Key Interasset Relationships are Bullish for Stocks and Commodities but Bearish for Bonds
The business cycle approximates 41-months between the low points of slowdowns or recessions. For the record, a slowdown develops when the growth path of the economy declines, but not sufficiently to result in an actual recession, when economic momentum goes negative. The important point to bear in mind is that bull market peaks and troughs for bonds, stocks and commodities go through a chronological sequence during the course of a specific cycle. The process is described in detail here.It's rather like a calendar year progressing through the four seasons. Just as each season is suitable for specific activities, such as skiing in winter and swimming in summer, so each "investment season" is suitable for exposure to specific asset classes and unsuitable for others.
A simple way of tracking the prevailing phase of the cycle is to compare two asset classes. The raw data derived from these relationships are not always that helpful in their own right. However, if we calculate their long-term momentum by way of the KST, it results in a more deliberate path with fewer false signals. If, using our seasonal calendar year example, we could identify a peak in the ratio between the number of active skiers in the US versus the number of swimmers, it would arguably top out in the mid-to late spring. The same principle can be applied to specific assets to help identify timely long-term entry and exit points. Notwithstanding corrections along the way, these relationships are suggesting that stocks and commodities are bullish and bond prices bearish. Let's take a look at stocks first.
Two Interasset Relationships that are Bullish for Stocks
Buying stocks reflects confidence, whereas the acquisition of gold is motivated more by concerns in the integrity of the system or fear of inflation. A KST for this stock/gold relationship is shown in Chart 1. Notice how the sub-zero KST lows in this ratio are typically followed by an extended period of rising equities. It's important to understand that this is a relative relationship; it says nothing about the trend of the gold price itself, though I address this below.
The ratio between stocks and bonds also provides signals that it's time to move into stocks. Chart 2 compares the S&P Composite to a KST-calculated from the ratio between it and the 30-year Bond. Troughs in this smoothed oscillator reflect points in the cycle when stocks are anticipating an extended recovery. At such times, market participants choose the growth promised by equities over relatively safe treasuries. Stock/bond momentum is currently in an upward trajectory, having bottomed at the end of last year. That suggests higher equity prices.
Two Interasset Relationships that are Bullish for Commodities
The inflation-deflation relationship is best reflected by the ratio between commodities and bonds. It's a very useful one because the business cycle is continuously transitioning between its inflationary and deflationary phases. This rotation is captured in Chart 3, where the ratio's momentum is compared with the CRB Composite. All the major commodity lows since 1982 have been identified with upside momentum reversals. Three weak rallies were also signaled. Recent months have seen another sharp reversal, this time confirmed by two major trendline breaks. One of those lines represents the secular down trendline. Provided this positive break holds, it means we will either see an extended trading range or, more likely, a strong extension to the recent rally.
Another relationship that has consistently called commodity bull markets is the ratio between gold and the 30-year Bond. It's featured in Chart 4, where the green arrows clearly demonstrate that upside reversals ratio have identified all the major CRB lows since 1993. The record is blemished by one false positive in 1990.
A Key Relationship that is Bearish for Bonds
Chart 5 turns the tables on Chart 3 by comparing bonds to commodities and its effect on bond prices. The secular trend has been a rising one for bond prices during the whole period covered by the chart. However, this has not stopped overstretched peaks in the KST for the Bond/commodity relationship from calling most of the major declines. That's because bonds abhor inflation, so when commodities begin to outperform, bond market participants get nervous and sell.
Gold is Bullish but Needs Close Monitoring
Chart 6 shows that upside KST reversals are followed by a decline in the gold price slightly over half the time. One way to tip the odds is to also observe whether the price is above or below its 12-month MA. In that respect, three of those failed signals did not experience a negative 12-month MA crossover. In effect, a rising stock/gold KST ratio offers a slightly better-than-even chance of a gold bear market. However, those odds increase substantially in the event that gold slips and stays below its 12-month MA. Right now, that call is pretty close, as Tuesday's mid-session price was $1863 versus the average, which is at $1831. Remember, this is a monthly chart, so only monthly closes count.
If these relationships strike a chord with you, remember it's possible to click on any of these, saving the result to a chart list.
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 Groupof Walnut Creek or its affiliates.
