The Reflation Trade's Upcoming Retest

JC Parets
September 24, 2020

From the desk of Tom Bruni @BruniCharting

In June we outlined that the "Reflation Trade" indicators we track had picked up significantly after reaching levels of long-term support in March.

Since then that thesis has played out and we've been taking advantage of it in Metals, cyclical stock market sectors like Materials and Industrials, and even Agricultural Commodities which managed to break out.

But...after a nice run many of these assets and intermarket relationships have pulled back over the last month or so...begging the question "is the reflation thesis over?"

Luckily for us, we only need one chart to discuss what's happening and how we're approaching it.

Here's the chart of the Treasury Inflation-Protected Securities ETF (TIP). For those that need a refresher, the reason we care about TIPs is because market participants buy them when inflation expectations are rising. No need for inflation-protected securities in your portfolio if you think there's not going to be any inflation, right?

Click on the chart to enlarge view.

After the massive move off the March lows, prices broke out of an 8-year base to new all-time highs in July and have been grinding higher since. The problem is that over the last 8 weeks momentum has diverged negatively and prices are back below their August highs.

So let's get back to our original question. Is the "reflation trade" over? The answer is no, but it's also yes.

It depends on your timeframe.

In the near-term, absolutely. The US Dollar stabilizing and breaking out is putting a damper on cyclical assets. We're seeing the weakness in TIPs over that same period, so for the short-term, we'd expect the assets related to our "reflation thesis" to remain under pressure.

But if we take a step back and look long-term, then we see a massive structural breakout that's still intact as long as prices are above 123.50.

So for now, the longer-term reflation thesis remains intact, but we want to see how this weakness develops. Do TIPs correct through time, price, or both? And if they do retest their 2012 highs near 123.50 is it successful, or does this turn into a major failed move?

That's where the real information will come from.

From that chart as well as Copper/Gold, Financials/S&P 500, Regional Banks/REITs, TIPS/Treasuries, the Australian Dollar, Copper, and all the other ratios/assets that have important retests of their own coming up.

As always, thanks for reading and please let us know if you have any questions!

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