The Trump trade comes unstuck

Last September, Donald Trump dismissed the buoyant US stockmarket as a "fat bubble", says Randall W. Forsyth in Barron's. But last week he was quite happy to take credit for the Dow Jones index's move past 20,000, an event that has been feverishly anticipated for months. Rarely has such a fuss been made about something so trivial, as John Authers points out in the Financial Times. "No sentient and sensible human being should base any investment decision on the Dow. Its methodological flaws are irremediable."

The problem is that a company's weighting in the index is based on its share price, rather than its market capitalisation (price multiplied by the number of shares in issue), which is the case with most indices. So a firm with a high share price is automatically more important in the Dow than a bigger and more important one that has more shares available, yet just happens to have a lower stock price.

For instance, thanks to its high share price (around $230) Goldman Sachs has a weighting eight times heavier than General Electric ($29), even though GE has three times the market capitalisation. Similarly, the Dow treats IBM as a far more important company than Apple.

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None of this is to say there has been no "Trump bump": the market-cap-weighted S&P 500, the widely watched US equity benchmark, has also hit a new record. Investors have rushed into the market in anticipation of tax cuts, higher spending on infrastructure, and deregulation, especially in the financial sector.

But this week brought a fresh reminder that "markets have been too willing to give Trump the benefit of the doubt", as Erik Nielsen of UniCredit told the FT. His travel ban on citizens from seven Muslim-majority states caused chaos, and there was more sabre-rattling against Mexico he is contemplating a 20% import tax to pay for his proposed wall on the border. All this signalled he could "turn his populist and protectionist campaign into bad policies".

Stocks slipped early this week as the president's erratic policy-making took centre stage, and they remain vulnerable to further setbacks. Quite how much of Trump's proposed stimulus will survive scrutiny in Congress is unclear, especially given the antipathy between Trump and the leaders of the House of Representatives and Senate.

Launching a trade war could both damage growth and drive up inflation as import prices climb. With earnings making a slow rebound from last year's decline and valuations extremely high, there is precious little margin for error. Bullish investors may wish to consider a safer way to play the Trump trade than Wall Street (seeRussian stocks will get the best of the Trump bump)