Lessons from the Pros

Hedging Your Bets With Matt
Davio:
Parabolic Destruction 

When I step back and look at the last 3 years of the one-way rally we have had in the US and world markets, I am truly amazed that we have not seen a break down of significance (say a 5% to 10% move down). That is not normal. But we are not living in normal times. We are living in a reflationary environment where all asset classes move in concert, propped up by the biggest governments and their easy monetary and fiscal policies.

After 5 days down in a row, Friday’s volatility on the traditional VIX again dove down under 12 as the markets rallied hard. And while no real technical damage was done to the markets after those 5 down days, one thing that has started to ease is the CRB (commodity – oil, gold, copper, wheat, etc) index. You can clearly see this in my first chart.

In particular, the commodities, which have been acting like tech stocks over the past 3 years, may finally be hitting the first wall. Overall they have come off their highs about 10% and the daily charts have broken both the 50 and 200 day moving averages.

Now if we look closely at the 2nd chart, you will also see the first break of the CRB’s parabolic move just beginning. I really would be concerned about the overall market here, as I am not finding great leadership in other sectors as the CRB begins what could be its first roll over. Without the leadership from the commodities and/or leadership and rotation into other sectors, the big picture starts to look weaker than advertised. 

The last chart to look at is the CRB index vs. the 30 year T-bond rate. The first thing to know is that the CRB/30 year ratio is a loose leading indicator of future stock prices. This is due to the fact that when the ratio is high and commodity prices go up and/or interest rates go down, liquidity increases and profit margins dwindle (due to higher commodity costs). As the ratio lowers and commodity prices go down.

Now as you can see, we have been sitting near the top of the CRB/30 year chart over the past few years, yet the stock markets, bond markets, and the commodities have all risen. If the CRB Index indeed begins a pullback and the CRB/30 year ratio lowers, that should be a signal for a bullish scenario in stocks. But with all asset classes rising without a major correction, and the CRB/30 year ratio still in the 95th percentile of its range, I believe that a true bullish scenario for stocks is a far ways off. Again, we come back to my theory that instrument pricing is indeed different under a reflationary environment. That is, until people realize the risk associated with pandemic price inflation and adjust accordingly.