U.S. consumer prices jumped in August at the fastest pace since January, the Labor Department said earlier this month, a report some analysts said should reassure the Fed after a string of muted inflation readings.

In September, the Fed's dot plots -- where central bankers project interest rates will go -- showed 12 of 16 central bank officials expected at least one more rate increase this year and most expect at least three more increases next year.

The revelation surprised some investors who thought the central bank would delay rate increases after a stretch of largely muted inflation data this year. Investors now see a 73% chance of one or more additional rate increases by the end of the year, according to federal-funds futures tracked by CME Group, up from about 50% before the September Fed meeting.

That put pressure on government bonds, whose fixed returns are worth less in a higher-rate environment. The yield on the 10-year U.S. Treasury note, which rises as bond prices fall, climbed to 2.309% Thursday from 2.122% at the end of August. Shares of utilities companies in the S&P 500, considered bondlike because of their relatively hefty dividends, lost 2.9% over the same period.

Meanwhile, the U.S. dollar, which typically rises on prospects of higher rates and a stronger economy, has rebounded, with the WSJ Dollar Index -- a measure of the U.S. currency against a basket of 16 others -- up 0.6% in September through Thursday following six consecutive months of declines.

Despite the market's reversal over the past few weeks, signs of skepticism abound.

Some say the shift is merely a "rotation," a chance for investors to cheaply scoop up stocks that had fallen behind this year, while selling areas of the market they fear have become crowded, possibly reducing their potential returns.

"We're still in a slow-growth, low-rate and tame-inflation environment," said Michael Arone, chief investment strategist at State Street Global Advisors. Mr. Arone added that he believes central banks will keep rates lower for longer, despite hinting otherwise in recent months.

In another sign of wariness, fund flows show investors are continuing to pour money into fast-growing technology companies, which are thought by some to offer the best returns in a sluggish economic environment.

Mutual funds and exchange-traded funds that invest in technology stocks drew in about $1 billion of inflows for the week ended Sept. 20, the second largest inflows for the sector on record, according to data from fund tracker EPFR Global.

"What I've been seeing is not indicative of total conviction to give up on some of these areas," said Robert Pavlik, a senior portfolio manager and chief market strategist at Boston Private Wealth, adding that any movement out of technology stocks into financial and industrial shares seems to have been "halfhearted."

Even with some recent share-price declines, the S&P 500 technology sector remains up 25% this year through Thursday, making it the best-performing of the 11 major sectors in the broad index for 2017. Stocks including Facebook Inc., Apple Inc., Google parent Alphabet Inc. and Microsoft Corp. are up double-digit percentages in 2017.

"If reports are true and we are indeed seeing some pickup in global growth," Mr. Pavlik said, "then why wouldn't one expect these growth leaders to participate and continue to outperform?"

Write to Akane Otani at akane.otani@wsj.com

(END) Dow Jones Newswires

September 29, 2017 12:40 ET (16:40 GMT)