Deflation Sensitive Stocks Are At A New All-Time High

• Deflation Index Leading the Market Higher
• Inflation/Deflation Ratio Starting to Break in a Deflationary Direction
• Several Deflation-Sensitive Industry Groups Looking Stronger

Deflation Index Leading the Market Higher

Last week, I wrote about the possibility of an upside price move in the bond market. So far, most areas remain below that key resistance, although some maturities, such as those reflected in the iShares 7-10-year Trust (the IEF in Chart 1), have started to move ahead. The big broad breakout embracing longer-term maturities, though, has remained elusive. Tentative signals from the stock market, in the form of recent price action by interest-sensitive equity industry groups, keeps the hope of an ultimate bond market breakout alive.

Chart 1

Chart 2, for instance, features my Deflation Sensitive Group Index (!PRDI). This is a composite that combines several interest-sensitive industry groups into one index. When rising, it tells us that early-cycle, liquidity-driven issues are generally performing well. Once an uptrend has been identified, the next task is to drill down to its individual components, with the goal of seeing which are acting in a promising way. This means considering utilities, REITS, telecommunications consumer staples, life insurance companies and the like. The Deflation Index also has a secondary function as a bell weather; when it reaches a new high, that generally means that the S&P is destined follow, and vice versa. It’s not a perfect indicator for the overall market, but I would rather have it on my side than not.

Chart 2 shows us a couple of things. First, the Deflation Index led the S&P at the 2000 peak by a couple of years and the 2007 top by a couple of months. It also played a leadership role at the 2002 low and during the 2015-16 mini-bear market, where it zig-zagged higher as the S&P went through its corrective wave. More recently, while it did not form a leadership role at the December 2018 low, it has nevertheless gone on to register a new bull market high. That doesn’t guarantee that the S&P will follow suit, but that has been the historical norm.

Chart 2

Chart 3 compares the Index itself to its relative action against the S&P Composite. Note how it temporarily violated its 2008-2019 uptrend line and is now decisively back above it. The false break enhances the significance of the line as a dynamic zone of support, as the Index was unable to hold below it for an extended period of time.

The lower window tells us that the relative action is above its 12-month MA. However, it has yet to rally above the all-important 2005-2019 downtrend line. If it can move above that zone of resistance, the implication would be for a lengthy period of superior performance by liquidity-driven equities. The green arrows offer hope in this direction, as they flag periods when the KST for the relative line reversed to the upside. In virtually every instance, such action was followed by a trend of superior relative performance, ranging from 6 to 24 months. If that pattern repeats itself, the tentative KST buy signal for relative action that has been triggered ought to be sufficient to power the RS line through that 14-year green resistance line.

Chart 3

Inflation/Deflation Ratio Starting to Break in a Deflationary Direction

Another piece of evidence pointing in a deflationary direction is the ratio between an inflation-sensitive group index (!PRII) and our Deflation Group Index (!PRDI). A rising relationship is inflationary as it indicates inflation-sensitive stocks are outperforming their deflation-sensitive counterparts (and vice versa). It is featured in Chart 4 along with a Special K (SPK) indicator. Last week, it tentatively broke below that dashed red support trend line. So far, this is a fairly anemic penetration, but it does suggest that the tipping point towards a more deflationary environment may not be that far away. We are likely to find out soon, because the SPK is in a declining mode and is resting right at its 2016-2019 support trend line. If it breaks the line, that will represent important supporting evidence that the drop by the ratio itself is valid.

Chart 4

Several Deflation-Sensitive Industry Groups Looking Stronger

Chart 5 presents the technical picture for the SPDR Utilities (XLU) on both an absolute and relative basis. Both series are in a rising trend and are comfortably above their respective 200-day MAs.

Chart 5

Chart 6 shows the same exercise for the iShares Cohen and Steers REIT (ICF). Here again, we see new highs being generated by the absolute price with a positive absolute long-term KST. The RS Line is in a bullish trend as well, but needs to clear resistance in the form of the 2017-2019 trend line. That is likely to happen, as the long-term KST for relative action is in a positive trend and at a relatively subdued reading.

Chart 6

Charts 7 and 8 feature two deflation sectors that look to be on the verge of breaking out. Firstly, the iShares US Telecommunications (IYZ) looks to be right at a breakout point on both an absolute and relative basis. Two rising long-term KSTs argue that this sector will likely join the Deflation Group Index in new high territory in the period ahead.

Chart 7

Second, Chart 8 features the defensive SPDR Consumer Staples ETF (XLP). The absolute price is running up against resistance in the form of its 2017-2019 downtrend line. The odds of powering through are good as the long-term KST is in a gently rising, but not overstretched, mode.

Relative action has already rallied through its 2016-2018 dashed downtrend line and has now fallen back to the 65-week EMA, where it should find support. Note that the relative long-term KST in the bottom window is in a bullish mode, suggesting that the RS Line itself stands a good chance of surpassing the solid green horizontal line, which is the neckline of a potential reverse head and shoulders pattern.

Chart 8

Good luck and good charting

Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.