Geopolitical uncertainties in Europe and Asia, recession fears, inflation concerns, banking turmoil, and other corporate and economic issues increased volatilities across financial markets.
Instead of focusing on headline news, it may be more effective for investors to closely monitor the relationships between the four asset classes, including stocks (SPX), bonds (TNX), commodities (CRB Index and Gold), currencies (USD), and investment styles (growth versus value and Technology versus SPX) to understand the sustainability of the primary trends and potential trend reversals.
There are well-defined historical relationships between stocks, bonds, commodities, and Currencies.
Understanding these relationships can help investors better manage their financial goals and, most importantly, determine the various stages of an investment/business cycle.
An inflationary environment differs from a hyperinflationary or runaway inflation. Inflationary periods occur when inflationary forces are greater than deflationary forces. Under this scenario, the relationships between the above four asset classes are as follows:
Stocks (SPX) and bonds (TNX) are positively correlated. They tend to move in the same general direction. Bonds tend to lead stocks in predicting pivotal trend changes.
Bonds (TNX) and commodities (CRB Index)are inversely correlated. The relationship moves in the opposite direction.
Currencies (US dollar) and commodities (CRB Index) are also inversely correlated.
Stocks (SPX) and Commodities (TNX) tends to be positively correlated.
A deflationary environment occurs when there are nominal or even no inflationary pressures. The four asset classes will have the same Intermarket relationships as during an inflationary environment except for one specific relationship - stocks and bonds are inversely correlated, during deflationary periods. Stocks rise when bond prices fall, and vice versa. It translates to stocks and interest rates also rising and falling in unison.
Enclosed below are Core Consumer Price Index (CPI), the Core CPI YOY, USD, CRB, TNX, SPX, IWF/IWD, XLK/SPX, and Gold.
Minor divergences or discrepancies from historical relationships alert investors and traders to potential corrective phases of an overall primary trend. However, if these trends persist, it warns of potential peaks/bottoms and impending directional trend changes in the asset classes.