In the classic 1939 film, “The Wizard of Oz”, while walking through the dark forest, Dorothy, the Tin Man, and the Scarecrow hear noises around them. This causes the Scarecrow to repeat over and over, “Lions and tigers and bears”, and Dorothy adds “oh my” as they skip through the forest chanting this line to calm themselves from an impending threat.
In today's financial markets it appears investors are overly focused on the threat of the escalation of the trade war between U.S. and China as they react to every news story that pertains to a trade deal. We believe that it may be more effective and productive for longer-term investors to monitor the relationships between the four major asset classes including Stocks, Bonds, Commodities and Currencies for the sustainability of the primary trends and most important, potential trend reversal.
Why? There are well-defined historical relationships between Stocks (S&P 500 Index – SPX), Bonds (30-year US Treasury – USB), Commodities (CRB Index – CRB), and Currencies (US Dollar Index – USD). Understanding these relationships can help investors better manage their financial goals and most important, determine the various stages of an investment/financial/business cycle.
In a normal inflationary environment – This is not a hyper inflationary period nor runaway inflation. Rather this is a period when inflationary forces are stronger than deflationary forces. Under this scenario the normal relationships between the above four asset classes are as follows:
Stocks and Bonds are positively correlated. They tend to move in the same general direction. Bonds tend to lead stocks in predicting pivotal trend changes.
Bonds and Commodities are inversely correlated. That is, they tend to move in opposite direction.
US Dollar and Commodities are also inversely correlated.
Stocks and Commodities tend be positively correlated.
Under a typical deflationary environment – This is a scenario where there are nominal or even no inflationary pressures. The four asset classes will have the same intermarket relationships as during inflationary environment except for one specific relationship - Stocks and bonds tend to be inversely correlated during a deflationary period. That is, stocks rise when bond prices fall and vice versa. This translates to stocks and interest rates rising and falling in unison with one another.
Enclosed are the longer-term charts of Stocks (SPX), Bonds (USB), Commodities (CRB), and Currencies (USD). Also attached are the intermarket relationships between SPX, USB, CRB, and USD since Mar 2009 stock market bottom.
Based on the intermarket analyses of the four asset classes, 2016 has emerged as an important time frame as key asset classes appear to decouple from their normal historical relationships. These discrepancies may very well be corrective phases of an overall primary trend. Nonetheless, if these trends persist it may also warn of peaks/bottoms and even hint of impending directional trend changes in asset classes in question.