The TACO trade - the week ahead

Important information -  the value of investments and the income from them can go down as well as up, so you may get back less than you invest.

Shares have bounced up against the top of their recent, wide trading range and the reason has been neatly captured in a four-letter acronym that’s caught the imagination of the investment world.

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Anyone for TACOs?

Coined by a Financial Times journalist, Robert Armstrong, TACO stands for ‘Trump Always Chickens Out’. It refers to a now well-trodden policy path: the US President announces a big, bold policy; markets respond badly; the White House retreats; markets recover.

We’ve seen several iterations in recent weeks. The first big U-turn was a week after the ‘liberation day’ trade tariffs were unveiled in early April. Within days, the measures were postponed after shares registered a 20% fall from their February highs. At around the same time, a threat to fire the Fed chair Jerome Powell, was quickly retracted, reassuring markets.

Then most recently the announcement of Trump’s ‘Big Beautiful’ tax bill confirmed what cynical investors had long believed that they had been wrong to take Trade War Trump too seriously. Tax Cut Trump had not gone away and the buy the dip crowd were vindicated. Fiscal extravagance continues and that, in the short-term at least, is good for the stock market.

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Trading range or renewed bull market?

So, at the top of the recent range, the big question is whether shares have bounced against the top of an ongoing trading channel or are poised for further gains?

Rapid recoveries from 20% falls have, in the past, signalled a bearish shock in a continuing bull market. Other positive pointers include reasonably strong earnings growth, cautious sentiment and lots of liquidity. Fiscal expansion is driving strong growth in the amount of cash sloshing around the global economy and that tends to be a positive for equity markets.

The counter to this optimistic narrative focuses on the bond market. Equity investors like liquidity but bond investors worry about it because it leads to rising deficits which have to be funded with the issue of ever more government bonds. With the buyer of last resort - central banks - now out of the picture the laws of supply and demand point to yet higher bond yields. And higher bond yields not only reduce bond prices (they move in opposite directions), they make shares less attractive relatively speaking too.

History shows that when the usual relationship between bonds and shares prevails, a bond yield of more than 5% usually implies a price-earnings ratio for shares of around 17 or 18. That’s well below the current ratio in the early 20s and suggests a fall of 15-20% for the stock market before shares are obviously attractive again.

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Is it different this time?

One way in which things might be different this time around is in the relationship between the US stock market and the rest of the world. For the first time in many years, investors are starting to question the narrative of US supremacy in economic and financial market terms.

So, a correction in the US market may not be mirrored in the rest of the world, where valuations are cheaper and the impact of protectionist US policy may be less damaging. Investors are warming to markets in Europe, including the UK, Japan and even China. And they are taking a second look at out of favour investment styles too. After years in which big US growth shares have been the default investment, out of favour value shares - low valuations, higher yields, lower growth - are back in the spotlight.

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On the radar this week

Two big announcements will grab the headlines this week. First, the European Central Bank will announce its latest interest rate decision on Thursday. Anything less than another quarter point cut will be a big surprise. That will take the cost of borrowing down to 2%, half its level a year ago when the ECB started to cut.

Then on Friday, we see how the US labour market is holding up to the shifting policy sands in the US. Non-farm payroll data is expected to show 130,000 new jobs were created in May, down from 177,000 in April and half the 272,000 created a year ago. A slowing jobs market is inevitable given continuing recession fears, but one of the big surprises of the past few years has been the resilience of America’s corporate sector.

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