The Week: Is the reflation trade at risk?

The reflation trade continues in earnest, with cyclical sectors leading markets in recent weeks. However, could problems in the vaccine rollout disrupt markets’ assumptions?


  • Markets have stayed optimistic in the face of mounting problems for the vaccine rollout
  • There have been some major setbacks to economic recovery across Europe
  • However, markets had not expected smooth delivery of the vaccines or immediate economic recovery

Financial markets are pinning a lot of hope onto the vaccine rollout. Not only is its success determining whether they rise or fall, but also the type of companies that do well. Economically sensitive areas such as energy, financials and materials have been on an upward trend, while areas such as technology have struggled.

Markets have clung to this view in the face of mounting problems for the vaccine rollout. Not only have some countries been woefully slow in rolling out the vaccine, there have been concerns over rare side-effects, particularly for the Astra Zeneca jab. This has seen countries limit use of the jab or halt the rollout altogether, delaying the point at which their economies return to normal activity and recovery begins in earnest.

Does this suggest that markets are about to have a moment of clarity? And might this moment of clarity see an abrupt reversal in the pro-cyclical, anti-growth trend that has characterised markets since the start of the year? Certainly, the inflation fears that initially drove the rally in cyclicals have proved without merit so far.

While this would seem an obvious conclusion, it seems that markets had already been expecting some setbacks in the rollout of vaccines. The IMF recently revised its global growth forecasts higher on the basis that rollouts had been faster than expected to date. Equally, even in countries where the rollout has been slow, many of the most vulnerable have already been protected.

At the same time, the long-term outperformance of growth versus economically-cyclical areas has given plenty of valuation wiggle-room. Several months of outperformance cannot adjust for the years of outperformance seen by the technology sector and other ‘long duration’ assets. These areas simply looked far too cheap and still do, even if the recovery isn’t as forceful as planned.

That said, there are some exceptions to this: the recovery has inevitably brought a rally for some of the most hard hit areas from the pandemic: airlines, specific retailers, restaurant chains. Capacity has come out of these industries, which should help support the survivors. However, even with that in mind, valuations may have run too far when their future is still precarious.

The challenge for investors today is to distinguish between recovery stocks with long-term growth potential and those that can only make progress if economic growth materialises. The latter are always likely to be vulnerable to bumps in the vaccine rollout or economic recovery.