SURGE IN COMMODITY PRICES IS TYPICAL LATE - CYCLE BEHAVIOR
STOCKS USUALLY PEAK AFTER BONDS... One of the most important features of intermarket analysis is the rotation that normally takes place between bonds, stocks, and commodities at major turning points in the business cycle. That rotation between the three asset classes is especially relevant to the current global situation. Those major turns usually start in the bond market which peaks first. Rising interest rates (and the prospect for even higher rates) eventually causes stocks to peak. The main factor pushing rates higher is a strong surge in commodity markets, and oil in particular, which causes the Fed to start raising rates to slow down the inflationary spiral. At that point, commodity prices become the strongest asset class while bonds and stocks weaken. And that's where we appear to be in the current environment.
SURGING COMMODITY PRICES ARE BAD FOR STOCKS AND THE ECONOMY... Chart 1 shows bonds, stocks, and commodities following the normal rotational script and in the proper order -- starting with bonds. The green bars show Treasury bond prices peaking during 2020 and declining since then. Notice that the 2020 peak in bond prices coincided with an upturn in commodity prices which is also part of the rotational process. Stocks normally peak next. The black bars show the S&P 500 peaking at the start of this year. It's likely that stocks have seen their highs for this cycle. Rising commodity prices are a major reason for the stock market peak. The brown line shows the surge in commodity prices over the past few months being a major contributing factor to weakness in stocks. Spiking oil prices are a big part of the decline in stock prices. Surging commodity prices force the Fed to start rising interest rates to combat that inflationary spiral. That normally causes the economy to slow which usually leads to a recession. And stagflation.
BACK TO THE STAGFLATION OF THE 1970S... Rising commodity prices in the face of a slowing economy are likely to lead to stagflation for the first time since the 1970s. Stagflation occurs when a slowing economy coincides with rising inflation. That combination is good for commodity traders, but bad for bonds and stocks. It also puts the Fed in a very difficult position. It has to raise rates to combat inflation. Rising rates, however are likely to push the U.S. economy into recession. Judging from the commodity price charts which are at or near record highs, the inflationary cycle is likely to last for some time. It lasted for an entire decade during the 1970s.
Chart 2 shows the S&P GSCI Commodity Index surging to the highest level since 2008. Which strongly suggests that the inflationary spiral is likely to continue. That's won't be good for bonds, stocks, or the economy.
