Reflation Trade Fades; Stocks, Commodities Lose, Bonds Gain

The so-called reflation trade had some air let out of it after China, which helped pump it up with its credit inflation, started to close the valve a bit. Stocks backed off while commodities slid, but the policy shift provided the wind beneath the wings of Treasuries.

Led by Alcoa (AA), the Dow Industrials shed 37 points, or just one-third of a percent, while the S&P 500, and the Wilshire 5000 all were off in the neighborhood of 1% and the riskier Nasdaq and small-cap Russell 200 were down 1 1/3%. China’s central bank raised reserve requirements to follow on its small increase in money-market rates, taking its toll on commodities, which have been driven by China’s stimulus-driven rebound. Crude oil settled down, just coincidentally, 2% as well, although traders also focused on a slight thaw from the nation’s deep freeze.

Underscoring the move away from reflation trade was Alcoa’s 11% plunge after its worse-than-expected results kicked off the fourth-quarter earnings season. Gold also took a hit with popular exchange-traded fund, the SPDR Gold Trust (GLD, lost 2%.

The clear winners of the day were Treasuries, which rallied in the face of heavy supply as a beneficiary of the less accommodative monetary policy from China. Following a well-bid three-year note auction, the Treasury 10-year note was up 26/32, putting its yield down to 3.72%, well below last week’s peak in the mid 3.80s. The US Dollar Index (DXY) also moved up despite a rise in the yen. Both the greenback and the Japanese currency benefit from investor risk aversion.

One other winner also is Venezuelan stocks, which are up sharply following the 50% devaluation by over the weekend. Hugo Chavez’s regime has vowed to punish anybody who raises prices on consumer goods in reaction to the halving of the value of the currency, which has set off a rush by Venezuelans to rid themselves of bolivares and hold any other asset as a store of wealth. That would also go for la bolsa in Caracas, which moved up again after spurting Monday. That’s a familiar pattern in Zimbabwe, where locals eagerly buy up shares, which are claims on real enterprises, rather than hold currency that rapidly loses its value.