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Key Intermarket Relationships

Stocks vs. Commodities

In Stages III and IV (see Figure 1) stocks and commodities are both rising. There are few distortions during this mid-cycle phase because commodities are not advancing with a vengeance, which reflects an improving economy. This, in turn, allows equities to thrive because they’re able to look forward to a healthy growth in profits. After a while, the economy picks up steam so commodity prices advance at a faster pace, triggering acceleration in the upward trend in interest rates. Stock market participants now begin to sense these pressures will eventually result in an economic slowdown, or actual recession, so they cull profits, and become more cautious. This results in a loss of upside momentum in equity prices, causing the balance to tip to the deflationary side, and the ratio of stocks to commodities peaks out.

Chart 10 shows this relationship. The arrows mark the chart points where the KST, or smoothed momentum, peaks out.

The chart also emphasizes that during the 2002-200? S&P bull market the commodity adjusted S&P Composite only managed to experience a sideways trading range. This in itself is a clear indication that a secular peak was reached in 2000. It has since moved close to a post 2000 low in May and violated its secular up trendline (Chart 11).

This is an extremely serious technical breakdown and offers further evidence that a secular peak was seen in 2000. This is one of the longest secular breaks in the last 200-years and if the average drop in real prices from previous violations is achieved, this would send prices back to the “real” levels last seen at the 1994 low. (This relationship is discussed at length, together with its performance since the mid 1950’s in, The Investor’s Guide to Active Asset Allocation.)

Chart 10. Arrows show KST peaks.

Chart 11. For more detail see Chart 11A.

Chart 11A. Arrows show KST peaks.