China Decides How High Reflation Trade ETFs Will Climb

by: Gary Gordon

Some investors have been overweight emerging markets because industrializing countries account for the bulk of the world’s gross domestic product (GDP). Yet few of those investors may be aware that studies consistently show an absence of any relationship between a country’s GDP and stock performance.

There are better reasons to invest in emerging countries. Most of them carry less debt. Many are seeing healthy middle classes contributing to corporate profits through conspicuous consumption. And depreciating dollars/euros boost emerging currencies such that foreign stock ETFs benefit from a rising rupee, rand or ringgit.

Lately, however, equity leadership has shifted from emerging countries back to mature economies. That’s right. When it comes to stocks, the good ol’ U.S.A. is back on top.

Sector rotation, country rotation and regional rotation are part and parcel of the investment markets. However, the continuous transfer of money is only flowing in one direction; that is, debtor nations that carry undeniably large current account deficits (like the U.S.) are increasing the wealth of creditor countries with large current account surpluses (like China).

Why is this important? Well, for one thing, if countries like China are in the process of rebalancing from exporters to conspicuous consumers, you ought to think about the long-term potential of Global X China Consumer (NYSEARCA:CHIQ).

Yet perhaps there’s a more critical dynamic to heed. Specifically, the easy monetary/fiscal policy of the world’s mature economies (e.g. Japan, U.S., eurozone) may play second fiddle to China’s (and possibly India’s) monetary/fiscal policy.

Right now, there’s a sense that China will curb inflation just enough to engineer the perfect soft landing. Its policies can be described as tight, but not too tight. It’s restrictive, but not too restrictive … at least, not yet.

And therein lies the real key to the raging bull for reflation trade standouts like Materials ETFs, Commodity ETFs and Energy ETFs. Sure, all of these assets are getting a lift from a relatively limp U.S. dollar. They’re also benefiting from China’s willingness to buy Greece (I mean, Greek debt), euro-dollars and U.S. treasury bonds.

More than anything else, however, China’s monetary and fiscal policies will determine what happens next. If China decides it needs to tighten its screws to prevent an inflationary bubble, the reflation trade performers will see significant outflows and painful price depreciation.

Obviously, there’s no way to tell with certainty whether China will succeed or fail in its soft landing experiment. I believe that it will be successful at minimizing inflation without killing the reflation winners in the table below. Get a gander at a few of the big name energy, materials and commodity ETFs:

Reflation Trade ETFs: At the Mercy of Chinese Policymakers?
Approx 3 Month %
Global X Copper Miners (NYSEARCA:COPX) 29.5%
PowerShares Dynamic Energy Services (NYSEARCA:PXJ) 28.6%
Market Vectors Coal (NYSEARCA:KOL) 26.8%
SPDR Select Energy (NYSEARCA:XLE) 23.5%
iShares MSCI Peru (NYSEARCA:EPU) 21.8%
Vanguard Materials (NYSEARCA:VAW) 18.2%
iShares S&P Commodity (NYSEARCA:GSG) 15.8%
SPDR S&P 500 Trust (NYSEARCA:SPY) 11.0%

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.