Which Asset Class is Likely to Outperform Going Forwards?
The business cycle undergoes a set series of chronological sequences, just like the calendar year goes through seasons. Over the course of many decades, economists have recognized this phenomenon and devised composite indicators to follow this progression. By way of an example, the Conference Board publishes leading, coincident and lagging indexes. They are named that way for a reason. Some sectors of the economy lead, others (such as GDP) coincide and, finally, lagging indicators come to life, just as the economy is slowing down or starting to contract.
At Pring Turner Capital we follow this stuff very closely, as the primary trend peaks and troughs of bonds, stocks and commodities are part of the chronological sequence, which is idealized in Figure 1. Our estimate is that we are currently positioned somewhere between the peak in bond prices and that of equities.
The diagram shows that identifying the current phase of the cycle is hugely important (detailed explanation here). First off, each "season" in the business cycle is suitable for a different asset mix. Second, having an informed view on the prevailing phase helps you to anticipate what might be coming next.
At first glance, this may sound a bit complex. Fear not -- I have a quick fix that will help us get there. It's based on relative action between the three asset classes.
To start with, Chart 1 shows their performance since early May, which, based on several internal indicators, broadly approximates when the correction began. Since that time, commodities and stocks have been the leaders, with bonds following up in the rear. Now it's time to tune into some of these cross relationships to identify where we are in the cycle and which asset class might outperform in the period ahead.
Stocks vs. Bonds
Chart 2 compares the S&P to the ratio between it and the price of the 30-year Bond ($SPX:$USB). The red arrows generally lean to the right, indicating that stocks usually begin to underperform bonds prior to a bull market high. That ratio is currently at a new high; Chart 3 shows that it has broken out from a trading range and looks set to move even higher. The only negative is that momentum, as measured by the Special K, is overextended.
Stocks vs. Commodities
The stock/commodity ratio peaked in April 2020 and has been zig-zagging down ever since. As a result, it decisively violated the 2011-2021 up trendline and is now below its declining 12-month MA. A falling ratio does not mean that stocks will decline in their own right, just underperform commodities. The green-shaded areas point out periods when the ratio fell but stocks rallied. Since last year, for instance, the ratio has dropped, but both stock and commodities have been on a tear.
Chart 5 monitors the more recent period, where the ratio has recently completed an upward-sloping head-and-shoulders pattern. That said, this week's daily KST buy signal suggests a near-term bounce favoring stocks may be in the cards. If my assumption of an overall trend favoring commodities proves to be correct, then it is likely that earnings-driven sectors in general, such as basic industry and commodity-sensitive will outperform their liquidity-driven (defensive) counterparts, such as utilities, telecom and consumer staples.
Commodities vs. Bonds
Our final area for consideration comes from the ultimate inflation/deflation relationship, that between bonds and commodities ($CRB/$USB). This ratio has been moving up sharply since the recession ended and has now violated its secular down trendline and completed a very bullish broadening wedge.
Daily data in Chart 7 shows that the ratio has just broken out from an inverse head-and-shoulders. It's also true that the Special K is very overextended. However, it recently moved back above the dashed up trendline and remained north of its signal line, price action that suggests very strong underlying momentum for this inflation/deflation relationship.
Conclusion
- An examination of several cross-asset relationships suggests that the current cycle position lies somewhere between the peak in bonds and stocks, as shown in Figure 1.
- Even though they are getting overextended on a primary trend basis, commodities will continue to outperform both bonds and stocks.
- The probabilities favor equities themselves extending their bull market until commodities really accelerate on the upside.
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.
