EURO REACHES THREE-YEAR HIGH AGAINST DOLLAR -- THAT'S GOOD FOR COMMODITIES -- ENERGY SPDR BREAKS OUT TO THE UPSIDE -- DECEMBER CPI ABOVE 2% SECOND MONTH IN A ROW -- CORE CPI HAS BIGGEST JUMP IN 11 MONTHS -- WHAT ENERGY DROP
EURO REACHES THREE-YEAR HIGH ... Yesterday's message showed the euro on the verge of a new three-year high. The weekly bars in Chart 1 show the eurozone currency achieving that bullish breakout in today's trading. I also mentioned yesterday that a move above 1.20 would push the common currency above a long-term resistance line. That's the red line Chart 1 which is drawn under previous troughs formed in 2010 and 2012 (not shown). That makes today's move above that barrier all the more important. [The British Pound (not shown) is trading at a new 18-month high in Europe as well]. I suggested yesterday that an upside breakout in the euro would be a positive sign for commodity prices. The reason is simple. A rising euro is bearish for the dollar. A weak dollar is bullish for commodities since a negative correlation exists between the two markets. A shortcut way of viewing that is that a positive correlation usually exists between the euro and commodity prices.
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Chart 1
EURO AND CRB TREND IN THE SAME DIRECTION ... The reason this next chart works is that the euro and commodity prices have one thing in common. They both trend in the opposite direction of the U.S. dollar. That means that the euro and commodity prices usually trend in the same direction. Chart 2 shows that close linkage between the euro and the Reuters/Jefferies CRB Index over the last two decades. Both rose together from 2002 to 2008 (as the dollar dropped) and declined together for the next eight years (as the dollar rallied). You can see that their peaks and troughs since 2008 have tended to match each other (down arrows). Notice also that both have been rising over the last two years (up arrows). Let's take a closer look.
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Chart 2
THE EURO AND CRB ARE RISING TOGETHER ... Chart 3 shows the same two markets bottoming together over the last two years. The blue bars show the euro having already reached a three-year high. The brown bars show the CRB Index (plotted through Thursday) challenging the highs formed in mid-2016 and early 2017. The blue circle shows the euro hitting a new low at the start of 2017, while the CRB Index was rising. Since the two are positively correlated, that increased the odds that the euro would soon rise as well. Now that same relationship is working in the other direction. Since the euro has already broken out to the upside, that increases the odds that the CRB Index will soon do the same. Some of the more economically-sensitive commodities have already broken out to the upside like copper and oil. Here's an interesting fact. Brent crude just yesterday reached the highest level since December 2014. The euro reached that same time level today. Now that's strong correlation.
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Chart 3
ENERGY SPDR EXPERIENCES BULLISH BREAKOUT... My message on Wednesday, January 3 showed the Energy SPDR (XLE) nearing a potential upside breakout through its late 2016 peak and a resistance line drawn over its spring 2015/late 2016 high. The weekly bars in Chart 4 show the XLE having achieved that bullish breakout which puts it at the highest level in three years (much like the commodity it tracks). There's more. The same message showed a bullish breakout taking place in the XLE/SPX ratio. That bullish breakout can be seen again in Chart 5 which shows the ratio rising above its September peak. That makes energy the market's top sector performer in the new year (after being the second weakest in 2017 behind telecom). Energy shares had been lagging behind the rising price of oil, but are starting to catch up. The fact that investors are buying energy stocks is a vote of confidence that the price of oil will keep climbing. That's also part of the reflation trade which favors stocks that stand to benefit from rising inflation.
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Chart 4
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Chart 5
DECEMBER CPI EXCEEDS 2% AGAIN -- WHERE WAS THE ENERGY DROP? ... The media reported this morning a big 0.3% jump in core CPI during December (the biggest in 11 months) suggesting that inflation is accelerating. That put it up 1.8% from the previous December which is just shy of the Fed's 2% target. The headline CPI number was 2.1% (the second month in a row over 2%). None of that surprised me. Here's what did. The headline CPI for December (including food and energy) climbed a smaller 0.1%. Food prices climbed 0.2%. What held the headline CPI back was a December drop of -1.2% in energy prices. That certainly surprised me because I thought energy prices were rising. Chart 6 shows the PowerShares DB Energy ETF (DBE) climbing 3.4% during December for one of its biggest monthly gains of the year. The DBE includes Brent and WTIC crude oil, as well as heating oil, unleaded gasoline, and natural gas. During the month, crude oil gained nearly 6%, heating oil jumped 8%, while gasoline rose more than 2%. The only negative I could find last month was a -3% drop in natural gas. How does a combined 16% jump in three energy markets and a -3% drop in one result in an overall loss? And I thought Chart 6 showed big gains in energy prices last month. What was I thinking? [Footnote: The DBE is up another 4% in January, crude has jumped 5% to a three-year high, while gasoline and heating oil prices are up 3%. And natural gas prices have surged 8%. I wonder if any of those increases will show up in next month's CPI report?]
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Chart 6
AIRLINES TAKE OFF WHILE REITS COLLAPSE... None of these events are dampening the new year's enthusiasm for stocks. All major stock averages are hitting new record highs including the three major U.S. stock indexes, small caps, and transportation stocks. And money continues to flow into parts of the stock market that stand to benefit from stronger economic growth (and the recent tax cut), and out of stocks that stand to lose in a climate of rising bond yields. I mentioned earlier in the week that the transportation sector was being led to new records by rails and truckers. Let's add airlines to the list. Chart 7 shows the NYSE Airline Index ($XAL) rising above its July peak to a new high. That's the good news. The bad news is on Chart 8 which shows the Dow Jones REIT Index ($DJR) plunging to the lowest level since last spring. Rising bond yields are causing money to leave dividend-paying stocks like REITS and utilities which have become the market's weakest sectors. That certainly suggests stock investors are beginning to prepare for higher interest rates with more inflation. That would explain why investors are buying energy, industrials (including transports), consumer discretionary, financial stocks and materials (including gold miners) -- while selling staples, utilities, and REITS. Maybe they're looking at the same chart of rising energy prices in Chart 6 that I am.
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Chart 7
