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The TACO that ate market strategy
Today’s Points: •There are no new peace talks, and the stock market doesn’t mind. •Which makes sense because Trump extended the ceasefire anyway. •Commodity prices (not just oil) suggest rising reason for concern.
When’s the Retest? The news that Vice President JD Vance wouldn’t be flying back to Pakistan for renewed peace talks with Iran, shortly before the ceasefire was due to expire, broke only minutes before the end of Tuesday’s trading on Wall Street. The stock market’s response: “I don’t care.” Or maybe, “I’m so bad baby, I don’t care.”
Crude oil prices surged, with Brent topping $100 for the first time in seven trading days. But the inverse relationship between oil prices and US stocks ended two weeks ago when the pause in hostilities was announced, and nothing — not even the continued blockage of the Strait of Hormuz or failure to advance the peace talks — could bring it back. A sharp rise in crude was balanced by only a muted fall for stocks:
If there’s a good basis for traders’ relaxed approach, it lies in a reading of the balance of risks and how they appear to President Donald Trump. The argument seems to go as follows.
First, a messy compromise in which Iran extracts tolls from ships passing through the Strait and life otherwise carries on would not be great, nor a worthwhile return on Washington’s decision to go to war, but capital markets could live with it — much as they have lived with the conflict in Ukraine. The world is de-globalizing anyway, and this just throws yet more sand into the wheels of trade.
Second, what markets really couldn’t tolerate would be an escalation involving a US ground operation and Iranian attacks on Gulf energy infrastructure. That would be a disaster. It can only happen if Trump decides, and he’s threatened it on several occasions. But the ceasefire has shown that he’s more concerned to find an off-ramp. Convinced that this meant that there would be no escalation, stocks have had space to surge (even without reopening the Strait). In the argot of the moment, the TACO trade is on; Trump is being relied upon on to “chicken out” and save markets from the worst.
As if to confirm this reasoning, the bad news that Vance’s trip had been called off was followed within 30 minutes by Trump announcing that the ceasefire would continue indefinitely until Iran offers a new proposal. This is how that drama played out in markets:
It was an instant victory for the TACO traders, and anyone who took part in the brief selloff at the end of the afternoon must be kicking themselves.
But there may be more to the market shrug, because it fits into a new pattern of behavior that has become the norm in this decade. These days, when the market sells off and then starts a rally, it just keeps rallying. ’Twasn’t ever thus.
To be clear, there isn’t a big sample of S&P 500 selloffs of more than 10%, but there’s nothing we can do about that. Yet over four decades leading up to the pandemic, the pattern was clear. London’s Longview Economics published this analysis back in 2020:
In almost all pullbacks, equity indices retest their lows from the initial “wave” of selling… the history of stock market pullbacks has a compelling message: Since 1978, there have been 15 S&P 500 corrections in bull markets in which the initial pullback was 10% or greater. In 13 of those corrections, the index retested its low (i.e. 87% of the time).
The two exceptions were both relatively minor selloffs that didn’t involve a macroeconomic shock, so a retest after a major correction and rebound seemed close to a given, part of the mechanics of markets and the crowd psychology that underlies it. Sentiment moves in waves, and technical analysts (sometimes known as chartists) have grown rich navigating such predictable moves.
However, since that passage was published, there have been five such selloff-and-rebounds (including the current one), and none has been retested. The pandemic somehow moved the retest rate from 87% to 0%. The small sample includes some substantial alarms — the pandemic itself, the Silicon Valley Bank crisis, the carry trade unwind in 2024, Liberation Day, and now the Iran war. And yet never once has the market questioned a judgment once traders have decided that risk is back on. How?
“You used to have retests and you used to have a sense of capitulation at the low,” says Longview Economics’ Chris Watling. Not any more. Instead, he finds hedge funds are putting tighter restrictions on their managers, while the wave of new retail investors who entered during the pandemic are committed to the notion of “buying on the dip.” All of this creates a herd, which tends to move in one direction.
Under Trump, that has morphed into blind obeisance of TACO. Peter Atwater of Financial Insyghts points out that the notion has become ubiquitous: “What started as an event a year ago became a pattern, became a trend, and is now a certain trend that can be extrapolated.” Confidence in the TACO trade is now so strong that “ChatGPT can and will tell you how you can maximize your financial return from it.”
To prove this, he asked for advice on dealing with Trump. The bot raised no concern about retesting lows. Instead, after a long exegesis, it concluded:
The big insight This isn’t random — it creates a tradable rotation pattern: • “Fear trades” → energy, defense • “Relief trades” → tech, consumer, growth That’s why some traders actually anticipate these swings rather than just react.
It’s possible that the automated buy-the-dip behavior can be attributed to a newfound reliance on AI. It’s certainly true that the tendency to buy and never rethink the dip has become almost an automated reflex, when for generations the conditioned reactions were different.
\[The above was an excerpt from John Waters' Point of no Return via Bloomberg\]