Newsom on the Market
Darin Newsom 2/16 6:14 AM

It's the week of Valentine's Day and therefore it's fitting for me to go all Dr. Phil on you for a moment. Give yourself a big hug if you're bullish on the grain and oilseed markets. You know who you are. Go ahead, you've earned it.

Now that we are all in our happy places, let's talk "relationships." Don't be uncomfortable. Opening up about your feelings is important, even cathartic. Trust me, you'll feel better.

Okay, let's get into what I'm really talking about, the relationship between different market sectors in general, and commodity sectors in particular. Why? Because recent volatility in U.S. stocks markets has raised the volume on chatter regarding investing money coming out of equities and moving into commodities. While there is some truth to the idea, painting the entire commodity sector bullish because of it is a bad idea.

Let's review how market sectors normally relate to one another. The stock market rallies, improving economic conditions lead to inflation (higher commodity prices), prompting raises to interest rates to strengthen the U.S. dollar. A series of higher rates to strengthen the dollar tends to spark selling in stocks, buying in bonds and lower commodity prices. It's the normal intermarket relationship cycle, the circle of life (cue the song form The Lion King) of markets, if you will.

Where are we now in this cycle? Let's start by looking at stocks through the Dow Jones Industrial Average (DJIA) lens. Though some would rather say the DJIA has been in an uptrend since November 2016, this major (long-term) uptrend has been in place since March 2009. That's correct, March 2009 when the DJIA established a spike reversal on its monthly chart. What's a spike reversal? One of the few turn signals I look for to indicate a change in trend (price direction over time). That month the DJIA posted a new long-term low of 6,469.95 before rallying to a high of 7,931.33 and closing at 7,602.92. By June of that year, the DJIA had posted a new four-month high of 8,877.93. The subsequent uptrend lasted until this month, when a sell-off from the January high of 26,616.71 took the stock market to a low (so far) in February of 23,360.29. If stocks stabilize for the rest of the month, the four-month low heading into March will be 23,242.75 -- well within striking distance.

What would be the catalyst for a long-term bearish turn signal in the DJIA? As noted above, the usual culprit is higher interest rates. Recently, the U.S. Federal Reserve has been making noise to follow through on Campaign 2016 promises of a more aggressive policy toward Fed Fund rate increases. Interest rates that are trending up will strengthen bond yields, pushing bond prices down. As discussed in his 1991 book "Intermarket Technical Analysis" author John J. Murphy sums up intermarket relationships with, "...a rising bond market is generally bullish for stocks. Conversely, a falling bond market is generally bearish for stocks. It can also be shown that bonds often act as a leading indicator of stocks."

The key to intermarket relationships between the four major components (stocks, bonds, commodities and the U.S. dollar) is the trend of the dollar. The greenback tends to trend up as interest rates increase, eventually putting pressure on commodities and supporting stocks. When the trend of the U.S. dollar turns down, commodities tend to trend up and eventually stocks turn lower.

Within this most recent cycle, though, those usual market relationships look to have been broken. Thirty-year T-Bonds have been in a downtrend since its peak in July 2016. The U.S. dollar index didn't firmly establish its major downtrend until January 2017 with its high of 103.82. Since then, both bonds and the dollar have been in solid three-wave downtrends. The oddity is that stocks haven't been trending with bonds the last couple of years. The fact the DJIA has extended its rally leaves the U.S. stock market vulnerable to a larger sell-off just as bonds look to be nearing a long-term bullish turn.

If the stock market does finally establish a major downtrend (it could be argued two years too late) will investment money flow to commodities? It depends. In the big picture, higher interest rates could push stocks down, but also establish a new long-term uptrend in the dollar index. It then follows that a stronger dollar would actually be bearish for the commodity sector in general, with more investment money possibly making its way to bonds.

That's not to say some commodities couldn't reap the benefit of increased investment interest, but it will be selective and driven by ... fundamentals. That's right. Dr. Technical is admitting that fundamentals are the key to attracting investment money. In the not too distant past we've seen strong rallies by crude oil (and heating oil) and cotton, both supported by inverted forward curves reflecting bullish supply and demand situations. More recently, the investment world's attention has turned to soybean meal, where weakening carry is seen in the nearby March-to-May spread, while the longer-term forward curve is inverted.

That's where the bullish fundamentals end, at least for now. Old-crop corn's forward curve continues to show a solid carry, as does old-crop soybeans. Wheat, in general, remains confusing due to Variable Storage Rates in winter markets, though the bottom line is strong carries are bearish. The only way for the grain complex to attract investment money is for bearish supply and demand situations to change. A stronger U.S. dollar will make that more difficult, meaning the best chance of a turnaround occurring has to come from weather -- domestic weather. And, after last year's supposed record yield in corn, it's going to be hard to start a weather market rally.

Nobody ever said relationships were easy.

Darin Newsom can be reached at darin.newsom@dtn.com

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