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As long term retail investors, our main concern when it comes to investing is looking for the warning signs that could send the stock market into secular decline. One of the main signals of a decline in stocks is a rise in inflation. At the time of writing on 2024/25, we need to keep a close eye on the US CPI inflation. After the Covid inflation spike we are seeing the CPI follow an eerily similar path to the 1970 reflation scenario which saw inflation come back even harder. If we start to see inflation trend up from this point, that would be a huge warning sign for stocks...
Increases in Inflation which are large enough to induce downturns in stocks will show up the DBA:SPY comparison chart below as was the case in 2022. The spike in the chart in 2022 is agricultural ETF "DBA" literally destroying the might SP500. These inflation spikes are a huge red flag for the stocks and the financial investment industry knows it, but of course, they will keep everyone invested as their 'official advice'. Hence one of the main reasons for the existence of this blog.
If inflation of that magnitude starts to rear it’s ugly head again, we would see something like chart below again... or at least DBA outperforming the sp500...
As used else where in this blog, the 30/40/50 weekly moving averages are used as longer term measures of price action to inform potential decisions on portfolio allocation...
The same goes for Individual commodities such as base metals, but also for the Energy sector using the same price performance comparison charts as above...
Base Metals ETF (DBB) in 2022...
Gold (GLD) vs SPY (SP500) showing a defensive risk-off market for equities during 2022…
The same goes for Individual commodities such as base metals, but also for the Energy sector using the same price performance comparison charts as above...
Base Metals ETF (DBB) in 2022...
Gold ETF (GLD) vs SPY (SP500) showing a defensive risk-off market for equities during 2022…
Energy sector ETF (XLE) vs SPY (SP500) showing a defensive risk-off market for equities during 2022…
Inflation
Inflation
As far as our investment portfolios go, We are only really concerned about the onset of elevated levels of inflation or even inflation spikes which can then cause downturns in bonds and even stocks if it gets high enough.
Oil predicts War?…
On the right hand side in OCT 2024, the trend down in Oil prices was reversed by a sudden escalation in the middle east war which then also sent the 10 year US bond yield spiking as fears of inflation returning took hold…
Inflation & Oil
Inflation & Oil
Global inflation in 2022 caused by excessive stimulus by both governments and central banks in response to the Coronavirus pandemic was a good example of inflation driving central bank policy. In short, the central banks raise interest rates to slow growth and therefore bring inflation down causing both bond and equities markets to sell-off.
The inflation charts are shown below but if you click the link through to the Trading Economics page and switch to the forecast tab you can see where they think inflation is headed. After high inflation occurs, it needs to come down to act as a tailwind for stocks.
OIL & INFLATION: f oil futures pick up (drawn in red line below) and inflationary pressures build then this would be another reason for the Fed to raise rates exerting downward pressure on bond prices...
US Core PCE Prices
The core price index CPI for personal consumption expenditures (PCE) in the United States excludes food and energy giving an arguably more accurate indicator of underlying inflation as these highly variable inputs are omitted.
INFLATION AS A LEADING INDICATOR OF RCESSION & LEADING INDICATORS OF INFLATION
rising inflation peaks coincide with recessions and correspond with stock market declines: -
A consumer led leading inflation indicator is the US University of Michigan 1-Year Inflation Expectations. We are looking for these indicators to reduce in order to see stock markets go higher
The Pro Shares Inflation Expectations is another widely watched 'expectation' barometer for this type of leading indicator:-
A well respected, 'leading indicator' of inflation used by analysts is the 5 year break-even inflation rate. This measure of inflation is what financial markets are 'pricing in' as the expected level inflation. If this is coming down it is bullish for equity prices as it indicates that headline inflation should also come down.
What we need to watch out for is when the 5Y BE rate goes above about 2.5%. This is the level at which the Federal Reserve will be more likely to raise rates to prevent inflation returning. Bond prices don't like high inflation expectations so this is one to watch when buying and selling bond funds.
(This 2.5% threshold is also one to watch for on the big US 10 or 20 year bond. View the TLT ETF on any chart to view that 20Y bond price action. You should also be able too see a chart of just the US 10/20 year bond rate.)
In general, bonds are best owned below that 2.5% level and when price are trending down below that 2.5% level...
THE DIFFERENCE BETWEEN 2005-2006 AND 2020
When the Five-year breakeven inflation rate heads north of about 2.6% then it's something to take note of. The 2022 inflation crisis peak shown in the chart above hit 3.57%. This is the highest reading since the Fed began tracking this data in 2003. It’s higher than in 2011, when inflation triggered a food crisis around the globe. It’s also higher than in 2005-2006 when housing was in the largest bubble of all time and oil was about to explode higher to $150 a barrel.
The Producer Price Index
The Producer Price Index for All Commodities on the Federal Reserve link below shows us the price inlation experienced by producers and manufacturers. (Switch to the 5year and 10 year charts on the page.)
US OIL
Energy and fuel prices are the main component of inflation and so we need to see oil prices come down before inflation comes down...
(Note: There is a correlation between oil/energy prices coming down and then equities coming down after)
The chart image below showed what happened to crude oil before the Great Financial Crash 2008... it spiked just before the crash. Spikes in the price of oil are something to watch out for...
But it's not just spikes in the price of oil we need to to be concerned about. Any elevation in the price of oil can spell problems. Rises in oil have historically been matched with a rise in unemployment claims and ensuing recessions. Even when there wasn't an 'official' recession in 2015/16 and 2018, these periods saw quite large drawdowns in global equities.
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