The small positivity of the economic cycle is part of the larger commodity up cycle, which threatens to destroy the concept of money beyond 2012
The term Intermarket was coined by John Murphy in 1990. Murphy said that all markets are linked, domestically and globally, no market moves in isolation, analysis of one market should include all the others. A simple look at Reliance and Exxon, Infosys and IBM, Alcoa and Hindalco would prove how it is just the reasons that we see are local, the similarity in the move of three pairs suggest that conclusions are global. You really cannot differentiate one from the other.
Start of the year I was invited at the Holland day in Cluj, where I met a top billion dollar group CEO (valuation at the top in 2007). After the general greetings, the talk immediately shifted to the crisis and general remarks like "Who knew?” My attempt to explain that that it was not true, led to some further questions like "where to invest now?" I mentioned about the value of gold in the coming decade. At this stage the CEO said, "Gold is for women". Maybe it was emerging market naivety, but there are still CEO's there running billion dollar companies who are clueless about what gold means. Actually we all are.
End of cash money
Gold has a case beyond 2012. It is true that the last deflation in 1930's gold had a limited history. But since 1970's gold can be considered both an inflation and deflation hedge. The only time, I think, gold can really fall is during disinflation, where the society is living prosperous times. Murphy talks about gold increase when stock falls and vice versa. He also explains how gold leads the commodity index (CRB), leads industrial metals, mirrors the dollars (weakening dollar hurts gold and vice versa) and has a synchronous movement with foreign currencies (pegged against dollar). A simple chart of gold with CRB since 1970 throws an interesting observation. It is the first time that on a primary (multi-month) basis that gold has made a higher high compared to the rest of the commodities. This divergence is the first sign that this is the beginning of end of cash money that the current generation is used too. Any dips on gold into 2010 should be last opportunity to buy gold in the 2010-2020 decade.
Interlinked assets
Murphy talks about mirroring effect in commodities and currencies of commodity-based economies like Canadian and Australian dollar and the connection of copper and Canadian dollar (both strengthen and weaken together). The book also makes a case of industrial metals like aluminium and copper, which are considered to be barometers of economic strength or weakness. Rising industrial metals are associated with stronger economic conditions as are higher interest rates. Falling industrial metals are associated with weaker and lower interest rates.
Though the author does not suggest importance of one asset over the other, I consider interest rates as a key asset in the Intermarket outlook. Rising interest rates are negative and falling rates are positive. High price-earning (PE) stocks get affected by rising rates, a weakening economic cycle, while strengthening economic cycle and falling rates benefit growth stocks. Inverted yield curve (short term rates higher than long term rates) have been illustrated as a case of most recessions.
Though depression happened in falling interest rates, it created the base for a multi decade bounce. The book suggests a normal Intermarket outlook where bonds, stocks and commodities move up from a bottom in succession and top in the same succession as economic cycle tops. It's in the deflation outlook that the respective sequence breaks as bonds continue to rise (or yields continue to fall), as they did in 1930s and later after the 2000 crash.
2010 Outlook
The outlook for 2010 based on the 30 year US yields, which fell secularly from January 2001 till December 2008 suggest a positive and prosperous time before commodities take over. I am not aware of Murphy's take on this but a secular fall in US rates on the long term suggest weakness over the period under study. Market analysts may have a categorical view on weakness of Dow and dollar, but a decade long drop in interest rate yields till December 2008, weakness on dollar accompanied by strength of commodities has already balanced a lot of secular weakness in Dow components. To expect Dow to secularly underperform commodities, interest rates to keep falling seems a long shot at this stage. Any collapse on US equities remains an intermediate (multiple weeks) case rather than a case for primary negativity (more than nine months).
The Orpheus Numeric Ranking products were recently extended to bonds, metals and global Indices. NR bonds suggest that till end of the year, 2 and 5 year US bonds should outperform 10 and 30 year US bonds. This means that yield curve should steepen and remain normal suggesting economic strength rather than weakness.
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One of the best parts of Intermarket analysis is sector rotation where Murphy details Sam Stovall's sector rotation. We have talked about it on prior occasions, how sectors move in an out of performance with the changing underlying economic cycle. The Orpheus ranking on Dow and Indian sectors brought out similar performing and underperforming sectors. Financials and materials led in both cases while consumer goods, utilities and health care lagged, a classic sign that the economic cycle had indeed turned up.
The gaps in the subject are that Intermarket addresses one economic cycle and not a larger or smaller one. Orpheus Numeric ranking can illustrate sector rotation on multi decade, yearly, quarterly, weekly, monthly, daily and lower time frames. What does this mean? This means that in the process of showing Intermarket linkages both Murphy and Stovall ignore recurring cycles at smaller and larger time frames. Murphy does not bring out the idea of time cyclicality in his original work and his method of looking at relative performance through trendlines is crude. Intermarket performance can be quantified by performance cycles (refer to our previous articles on the subject).
The outlook for end of the year can be made from the current rising CRB-Bond, which favours gold, energy, and basic materials like aluminium, copper and paper products. Rise in industrial metals are sign of economic strength, the case now. The moment this performance cycle CRB-BOND will turn lower, staples, pharma and other interest rate sensitive stocks will start to perform. If a falling dollar pushes commodity prices higher, it is usually bearish for bonds (the case now). This cannot last long and is only making an intermediate negative case for stocks potentially till end of the year. CRB vs. gold is starting to push higher suggesting that the best of gold outperformance for the year maybe behind us.
Early next year can be understood by Dow vs. CRB ratio line. After 10 year of underperformance the Dow performance cycle against commodities should also turn up. This means after any dip till end of the year, Dow should head into a positive 2010. This is positive for global equities also. It’s only when commodities re-emerge mid-2010, it will be time for us to review, the larger commodity cycle and agro, as the food crisis question will emerge again.
The author is CEO, Orpheus.asia, a global alternative research firm
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