The most talked-about investing strategy these days isn'tstuffing money in a mattress, it's the reflation trade-the bet thatthe world economy will rebound, driving up interest rates andcommodities prices.
Even though the economy continues to struggle, investors are looking ahead to the time whenthe massive rescue efforts by central banks and governments gain traction.
They are focused on raw materials and commodity-related stocks that would benefit from thesurge in infrastructure spending. They are looking to exploit potential bottlenecks in productionthat could lift prices and corporate earnings.
"Between the bailouts and the stimulus, it's pretty clear that we're going to have some inflationwhen we get out of this mess," says Roger lbbotson, founder of lbbotson Associates and chairmanof hedge-fund manager Zebra Capital Management. He says, "It may not show up for another twoyears, after that I think it's quite likely and I think you should be positioning a portfolio againstthat."
Shawn Rubin, an adviser at Smith Barney in New York, has moved some clients partly into natural-resources stocks while using strategies to protect against a spike in inflation.
One way is to use options, where an investor is able to use relatively small amounts of moneyand take positions that would profit from a massive drop in Treasury prices or a near doubling ingold prices. "While in the short run such trades may not work, it's a long-term move," Mr. Rubinsays. "You should buy insurance when it's cheap."
And despite the recentl altirity that lifted stocks 20% from their lows as of Thursday-the commondefinition of the return to a bull market, though they promptly fell again Friday-most investorsexpect a challenging environment well into next year.
But the Federal Reserve has taken dramatic steps to revive the economy and stabilize the financialsystem. It has lowered interest rates essentially to zero and is on track to pump more than $2trillion into the credit markets.
On top of that, there is the $787 billion federal stimulus program coupled with a growing budgetdeficit. Around the globe central banks and governments are making similar moves.
Paul Kasriel, director of economic research at Northern Trust, says "the Fed will likely err on theside of ensuring that the recovery is sustained and usually that means they will be late in turningagainst inflation. The political sentiment will be toward inflation and in preventing deflation," headds.
Mr. Liinamaa suggests investors keep a "survivor bias". That means "looking for names that havelow cost structures and balance-sheet capacity to still be standing" even if demand doesn't recoversoon. He cites steel producer Nucor as one example.
Already there are signs that the market is less worried about deflation. That's clearest in themarket for Treasury Inflation-Protected Securities. Back in February, five-year TIPS were priced fora 0.5% drop in consumer prices, now that's swung around to a 1.35% increase.
"The magnitude of the expected inflation rise predicted by TIPS may be small, but the directiontells the tale," says John Hollyer, a co-manager of Vanguard Inflation-Protected Securities Fund.
"The fiscal and monetarystimulus are causing investors to say there's a decent chance the Fedwill be successful and there will be an increase in inflation," he says.