How to Profit from the Reflation Trade

When macroeconomic indicators show neither inflation nor deflation, what happens to our currency? Reflation!

Although the United States, through its monetary and fiscal policy, has added trillions of dollars to the financial system, consumer prices and other aspects of the economy show deflation, as consumers purchase less and value products at lower amounts.

Inflation Imminent

Inflation is the black cloud hanging over the market, which is getting ready to pounce. The mathematicians at the Fed say inflation isn't occurring; prices are low, but we have yet to see consumers spend money. Secondary inflation, including rising prices, only begins after the general populace has a willingness to spend money.

Compare the modern day to 1970’s stagflation; after everyone realized that the money supply was inflating, they started spending their money to make sure their currency wasn't worth less the next month.

What's a Good Reflation Investment?

Any financial instrument that is not currency-based is a good investment for the reflation trade. At this point in time, the most attractive investments are both gold and inflation protected treasury bonds, or TIPS. However, remembering back to 2002 when the reflation trade was again present, stocks fared relatively well as the economy improved.

Banks Benefit the Most from Reflation

The banking system, by far, has the most to gain than any other industry in a reflation trade setting. When the value of all assets rise, including their own devalued mortgage backed securities and poorly performing derivative investments, the result is improved profits and better quarterly results for the banking sector. If the industry didn't come with the baggage or the smoke and mirrors of the modern stock market, the banking sector would be a great place to put your money – but only if you can afford the risk.

Learn from History

History suggests that the Federal Reserve does not have a good track record in removing inflation after it has been injected into the market. Although the Fed has a greater grasp on the market with its ability to sell the securities and treasuries which it has purchased, economics decided by one board of members is rarely a perfect policy. Just as credit was pushed into the system, it can be removed. Keep in mind the Great Depression was started by a contraction in the money supply by 33%, primarily lead by poor Federal Reserve decision making. Catch on the reflation trade while it exists, but don't be afraid to bring it all back into your portfolio when inflation is official.

Comments

[Tony Petroski:]

Real Estate is thought to be a good inflation hedge.

Apr 30 08:30 PM