Taking the Global Reflation Trade to Task

Posted: Oct 09, 2017 6:31 PM

The stock market rally is running hot, buttressed by three main factors that have yet to be verified.

They include the passage of tax reform, the appointment of a new dovish Fed chair and the notion of the global reflation trade that lifts all world markets, thanks to rising economic growth rates in developed and emerging economies. It is like having perfect growing conditions for exotic flowers.

The fact that the market doesn’t really get rattled about threats from North Korea’s dictator and crossing the $20 trillion debt threshold for the U.S. federal balance sheet makes this rally even more interesting.

Assuming one, two or even all three of these market catalysts come to pass, as is currently being priced into stocks, opens the way for the S&P 500 earnings to climb by another 10% or more. That is, the S&P 500 index could trade up to 2,800 over the next three to four months. Market technicians are citing the broad sector participation and yet one key indicator, Relative Strength Index (RSI), is flashing a short-term overbought reading and has a pretty solid track record of being a precursor to rallies and pullbacks.

The Relative Strength Index, developed by J. Welles Wilder, is a momentum oscillator that measures the speed and change of price movements. The RSI oscillates between zero and 100. Traditionally, the RSI is considered overbought when above 70 and oversold when below 30. The current RSI reading is bumping up against 90, indicating some steam might have to come off this rally before constructively pushing higher. It makes perfect sense and would be healthy for the market at the same time.

If there is in fact a global reflation trade in the works, then investors should pay close attention to how copper trades. Not only is copper the most widely utilized metal for industrial and commercial purposes, but it also is a major component in the big push towards electric cars throughout the world. Even now, China has stated that it is considering phasing out cars with traditional combustion engines.

This means a huge amount of copper is going to be in demand in the future, as most of the major auto manufacturers are starting to expand their electric vehicle product line. As a byproduct of this transformational shift in the automobile industry, all of the electrical components are going to require copper. Over the longer term, that growing demand could cause supplies to shrink and prices to rise. A quick view of the iPath Bloomberg Copper Subindex Total Return ETF (JJC) shows a massive reversal off a multi-year low following the Trump election win that now is stair-stepping higher with the prospects of both rising global gross domestic product (GDP) growth and autonomous vehicles.

For dividend investors, the two stocks that come to mind in the copper mining sector are Rio Tinto (RIO) and Vale S.A. ADR (VALE). Rio Tinto is based out of London, United Kingdom, and Vale is based out of Rio De Janeiro, Brazil. Both stocks are widely traded as American Depository Receipts (ADRs) on the NYSE. RIO pays a dividend twice per year and currently yields 4.53%. Vale pays a dividend only once per year and its current yield stands at 5.63%.

Both stocks also make for attractive covered-call candidates where investors can boost their income yields above 10% from selling calls against the underlying common stocks. However, if the global reflation trade is legit, then there is plenty of upside to be made in copper stocks like Rio Tinto and Vale. They trade at roughly 70% discounts to where they were priced in 2007. So, the glidepath to steady gains looks very appealing if the economic data continues to pick up in the months ahead, and the copper trade is one of the best time-tested ways to leverage a rebound in the global economy for one’s portfolio.

Perry’s Options Corner

The selling of covered calls is the most conservative of all options strategies and one that I use extensively in our advisory services. It’s a fantastic way to create an immediate stream of income for one’s stock portfolio and makes the most sense for utilizing the strategy in a tax-deferred account to avoid short-term taxable gains if calls are exercised and underlying positions are called away. For those investors seeking to explore or get started in the business of options, I recommend going to the homepage of the Chicago Board Options Exchange www.cboe.com and clicking on the Education tab where there are online courses, seminars, webcasts and all manner of tutorial tools that can even further hone the skills of a professional options trader.

Like any investment strategy, if you don’t understand it, you won’t use it and might miss out on a wonderfully lucrative method of generating income and capital gains. For investors who do take the time to gain some knowledge of trading and using options and yet want an experienced options trader to present trading strategies on a weekly basis, then I extend an invitation to my advisories at www.bryanperryinvesting.com, where there are three advisory services, Premium Income, Quick Income Trader and Instant Income Trader, dedicated to option income and short-term capital gains.

Personal Note: I’m going to be one of the featured experts on the Legends of Wall Street Cruise from January 12 – January 22, 2018. My subscribers are invited! For more information and to request a brochure, click here.

In case you missed, I encourage you to read my e-letter from last week about the strategy of selling naked puts.

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