Reflation Trade: Major Investor Opportunity Ahead?

The financial market cycle that followed the great financial crisis of 2008-2009 was associated with sharply declining inflation expectations. Long-term nominal GDP expectations slowed, as did revenue growth in the corporate sector outside of the technology area.

The period since 2009 can certainly be described as deflationary. We had significant declines in interest rates over this period, with massive monetary stimulus and now massive fiscal stimulus as a response to COVID-19.

The net effect of all of this is shown in the chart below which spans the years 2009-2020. As seen, financial asset price returns have far exceeded real economy price returns.

The variance is really quite striking when presented in the way this chart shows the return relationships.

The shift towards the combination of huge monetary support and fiscal expansion, which we have undergone over the past several months, coupled with a very strong synchronized economic rebound as COVID-19 vaccination take hold, in my opinion raises the probability of a reflationary cycle start to build.

If this were to start to play out, this chart will start to tip in a see-saw fashion.

The right-hand side of the chart will slowly start moving up (higher interest rates, higher commodity prices, higher inflation), while the left-hand side slowly starts moving down (slowing equity market returns, slowing bond market returns, possible reversal of tightening high yield credit spreads).

Mean reversion

How might investors take advantage of this reflationary rotation in the markets? Proactive positions in asset classes such as commodities, including industrial and precious metals, agricultural products, food items, energy, etc. come to mind.

Additionally, although the housing market has certainly been robust for several quarters now, having a position in real estate would qualify as well.

The great Peter Allen song entitled “Everything Old is New Again” might seem to apply to this situation. Welcome to the world of financial markets and reversion to the mean!

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Gary has more than 30 years of industry experience, which includes research analysis and portfolio management for both retail and institutional accounts. He worked as a Senior Vice President at Wells Fargo Advisors and Wells Fargo Investment Institute for approximately 14 years in total, where he was a senior portfolio manager for both equity and asset allocation portfolios. He was also involved in investment manager due diligence and selection for the firm’s multi-manager portfolio models. Prior to joining Wells Fargo, Gary held senior-level investment management positions with several registered investment advisory organizations. He has been a Chartered Financial Analyst (CFA®) charter-holder since 1989. The CFA is a professional credential earned by investment management professionals after successfully passing three years of rigorous examinations and recording several years as a practising professional within the industry. Gary received his Bachelor of Science in Engineering from Purdue University and his M.B.A. in Finance from The University of Missouri. Additionally, Gary holds his FINRA SIE, Series 7 and Series 66 securities registrations as well as his Missouri Life Accident & Health insurance license. He is a member of the CFA Society of St. Louis and the Financial Executives Networking Group. He resides in Kirkwood, MO with his wife Kathy, and they have three adult age children, Aly, Ryan and Josh.