Sentiment needs to get more negative for a real TACO trade to emerge
Subscribers to Chart of the Week received this commentary on Sunday, June 8.
Since ‘Liberation Day,’ the S&P 500 has made six moves to the downside of 2% or more and six upside moves of 2% or more. Welcome to 2025, where whiplash is a common side effect to seemingly endless tariff rhetoric and global uncertainty.
A new wrinkle to the tariff drama unfolded a few weeks ago, when the Financial Times coined the TACO moniker, ‘Trump Always Chickens Out.’ This refers to the whipsaw price action on Wall Street where markets sell off when tariffs are announced, then bounce back when trade deals – featuring much lighter tariffs than initially imposed – are announced in the subsequent weeks. TACO has become a hub for quantitative analysts everywhere, flooding the internet with think pieces detailing TACO, Trump puts, and even Trump collars that track the President’s tariff volatility. It’s additive information for any investor, but we want to unpack it a little more, because its not as easy as rinsing and repeating.
The next 40 days will really put TACO to the test. Will another massive rally materialize if a trade deal with China is announced? Or if the EU deadline gets pushed back again? Markets are in a different place than the spring. Take the recent developments; the TACO gag reached critical mass on Friday May 30, when a CNBC reporter had the temerity to ask the President about the phrase, which led many to consider whether he would begin to dig his heels in on negotiations. Right on cue, Trump announced additional steel tariffs on the European Union (EU). At the same time, he re-engaged barbed rhetoric with China about their own trade deal.
However, the broader market didn’t deflate from any of this. All three major indexes notched their second-straight weekly win. The S&P 500 Index (SPX) has retaken its year-to-date breakeven level, as well as the psychologically-significant round-number 6,000. Wall Street’s “fear gauge,” the Cboe Volatility Index (VIX), has fallen in six of the last seven sessions, including the Monday when the EU tariffs were announced. Equity markets only know how to rally it seems, even as the July 9 deadline for EU tariffs looms.
If stocks keep climbing in the next 40 days, and trade deals are either announced or kicked down the road again, will there be as robust of a rally as we just saw? Overly negative sentiment getting wringed out was the fuel that ignited the May rally; TACO is essentially a politically-charged version of ‘buy the dip.’ But what if there’s no dip? That will depend on how investors feel, and they’re starting to get uneasy again.
Heading into Liberation Day, per the chart below, the American Association of Individual Investors (AAII) survey showed bearish sentiment ramped up as high as 60% in favor of bears in late February. The current reading is at 41.4% bearish, up from the May 21 lows of 36.7%. The higher that number gets, the greater the chance the market can mimic the TACO trade.
Options trends are also starting to shift back toward that early 2025 skittishness that set up the TACO rallies. Roughly 20% of SPX components boast a 10-day put/call ratio above 1.0. On Thursday, the SPDR S&P 500 ETF Trust (SPY) saw a massive weekly 7/25 put spread on the 465- and 480-strikes cross the tape. Earlier in the week, there was a massive buildup of SPY put open interest. Hunkering down even as milestones like 6,000 are reclaimed shows how seriously options traders take geopolitical uncertainty.
On Thursday, Bloomberg said the U.S. is “walking the recessionary gangplank.” Hard data is starting to quantify the impact of tariffs and just how thin of ice the economy is on. The confluence of retail giants pulling their 2025 guidance is a smoking gun. All it takes is a sticky consumer price index (CPI) reading for June, a subsequent bond yield spike, sprinkle in some cautious Fed rhetoric, and markets are back in a tailspin leading up to the tariff deadline. The climate could be ripe for another TACO trade, in which you rinse and repeat from the spring and scoop up beaten down tech on the dip.
But what if the ever-volatile Trump barrels through the deadline without any deals? If stocks are so resilient now, maybe Trump –because he cares so much about the stock market and his perceived role in it -- becomes emboldened that he can have his tariffs and stock market gains too. If that’s the case, recent price action has supported the case to target sectors that produce domestically already. A major overhang to U.S.-China talks is rare-earth magnets, a key component to defense, electric vehicle (EV), and semiconductor sectors. MP Materials Corp (NYSE:MP), the U.S.’ leading rare-earths producer, is intrinsically tied to tariffs, given China controls 90% of the world’s supply. When the two superpowers locked horns and China froze rare-earth exports, MP traded as high as $29.72. When deadlines were extended and reprieves announced, the stock within the same month as that peak traded as low as $18.75. You can visualize this volatility with the size of the daily candles in the chart below.
On Friday, MP was upgraded by Morgan Stanley to “overweight” from “equal-weight,” with a price-target hike to $34 from $23. But in the ensuing hours, China granted a six-month export license to rare earth suppliers of Ford Motor (F), General Motors (GM), and Stellantis (STLA). All three auto stocks extended their gains on the news, while MP pivoted into the red, a stark reminder of how quickly an investing narrative can change when geopolitics are a major catalyst. But with 20% of the stock’s total available float sold short, a short squeeze could send MP ripping higher should setbacks in U.S.-China relations result in permanent levies.
On Monday, U.S.-based steel stocks Cleveland-Cliffs Inc (NYSE:CLF) and Steel Dynamics Inc (NASDAQ:STLD) added 23% and 10.3%, respectively. Both CLF and STLD have a ways to go on the charts but are names to watch in the event Trump digs his heels in on his EU tariffs. U.S. Steel (X) melted up on May 23 when the Nippon merger was announced and is another player to be mindful of, as are Deere (DE) and Caterpillar (CAT).
Tracking tariff rhetoric – and the sentiment shifts it brings -- means being comfortable with outsized swings in either direction. If you don’t want to time the direction, options strategies like straddles, strangles, and iron condors offer directional neutrality but can capitalize on volatility. Whatever the move, maybe instead of ‘Trump Always Chickens Out,’ adhere more to ‘Tariffs Always Create Opportunity.’