As the dollar has fallen, it has helped ignite a trade that is commonly referred to as the “reflation” trade. Reflation is the act of stimulating the economy via monetary and fiscal stimulus to expand output. Typically as the stimulus is applied, lower real interest rates and deficit spending combine to weaken the currency, which makes exports cheaper and in turn fuels growth. We consider a number of sectors and asset classes to be particularly sensitive to reflationary policy as well as a weak dollar, including certain US equity sectors (like materials, energy, and industrials), emerging markets stocks, commodities (such as oil, copper, gold, etc.), and other hard assets like property. If one looks at the performance of those assets since the March bottom in stocks (shown in the table below), it’s clear that reflation trades have outpaced the broad market. But beware, since even strong market trends are subject to periodic adjustments, and these reflation trades have reached a point where they seem vulnerable if the markets correct and the dollar bounces.
Our current view is that the cyclical bull market in stocks has not yet fully run its course. At the same time, some of the shorter-term technicals we monitor appear stretched, and a healthy correction would not be surprising. Should that occur, we won’t be surprised to see short term fireworks in the dollar and reflation trades.
