By Carla Mozee, MarketWatch
The prospect of higher inflation, driven by plans for Trump administration spending, has lifted spirits on U.S. markets. But there’s another land of opportunity for the reflation trade, analysts say: Europe.
Financial markets worldwide have been lifted by U.S. President Donald Trump’s promise to ramp up fiscal spending and reform taxes. The hope is that these projects will spur economic growth in the U.S. and help drive up inflation.
In anticipation, investors have been buying stocks — sending some global benchmarks to record highs — as well as the U.S. dollar /zigman2/quotes/210598269/delayed DXY -0.05% . At the same time, they have been dumping safe-haven assets such as bonds, sending yields rising as their prices fall.
Just as headline inflation has risen in the U.S., it has marched up in Europe, too. In the eurozone, it jumped to 2% in February, outstripping the European Central Bank’s target. In the U.K., inflation has hit 1.8%, driven to multiyear highs by rising oil prices and a double-digit slide in the British pound /zigman2/quotes/210561263/realtime/sampled GBPUSD +0.1607% since the Brexit vote.
Now that global inflation is heating up, an opportunity has opened up for European companies to raise their prices for goods and services, according to Barclays analysts. For some time, businesses had to tailor their pricing to the subdued inflation environment at home, while at the same time having to follow the lead of local competitors abroad.
That added up to “a strong relationship between pricing and developed-market inflation,” especially international inflation, the analysts said.
“With this in mind, if inflation picks up, we think pricing should improve, thereby driving an increase in European profit margins,” the Barclays analysts said. “Even a 2% increase in margins, combined with positive sales growth, mathematically leads to strong earnings growth over the coming few years.”
How to play inflation
Given that prospect, how can investors play the potential European and British reflation trade? Strategists provided some suggestions for funds and exchange-traded funds to consider, focusing on various types of stocks. Financials are one sector they highlight.
“The banks will do well with interest rates rising and inflation rising, and that helps banks because it helps their margins,” said Michelle McGrade, chief investment officer at TD Direct Investing.
“In the U.K. especially, banks have been struggling to get ahead. But as they repair their balance sheets ... they are starting to provide dividends. In the long-term, banks should be dividend cash cows for investors.”
McGrade suggested looking at Old Mutual UK Alpha Fund, which has an overweight position in banks, and Investec UK Special Situations Fund, which has lenders HSBC /zigman2/quotes/203901799/delayed UK:HSBA -1.48% /zigman2/quotes/208272822/composite HSBC -3.37% and Barclays /zigman2/quotes/208409333/delayed UK:BARC -0.81% among its top five holdings.
Peter Garnry, head of equity strategy at Saxo Bank, also sees banks getting a boost. He suggested the iShares Stoxx 600 Banks ETF /zigman2/quotes/209205343/delayed DJXSF 0.00% /zigman2/quotes/202379457/delayed XE:EXV1 -2.33% , whose 45 components include Spain’s BBVA /zigman2/quotes/209653399/delayed ES:BBVA -3.83% , France’s Société Générale /zigman2/quotes/206663756/delayed FR:GLE -2.92% and U.K.’s Lloyds Banking Group /zigman2/quotes/202285510/delayed UK:LLOY -2.45% /zigman2/quotes/200709414/composite LYG 0.00% .