As we end this week with a strong 7% plus gain in the S&P 500, it is clear that the reflation trade is back on. These are generally stocks characterized as benefiting from rising inflation, which would be welcomed by some at this point in time. The usual suspects in this group include commodities and commodity related stocks, and emerging markets. Metals and Mining and steel stocks soared 15% this week, and natural gas posted a strong 13% in four days to provide some examples. So why was there a stampede back into these positions?
One reason is simple – the dollar has fallen this week due to increased action at the Federal Reserve. In the four weeks prior, the Federal Reserve held steady on its Quantitative Easing program and they did not increase their balance sheet. Now, this week the Federal Reserve increased its balance sheet by $80 billion mostly through Mortgage Backed Security purchases. This caused a 1.5% drop in the dollar and due to negative correlations commodities and related stocks were bought.
Secondly, perhaps the rebound in the Chinese economy contributed to the renewed enthusiasm for emerging stocks. The growth for the second quarter came in at an annualized rate of 7.9% which is stunningly close to the hoped for growth rate of 8%. (Insert generic disbelief about China economic statistics) This was enough to allow Chinese economists to declare that the ‘downturn has been successfully reversed’ and they are ‘leading the turnaround in the global economy.'
I’m sure there are other reasons behind the surge as well, but one thing for sure is that it occurred. Now it is time to see for how long.
