One of the biggest influences on inflation this year has been commodity-based inflation. Food, and energy in particular, but also industrial metals. Commodities are often key harbingers of shifts in economic growth and economic cycles, so we always want to listen to what commodities are saying for insights.
Some major bellwethers in the commodity complex are starting to correct sharply enough that further breakdowns could portend a shift in the economic backdrop and perhaps even a temporary shift in the intermediate-term inflation outlook. This could be equity positive if it leads the Fed to back off after July’s 75 bp (or 50 bp) hike. It could also warn of a recession ahead if these declines pick up steam. It is quite important for investors to watch commodities and other recession warnings ahead.
Copper
Dr. Copper (see chart below), the so-called economic Ph. D., has foretold shifts in global economic growth so well over many decades. Things are starting to breakdown here and warn us of global economic deceleration and increased recession risks. After rising just over 125% off the March 2020 lows, Copper had a weekly close (3.7440) under 3.96 that signaled a three-month trading range breakdown, and breakdown of a potential handle pattern on monthly charts. Copper’s close on Friday is the first bellwether commodity to warn of a commodity correction underway and economic deceleration ahead. If it declines further, recession risks will rise.
Commodities normally peak after the peak of the economic cycle, and often only after recession becomes nearly imminent. The 2008 cycle had commodities peaking even later than usual, in late spring to summer of 2008, after the recession was already underway (and following the October 2007 stock market peak and first wave decline). For commodities to give intermediate-term topping signals in unison, it would be a clear warning economic deceleration risk is turning severe.
Wheat
A major concern for much of the world, particularly parts of Africa and the Middle East, which get over 70% of their wheat supply from Ukraine-Russia, has been the food shortage and price explosion. Wheat prices were already up over 70% prior to the Russian invasion, but have spiked up another 60% since, in the largest and quickest runup since the 1970s in terms of Year over Year price increases.
Wheat broke out down last week from a descending triangle (also a trading range breakdown) on the weekly close Friday at 937.25. Wheat backed off from the spike 2008 peak resistance zone around 1300-1350¬—a natural pause and resistance point. With Copper breaking a key trading range support level, and wheat doing the same on the weekly charts, we have two major bellwether commodities signaling more downside ahead. This suggests global economic deceleration risk, and even potential recession risk rising sharply.
Crude Oil
The third major bellwether commodity to watch is $WTIC West Texas spot Intermediate Crude Oil prices. Oil is not as near to a potential intermediate-term trading range breakdown as Copper and Wheat have been, but one can see a potential range to watch ahead. Spot crude is up from theoretical 0 at the depth of the COVID crash to $130 at recent peaks. Although on a monthly and weekly basis, spot crude has had trouble breaking and closing over the $115 resistance level from the 2011 peak. So, this too is backing off from a natural resistance level. $WTIC has made a multi-month trading range between around 123-92.8, and a breakdown and close by crude below 92.8. Following breakdowns by both copper and wheat, this would be a major warning sign of a potential recession ahead that we should look out for.
We’ve already seen a classic sign of capitulation. Energy stocks, and many commodity-oriented stocks that had held up so well for most of the correction, have started to give way, leading lower as all stock investors throw in the towel to the correction.
Let’s remember to watch our market peak checklist macro indicators that can help warn of imminent recession as well. Two of our favorites to keep a close eye on include the 2/10 yield curve rising back over 0.5, and the three-month unemployment rate rising above 20m EMA. Neither of these has triggered yet, but we will be watching them closely.
Macro-economic indicators are often the last to give recession signals, but still often trigger just before a recession officially launches. Other ones to watch (that we teach in our Market Timing course) include the YoY rate of change for the LEI turning negative, the US Philly Fed Coincident Economic Activity Index declining, and the Chicago Fed National Activity Index 3m avg <-0.7. We will comment on these ahead, should they trigger, but you can watch them yourself at https://www.conference-board.org/topics/us-leading-indicators and https://fred.stlouisfed.org/series/USPHCI and https://fred.stlouisfed.org/series/CFNAI respectively.
When the outcome for the market hinges on recession or no recession, and when inflation peaks, investors need to pay especially close attention to indicators of such developments to gauge the backdrop properly.
Jobless claims were relatively flat last week, but the manufacturing PMI was down to a 23-month low, in mixed news. But in European trading hours, a German official actually warned of a potential “Lehman-like” contagion from shifts away from Russian gas.
Powell was asked, in his testimony before the house, whether rate hikes can adjust the supply of oil and other key commodities that are pushing inflation. Of course, he had to reply that monetary policy can’t really control supply. The idea of rate hikes is demand destruction: bring demand down to the level where prices aren’t rising given the existing supply constraints. But rate hikes are a very blunt instrument, and they can often lead to unintended negative consequences that lead the Fed to shift policy directions before the goal of slaying inflation is achieved.
Moves in major corrections and bear markets are chronically violent, and this one is behaving no differently. This is one reason to pull back size or go heavily to cash in these kinds of backdrops. Violent markets, trying to hash-out the upcoming uncertain macro backdrop, can move sharply on news or developments. Harkin today implied maybe only a 50 bp hike in July, and bonds rallied further, helping support stocks. That’s not something very definitive in the outlook though, nor is it a potential major policy shift.
Many analysts are starting to come around to the idea that stocks need to fall back into pre-pandemic levels before this correction has a chance of ending. That would put the S&P back below 3393 (in our 3200-3400 downside target zone). Stocks are oversold and can bounce. We have not gotten a clear demand response off recent lows thus far and until we do, the bias should be that rallies are temporary and against the dominant intermediate-term trend down.
We know so many of you are dealing with the squeeze of losses in your investment accounts and the rising cost of living. This is such a painful experience that often makes you feel like your life is out of control. Our primary mission in the teaching and advisory work we do is to help people like you gain control of their lives—a life that is above this type of pain. This was Van’s biggest wish for you as well. Van wanted for all of you to achieve Infinite Wealth, pursue your bliss and have the space to create transformation in your life. As these different economic environments emerge, they should always be opportunities to raise our standard of living, not a crisis that we hope we can survive. We have the systems and methods to support you to never be “squeezed” again and hope we get to have the pleasure of sharing them with you.
In the meantime, keep an eye on the markets and indicators we highlighted today. Beware of the washout which we have yet to see in equities. The washout where volatilities explode, and panic selling ensues. We haven’t seen it yet but it’s likely coming. When it does come, amazing opportunities will be at hand. Will you be ready?