At this point, my view is that most of the market activity since the election can really be broken down into two distinct categories.
The first category are stock sectors that clearly stand to win or lose from expected changes in government policy. The most obvious winner is bank stocks, which will benefit from lighter regulation. The big loser is hospital stocks that will lose Obamacare related revenue.
The second category is broader and includes all kinds of assets from emerging markets stocks and REITs to government bonds.
While you can make the argument that the rout in emerging market stocks is policy related, I actually think that there is something larger going on – what traders are calling the ‘reflation trade.’
Generally, reflation refers to the first phase of an economic recovery following a contraction and can be the result of fiscal or monetary policy stimulus.
Although the US has been in contraction mode since 2009, the growth has been extremely sluggish with almost no inflationary pressure. Trump is promising stimulus in the form of large infrastructure spending projects and lower taxes, both of which should spur growth and inflation.
The most basic element of the ‘reflation trade’ is to buy stocks and sell bonds, which we’ve seen in spades since the election; but other elements include a stronger dollar and some commodity prices, such as copper.
Additionally, if bond prices are falling, which means that interest rates are rising, then stocks that are rate sensitive should also fall. For example, the S&P Utilities index has fallen -5.77 percent in the last week.
It’s unclear how long the reflation trade will last and as I’ve noted a few times in the past few days, I think that there is a lot of noise in both stock and bond prices right now.
It’s quite possible that the reflation trade will carry on for a few years, but right now there aren’t a lot of details and we’ll just have to wait and see what actually shakes out between the new administration and Congress.