Vanguard's ETFs Regain Strength Following Trump's Return to the White House. Should Investors Remain Cautious About the Recovery?
In the run-up to Donald Trump's second term as U.S. president, several stocks saw a surge, yet bonds took a hit. For instance, the Vanguard Long-Term Bond ETF (BLV) and the Vanguard Long-Term Corporate Bond ETF (VCLT) slid by nearly 8% and 7.9%, respectively. A surprise turn of events unfolded when these ETFs rebounded during Trump's first days back in office. But should investors view this as a sign that the bond market is back on track, or should they tread cautiously?
Why the Rebound?
To get to the bottom of this, let's start by understanding why these ETFs initially struggled. The price of a bond fund is directly influenced by the underlying bond prices. Bond prices generally decrease when yields increase, and vice versa. Ordinarily, bond yields mirror interest rates, so when the Federal Reserve cut interest rates at the end of 2024, one would expect bond yields to decrease and prices to rise. However, this didn't happen for long-term bonds like BLV and VCLT.
The reason behind this anomaly lies in the forward-thinking nature of bond investors. While the Fed was cutting interest rates, these investors were worried about an imminent rise in inflation. This concern stemmed from the potential impact of Trump's proposed tariffs. During his campaign, Trump pledged to impose tariffs of up to 20% on all U.S. imports and even higher tariffs on goods from certain countries. He also announced plans to impose 25% tariffs on Canadian and Mexican imports on his first day in office.
But why did these ETFs rebound during the initial days of Trump's second term? While Trump did issue several executive orders, none of them introduced new tariffs.
Should Investors Worry about the Bounce?
Although the Vanguard ETFs showed signs of recovery, investors should approach this rebound with caution. The main reason for the potential post-bounce downtick lies in Trump's continued push for tariffs.
Shortly after his inauguration, Trump announced his commitment to an "America First" trade policy. He directed the secretary of commerce, in consultation with the secretary of the treasury and the U.S. trade representative, to propose measures to address trade imbalances. Trump also signaled his intent to implement tariffs on products imported from Canada and Mexico on February 1 and threatened to levy a 10% tariff on goods from China.
Many leading economists believe that these tariffs could lead to inflation. If they're right, this could have negative consequences for bond prices and ETFs like BLV and VCLT.
A Better Vanguard ETF to Buy
Given these developments, it might be wise for investors to steer clear of long-term bond funds for now. But is there a Vanguard ETF that could be a more attractive option? I believe so: the Vanguard Financials ETF (VFH).
This ETF owns 490 financial stocks, with prominent holdings such as JPMorgan Chase, Berkshire Hathaway, Mastercard, Visa, and Bank of America. These stocks could potentially benefit significantly from deregulation and potential corporate tax cuts during Trump's second term.
While there's no guarantee that VFH will be a hit in the near term, it's a safer bet than Vanguard's long-term bond ETFs, in my opinion.
[1] Enrichment Insights:
Several factors contributed to the resilience of the Vanguard Long-Term Bond ETF and Vanguard Long-Term Corporate Bond ETF despite the concerns over Trump's proposed tariffs and potential inflation. Firstly, the week saw mixed economic data, which contributed to market volatility but also offered some positive signals. Encouraging January PMI activity data in Europe slightly reduced rate cut expectations, indicating some stability in economic fundamentals.
Secondly, credit markets demonstrated resilience. Credit spreads tightened, pushing credit indexes further into positive territory, with U.S. investment-grade credit performing well due to a 2bps tightening in spreads and support from U.S. Treasury gains. High-yield credit also tightened by 6bps, reaching its tightest levels this year, thanks to strong investor demand and robust primary market conditions.
Emerging market bonds also performed well, driven by declining U.S. interest rates, a weaker dollar, and the absence of major trade tariffs from the Trump administration. Local currency debt in emerging markets also showed strong gains due to the dollar's decline.
Technical factors also played a role in the rebound. Positive inflows into both investment-grade and high-yield funds accelerated, indicating continued investor confidence. European credit markets outperformed their U.S. counterparts, with investment-grade spreads tightening and high-yield spreads contracting, as recovering economic momentum spurred optimism.
Lastly, the overall market sentiment was influenced by the anticipation of a status quo on Fed Funds rates at the upcoming FOMC meeting and reassuring comments from the Swiss National Bank (SNB) president on inflation in Switzerland, contributing to market stability.
After the initial struggle of the Vanguard Long-Term Bond ETF (BLV) and the Vanguard Long-Term Corporate Bond ETF (VCLT) due to investor concerns about potential inflation caused by Trump's proposed tariffs, their rebound during Trump's second term can be attributed to the absence of new tariffs being introduced. However, investors should remain cautious as Trump's continued push for tariffs could negatively impact bond prices and these ETFs in the future.
Given this uncertainty, Vanguard's Financials ETF (VFH) could be a safer alternative for investors. With holdings in prominent financial stocks such as JPMorgan Chase and Bank of America, VFH could potentially benefit from deregulation and corporate tax cuts during Trump's second term.
