3 Market Themes That You Should Be Aware Of
Craig Thompson | Aug 02, 2021 04:31PM ET
While we are likely at the beginning of a long-term (secular) period of inflation, in the near term, we seem to be experiencing deflation as seen in financial markets. I know that this may come as a surprise given that the price of consumer goods is rising and all the media content seems to be highlighting an environment of run-away inflation.
Maybe the inflation trade just got overextended and this is a healthy pullback before we get another strong advance. Only time will tell, but the charts are suggesting deflation right now – not inflation.
During deflationary environments, investors should focus on capital preservation. The best asset class in this environment is typically bonds. On the equity side, risk-off sectors such as utilities, health care and consumer staples tend to outperform.
h4 /h4 h4 Market Breadth Continues To Deteriorate/h4As I mentioned in last month’s newsletter , market breadth is poor. While the S&P 500 grinds to marginal new highs, it is on the back of a handful of large-cap stocks that account for an outsized portion of the index’s return.
There are numerous charts that I could show that illustrate the market’s deteriorating breadth. Here is one that drives the point home.
Below is a chart of the Nasdaq Composite Index in the top panel and the number of stocks within that index that are above their respective 50-day exponential moving averages in the lower panel.
Notice how the index is well above its moving average, yet there is only 37% of the stocks within that index above their moving averages.
If we were in a high growth, inflationary environment, you would expect to see risk-on assets like semiconductors, transportation and small caps outperforming. But that is not what we have been seeing over the past few months.
Below is a relative strength chart that illustrates the performance of semiconductor stocks relative to consumer staples stocks. When the line is rising, semiconductor stocks are outperforming consumer staples.
Consumer staples have been outperforming semiconductor stocks since the beginning of March. For the sake of brevity, I won’t show similar charts of small caps and transportation stocks; but they are underperforming as well.
Get The News You Want
How is the S&P 500 Index performing relative to Treasuries? Not good. For the past three months, Treasury Bonds have been outperforming the S&P 500.
Treasury Bonds are outperforming stocks. Investors are not being rewarded for taking risk.
During periods of economic expansion, which is the engine that drives inflation, you usually see yields rise and commodities like copper rise.
The price of copper is mainly influenced by the health of the global economy. This is because of the widespread applications of this commodity in the economy. A rising copper market suggests strong economic health, while a decline suggests the opposite.
Copper had a strong advance that began at last year’s stock market bottom. That strong performance has petered out, and copper has been underperforming Treasuries for the past three months.
Bank stocks do well in a rising yield environment and Treasury prices perform well in a falling yield environment. Treasuries have been outperforming bank stocks recently. This is because of falling bond yields.
If we were in an inflationary environment, treasury yields would be rising and treasury prices would be falling. That is not what we are now seeing.
Treasury prices bounced at support in March, advance above a downtrend line, and their 200-day moving average.
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.