The reflation trade — a bet that assets that benefit from a post-pandemic surge in growth and inflation will outperform their traditionally safer counterparts — might not be as popular as many believe, say analysts at Jefferies.
If so, the trade may have plenty of room to run, they argued, in a weekend note.
“The recent price action, earnings revisions and economic stats are dwarfed when compared with the strength seen in prior cycles,” they wrote. “We’d argue that if you are judging by these numbers, the consensus call is actually skepticism.”
Since last March, when the bear market triggered by the COVID-19 pandemic bottomed, value stocks have outperformed growth stocks by 10%, they noted, while a bet that the small-cap Russell 2000
would beat the tech-heavy Nasdaq-100
trade is up 20%. Value stocks are shares that are viewed as undervalued against metrics like price-to-earnings or book value; growth stocks are shares of companies that are expected to see earnings and revenue grow faster than their peers. Value typically outperforms growth as economies exit recessions and transition to growth.
“Coming out of the dotcom bubble, these trades posted +120% and +260% trough to peak, respectively,” they said.
Stocks overall edged lower on Monday, with the S&P 500
off 0.5% and Dow Jones Industrial Average
down around 117 points, or 0.3%, after ending Friday at records. The tech-heavy Nasdaq Composite
was off 1.1%.
Meanwhile, the sectors expected to benefit from the reflation trade, such as financials, materials, industrials and energy, remain below the pre-COVID relative level, the analysts said, despite the highest inflation expectations in several years (see chart below).
A pullback by Treasury yields
after hitting 14-month highs in part due to rising inflation expectations, has allowed some of the initial pandemic highfliers recoup some lost ground relative to beneficiaries of the reopening trade, but Jefferies is skeptical that can last.
“A short-term pause in the massive backup in rates is certainly good for tech shares, but how long can it last for and what will happen once cyclical sector [earnings-per-share] growth is leaving tech in the dust?” they wrote.
Beyond that, a key reason the reflation trade is “understood but not working” may have to do with the magnitude of earnings revisions for the…