The Reflation Trade Isn’t Dead and Evergrande Isn’t Lehman

Just hear me out. You think it’s merely a capitulated bear talking (it is), but I bring you some charts and not simply my severed, emotionally burdened heart (though I bring that, too).

We often make comparisons between the events of the last year and a half and the Great Financial Crisis (hallowed be thy name) because deleveraging events seem to be needed in an era when everything seems so god damned levered up, and so when a great shock struck (I wrote that so your mental tongue would hurt) our economy, which was followed by a great recovery—at least on paper—we have our doubts about that recovery because those of us who are not twelve won’t allow ourselves to be fooled twice in the same lifetime if we can get away with it.

However, packaged neatly into that arrangement is the very evidence we may need to cast doubt on the whole thing: perhaps it was not as much the excess leverage in the system as it was our (lack of) preconceptions about the imminent dangers of that leverage that caused the deleveraging event. And so today, worried to death that we will travel down that same path again, maybe we won’t, because worrying wasn’t a feature of that path.

Now that’s not to say that some folks weren’t worried about Lehman Brothers. It was on some people’s radars but it largely took the world by surprise. And it seems to me today that Evergrande is widely understood to be the next Lehman Brothers, but I wonder if it even can be because in order to replicate that collapse, it needs to take us by surprise: in other words, there was no “it’s another Lehman Brothers” in the time of Lehman Brothers. Lehman Brothers lacked an appropriate precedent and it is being interpreted right now as the precedent for Evergrande. Black Swans by their very natures must be dark, largely hidden except to most prescient. And while some at the time may have been making comparisons between Lehman Brothers and LTCM, most people thought LTCM couldn’t happen again (and so it did) whereas today—so it seems to me—everyone and his or her mother believes it can happen again (so maybe it won’t). Now that is not to say that deleveraging events are ancient history. It just seems to me that this isn’t the one.

So that’s my thought from a purely psychological perspective. On to the reflation trade.

The same temptation seduces us here. Let us recap the order of events of the Great Financial Crisis (hallowed be thy name): economic shock, reflation, crash, money printer goes brrr. And so here we sit in the midst of a reflation trade and we want to call bullshit. We know what’s coming next. But it may be strange to make such a comparison because the order of events seems to be different this time (oh God, I said it): economic shock, crash, money printer goes brrr, reflation. So this becomes puzzling. In 2008, if we crashed because the reflation trade was fake (it was) then it stands to reason that if our reflation trade is fake, then we should crash. There are two problems: what if we have that logic wrong, and what if our reflation is real?

On the first point, what if we are reading our causal compasses backwards? What if, instead of understanding the events of 2008 as “fake reflation led to crash,” it should be read as “money printer goes brrr was preceded by crash?” What if reflation has less to do with crash than we might think because we are strangely causal-focused creatures? I won’t carry on about this point because I have the capacity to make things really weird from here1, so I’ll just move on to the next point and let those who are prone to stroking their beards stroke their beards. Go on, guys, stroke them. The next point: is reflation even dead?

Many people seem to think so (okay, lol, poor sample, it’s a feed full of bears):

Lemme show you what dying reflation looks like. Oil in 2008 was looking real slick leading up to Evergrande Lehman Brothers. Leading the market lower, it had fallen 36% by the time Armageddon arrived and the Bidless Beast (hallowed be thy name) arrived on scene. In today’s environment, that would put us under $50 oil but we’re over $70, less than 7% off of our recent highs. Do you know how much smart money flows in oil? You think they wouldn’t sniff out Armageddon before any of us would?

OIL

And Copper, Doktor Copper, oh Daddy tell me if I’m sick. And in 2008 he said we were sick as shit. A giant bearish wedge which did what giant bearish wedges often do:

COPPER

Now lemme show you what we got right now.

Oil um, well, gosh, those are bull flags, son (and do you see the inverse that’s formed in the recent one?). We’re erupting out of a bull flag that erupted from a bull flag. Now granted, we’re at a very significant trend line (one that originates, lol, from the top of none other than the 2008 reflation) but that last flag may just have been building the energy it needs to get through it. Measured moves here take us to triple digit oil real fast, too. This looks nothing like the 36% slide we were seeing in 2008. To the contrary, it looks exactly opposite to that grim picture.

OIL

And Copper? Jesus, yes, that’s what it looks like. A high and tight™ bull pennant, the measured move of which makes me blush. Dr. Copper appears to be conducting a very bullish examination at the moment.

COPPER

Now I’m not saying reflation isn’t going to die a grisly (or even better, grizzly) death, but if it is going to, I seriously doubt that it is going to do it here.


1 This will get you started.

One thought on “The Reflation Trade Isn’t Dead and Evergrande Isn’t Lehman”

Leave a Reply

Your email address will not be published. Required fields are marked *