Navigating the TACO Trade: Can U.S. Equities Sustain Optimism Amid Trade Volatility?

The U.S.-China trade conflict has entered its eighth year, yet U.S. equities remain defiantly resilient. The S&P 500's 2.6% gain since the 2024 election defies intuition, sustained by a cocktail of sector adaptation, Federal Reserve patience, and the notorious "TACO trade" phenomenon. But as the June 2025 jobs report looms, investors face a critical question: Can this optimism survive deteriorating economic signals, or will the market finally succumb to the weight of unresolved trade tensions and a cooling labor market?

The TACO Trade: A Pattern of Precarious Optimism

The TACO trade—born from the maxim "Trump Always Chickens Out"—has become a cornerstone of equity strategy. Traders buy dips following tariff threats, betting on eventual policy reversals. Recent history validates this: in May 2025, U.S. tariffs on Chinese goods dropped from 145% to 30% under a 90-day truce, while China reciprocated by lowering retaliatory tariffs to 10%. The S&P 500 surged 0.4% that week, ignoring ongoing legal battles over steel tariffs.

Yet the TACO trade's longevity hinges on two fragile assumptions: that President Trump will continue to retreat from extreme tariff threats, and that markets can shrug off the cumulative drag of even "moderate" tariffs (now projected to settle at 15–17%). The latter is already materializing: a 10% tariff-induced trade cost increase raises core inflation by 0.3%, per Cuba-Borda et al. (2024), and persistent supply chain disruptions could erode corporate margins.

Labor Market: The Tipping Point

The TACO trade's recent success has been bolstered by Fed inaction. With PCE inflation at a 4-year low of 2.1%, the central bank has refrained from tightening, allowing equities to remain elevated. But the labor market is flashing mixed signals.

May's private payroll report of 37,000 jobs—far below the 110,000 estimate—hinted at a slowdown, while the May nonfarm payrolls report (due Friday) could confirm or disprove recession fears. A weak jobs report would amplify calls for Fed rate cuts, potentially buoying equities but underscoring economic fragility. Conversely, a strong report might revive inflation concerns, testing the market's faith in transitory tariff effects.

Analysts like Raymond James' Larry Adam warn that 30% tariffs are still punitive, and with U.S. GDP growth projected at just 1% for 2025, the economy is on a knife's edge.

Positioning Portfolios for the Crossroads

Investors face a pivotal week. Here's how to navigate it:

1. Monitor the Jobs Report Closely:
2. If Friday's data shows payroll growth < 100,000, expect Treasury yields to drop, the dollar to weaken, and equities to rally on Fed easing hopes. Overweight mid-caps (Russell Midcap Index) and value stocks (Russell 1000 Value Index), which have outperformed by 5.2% and 5.8% respectively since early 2025.

4. If the report exceeds expectations, prepare for rotation into growth sectors and reassess TACO trade assumptions.

5. Hedge Against Tariff Volatility:

6. Pair equity exposure with short-term Treasuries (e.g., TLT for duration) to buffer against geopolitical shocks. Consider adding gold (GLD) as a safe haven, given its 2025 surge to $3,375/oz amid trade tensions.

7. Target Sectors with Trade Resilience:

8. Focus on domestically oriented firms (e.g., IWR for regional banks, IVE for value stocks) and companies with diversified supply chains (e.g., United Airlines, which has reduced Chinese exposure).

9. Avoid Overexposure to Tariff-Exposed Sectors:

10. Steer clear of industrial and tech stocks heavily reliant on semiconductor imports until tariff rates stabilize below 20%.

Conclusion: The TACO Trade's Expiration Date

The TACO trade has thrived on geopolitical fatigue and Fed patience, but its sustainability is now tied to two variables: the labor market's health and the trajectory of trade negotiations. A weak jobs report could extend optimism via rate cuts, but it would also validate recession risks. Investors must balance the TACO trade's historical efficacy with the reality that even "muted" tariffs are no free lunch.

With the S&P 500 trading at a 22x forward P/E—30% below its 2021 peak—equities are not overvalued, but their resilience will depend on resolving the twin uncertainties of trade and labor. Position for volatility, prioritize sectors with defensive qualities, and await Friday's data to chart the next move. The TACO trade may still work, but its days could be numbered unless the U.S. and China finally deliver a lasting resolution.