There's been a lot of talk over the past few months about a potential unwinding of the so-called Trump Trade, which sent stocks, particularly ones in industries likely to benefit most from the current administration's policy leanings, soaring in the wake of the presidential election. This talk no doubt makes bank stock investors nervous, as the financial services industry has been among the biggest beneficiaries of the Trump presidency. But is there actually a reason to be concerned?

This certainly isn't a five-alarm fire, as the market goes up and down every day, but I would argue that investors should indeed be prepared for the Trump Trade to unwind -- at least partially. While it may not happen, investors would be smart to keep the possibility in mind.

A rope unwinding.

Image source: Getty Images.

Some banks would suffer more than others

Most bank stocks would suffer if this were to happen, but some more so than others. You can see this by looking at the KBW Bank Index, which tracks two dozen of the nation's biggest banks. The index itself is up 27% since the beginning of November -- right before the presidential election. But that's an average, meaning that some bank stocks on the index are up more than others.

The best-performing bank stocks on the index are Bank of America (NYSE:BAC), Citigroup (NYSE:C), PNC Financial (NYSE:PNC), and JPMorgan Chase (NYSE:JPM). One would assume, in turn, that these would be the most vulnerable to any unwinding.


Stock Performance Since Nov. 1, 2016

Bank of America




PNC Financial


JPMorgan Chase


Data source:

Four ways the Trump Trade could unwind

It's hard to say for sure what would trigger such an unwinding, but we can certainly make an educated guess. In the first case, investors might come to the conclusion that stocks in general are too high right now. According to the most commonly cited large-cap stock valuation measure, Robert Shiller's cyclically adjusted price-to-earnings ratio, stock valuations have been higher than they are today only twice in history: in 1929 and 2000. That isn't a good sign, as those peaks were soon followed by dramatic market declines.

Another reason the Trump Trade could unwind is that the economy could enter a recession. It's impossible to predict when a recession will occur, but they are inevitable. Moreover, recent data seems to point to a decelerating economy. Just this week we learned that inflation and retail sales came in lower than expected in May. This could be a temporary drop, but it could also be the beginning of an economic contraction, as both measures are considered to be leading indicators.

Bar chart showing recently monthly inflation figures.

Data source: U.S. Department of Labor. Chart by author.

This would hurt Bank of America, Citigroup, PNC Financial, JPMorgan Chase, and other banks in two ways. First, it would reduce the demand for loans, which is the principal product sold by banks. This would lower revenue. And second, a recession would cause an increase in loan losses, as businesses and consumers impacted by the downturn struggle to pay off their debts. This would increase credit costs and thus eat into profit.

A third reason the Trump Trade could unwind is that Donald Trump's vows on the campaign trail may not translate into legislation. It remains to be seen, for instance, whether they can cut corporate taxes as much as Trump promised, dropping the tax rate for corporations from 35% down to 15%. The same is true for his proposed infrastructure spending, which, holding all else equal, would serve to ignite a more robust recovery. Finally, while House Republicans recently passed a bill that goes a long way toward dismantling the Dodd-Frank Act of 2010, it remains to be seen whether the so-called Financial CHOICE Act can make it through the Senate.

Finally, investors shouldn't rule out the potential impact from the turmoil in the nation's capital. If the ongoing investigation into the Trump campaign's interactions with Russia does indeed reveal an illicit connection, then it seems fair to assume that the Trump Trade would be in jeopardy.

And, of course, another possibility is that none of these things happen and that shares of Bank of America, Citigroup, PNC Financial, JPMorgan Chase, and other banks continue to ascend. I'm skeptical of this thesis, but it's not outside the range of what's possible. Either way, it's my opinion that investors have more to gain than to lose from waiting for a potential pullback in bank stocks before piling further into the sector.