Wall Street has been abuzz with the "Trump trade," as investors pour money into stocks and assets tied to the policies of the former president. However, history has shown that basing investment decisions solely on campaign promises can be a risky proposition. As the market continues to react to the political landscape, it's crucial for investors to approach these opportunities with a measured and informed perspective.

Proceed with Caution: Lessons from Past Policy Shifts

The Allure of Small-Cap Stocks

Small-cap stocks, as represented by the iShares Russell 2000 ETF (IWM), were initially expected to benefit from Trump's pro-business policies. In the immediate aftermath of the 2016 election, small-caps outperformed the S&P 500 by 8%. However, this outperformance was short-lived, as the asset class gained only a bit more than 2% relative to the broader index one year after the election. In fact, over the entirety of Trump's term, small-caps tumbled more than 22%. This month, the IWM has surged 9%, but investors should be cautious about extrapolating long-term gains from such short-term movements.

The Real Estate Conundrum

The Real Estate Select Sector SPDR Fund (XLRE) was also expected to benefit from Trump's promises to cut regulations and loosen permitting requirements in the housing market. However, the reality proved to be quite different. In the immediate aftermath of the 2016 election, the XLRE fell more than 4% relative to the S&P 500. Expanding the timeline to one year out from the election, the ETF underperformed the broader index by 11%. Over the entirety of Trump's term, the real estate sector tumbled more than 40%. This month, the XLRE is slightly down, underscoring the need for investors to look beyond short-term market reactions.

The Volatile Energy Sector

Energy stocks, represented by the Energy Select Sector SPDR Fund (XLE), were expected to receive a significant boost from Trump's pro-energy policies and his promise to "drill, baby, drill." However, the sector was a sore spot for the duration of Trump's presidency. On Election Day 2016 through the remainder of that year, the XLE gained 4% relative to the S&P 500. But one year from that election, it tumbled 11%. Across Trump's entire four-year term, energy stocks plunged. This month, the XLE gained 7%, but investors should be wary of extrapolating long-term trends from such short-term fluctuations.

Broader Economic Factors Matter More

While a candidate's policies can be consequential, they should be weighed against broader economic factors, such as overall growth, earnings expansion, and the course of interest rates, which more directly influence the equity market. As the Wells Fargo Investment Institute note suggests, "For those investors hoping campaign promises translate into policy-targeted asset outperformance, we would urge caution."

The Importance of Diversification and Patience

The lessons from the past suggest that investors should approach the "Trump trade" with a healthy dose of skepticism and a focus on diversification. Rather than chasing short-term market movements, investors would be better served by maintaining a well-balanced portfolio and a long-term perspective. By doing so, they can navigate the political landscape and capitalize on genuine opportunities, rather than falling victim to the allure of campaign promises.