The Resurgent TACO Trade and Tactical Allocation in a Fractured World

The so-called "TACO trade"-a speculative strategy rooted in the expectation that President Donald Trump will eventually "chicken out" of aggressive tariff actions-has resurged amid escalating U.S.-China tensions. This trade, which involves buying the dip in equities and hedging against short-term volatility, has historically capitalized on the cyclical nature of Trump's trade policy announcements. However, as the geopolitical landscape evolves and Trump adopts a more confrontational stance, investors must reassess the risks and opportunities embedded in this strategy.

The TACO Trade: Mechanics and Historical Performance

The TACO trade derives its name from the recurring pattern of market reactions to Trump's tariff threats. When Trump initially imposes tariffs, global equities often dip due to fears of trade war escalation. However, markets have historically rebounded when these threats are delayed or softened, creating a predictable cycle for tactical investors. For instance, in April 2025, the S&P 500 fell sharply after Trump announced sweeping tariffs on Chinese imports but rebounded when he paused them for 90 days. Analysts like Charlie McElligott of Nomura estimate that shorting S&P 500 futures during such escalations and buying them five days later could yield a 12% returnWhy the 'TACO' Trade Is Tempting Investors Amid US-China Talks^[1].

This strategy has been particularly effective for stocks with global supply chains, such as Marvell Technology, Target, and Lululemon, which benefit from de-escalated trade tensionsThe TACO Trade: What it Means and 8 Ways to Play It^[2]. However, the TACO trade's efficacy is now under threat. Trump's recent warnings of 30% tariffs on the EU and Mexico, coupled with his refusal to retreat from aggressive rhetoric, suggest a shift in his approach. As JPMorgan CEO Jamie Dimon warns, complacency about this trade could backfire, leading to prolonged volatilityTACO trade backfires on Wall Street as Trump charges ahead^[3].

Historical Context: Lessons from 2018–2020 and 2025

To evaluate the TACO trade's viability, we must examine historical market behavior during prior U.S.-China conflicts. During the 2018–2020 trade war, Treasury yields and Chinese A Shares exhibited divergent trends. U.S. 10-year Treasury yields flattened by 12 basis points during trade war escalations, reflecting flight-to-safety demandFinancial Market Implications of the Trade War between the United States and China^[4]. Meanwhile, the NASDAQ China A Shares Index (^NQCNAP) experienced sharp volatility, with profit margins for Chinese exporters dropping by 0.35 percentage points for every 1% increase in U.S. tariffsHow Did the 2018 U.S.-China Trade War Affect China's Exporters?^[5].

Commodities also reacted to trade tensions. In 2024, Brent crude oil averaged $75 per barrel, down from previous years, as demand from China weakened. Base metals like copper and aluminum saw temporary recoveries in late 2024 due to Chinese stimulus measures but stabilized in 2025 amid moderate industrial growthThe Commodity Markets Outlook in Eight Charts^[6]. Offshore assets, particularly the USD/CNH exchange rate, displayed heightened volatility, reflecting capital outflows and geopolitical uncertaintyUS-China Trade War 2018: Background, Economic Impact^[7].

Tactical Allocation in a High-Risk Environment

Given these historical patterns, tactical allocation strategies must balance the TACO trade's potential with hedging against downside risks. Here are three key considerations:

1. Equity Exposure with Selective Hedges: Investors can overweight stocks benefiting from de-escalated trade tensions (e.g., global exporters) while using options or futures to hedge against sudden tariff announcements. For example, buying call options on the S&P 500 during dips could capture rebounds while limiting downside riskWhy the 'TACO' Trade Is Tempting Investors Amid US-China Talks^[1].

2. Duration Management in Fixed Income: Treasury yields have historically risen during trade escalations as investors seek safety. Extending bond durations or tilting toward short-term Treasuries can mitigate interest rate risks. Conversely, Chinese government bond yields have trended lower, reflecting pessimism about China's economic outlook, making them less attractive for hedgingChina 10-Year Government Bond Yield - Quote - Chart - Historical Data^[8].

3. Commodity Diversification: Commodities like gold and safe-haven assets (e.g., Swiss francs) have gained traction as geopolitical risks rise. Meanwhile, energy and industrial metals remain vulnerable to supply chain disruptions. A diversified commodities portfolio, weighted toward defensive assets, can offset equity volatilityThe Commodity Markets Outlook in Eight Charts^[6].

The Risks of Complacency

The TACO trade's success hinges on the assumption that Trump will eventually back down-a premise now in question. As GMO's Ben Inker notes, the absence of market reactions to check Trump's aggression could lead to a self-fulfilling trade war, with broader economic consequencesHow the TACO Trade Could End Up Backfiring on Investors^[9]. Investors must also consider the impact of China's domestic challenges, such as its real estate crisis and slowing growth, which could amplify the fallout from trade tensionsChina-US Tensions Fuel Hopes for Return of 'TACO' Trade^[10].

Conclusion

The TACO trade remains a compelling, albeit high-stakes, strategy in a world of geopolitical uncertainty. However, its effectiveness is contingent on Trump's evolving approach to tariffs and the broader economic context. By combining historical insights with tactical allocation-balancing equity exposure, fixed-income duration, and commodity diversification-investors can navigate the volatile landscape of U.S.-China tensions. Yet, as the 2025 escalations demonstrate, complacency is a dangerous assumption in an era of unpredictable policy shifts.