FALLING DOLLAR PUSHING CRB HIGHER... One intermarket principle that has stood the test of time is that a falling dollar pushes commodity prices higher (partially because commodities are priced in dollars). Charts 3 and 4 show that the rally in the CRB Index since the start of this year started with the peak in the dollar around the same time. Both have been consolidating for the past few months. If the dollar breaks down, the CRB Index will most likely breakout. Chart 5 shows why an upside move here in the CRB Index would be very significant.
CRB INDEX NEARING MAJOR UPSIDE BREAKOUT... The monthly chart of the CRB shows a major double bottom forming since l999. This year's rally has pushed the commodity index right up against its late 2000 peak. An upside breakout through that major chart barrier would leave little doubt that commodity prices have put in a major bottom (thanks in part to a breakdown in the dollar). Normally, rising commodity prices would push bond prices lower -- and interest rates higher. That's because long term bond yields (which are most sensitive to inflation) normally trend along with commodity prices. Chart 6 shows that the 30-year T-bond yield has a strong tendency to rise and fall with the CRB Index. At least, up until the last six months. The blue boxes, however, show that interest rates have been dropping since last May -- while commodity prices have been rising. That's unusual. Given the historical record, however, a major upside breakout in the CRB Index could start putting upward pressure on U.S. interest rates. What may be counter-acting the upward pull of commodity prices on bond yields may be a weak stock market.
FALLING RATES HAVEN'T HELPED STOCKS THIS TIME... The next two charts compare long term rates with the S&P 500. Normally, they trend in opposite directions. Falling rates normally coincide with rising stocks -- rising rates with falling stocks. And that was the case -- until 1998. Since then, long term rates and stock prices have been trending in the same direction -- as shown by the green and red trendlines. We suspect (and have said so many times) that deflationary tendencies that erupted in Asia during 1997-1998 may have changed the normal link between bonds and stocks. During a deflation, falling bond yields don't help stocks. They fall together -- which has been the case for the past three years. Falling stock prices imply economic weakness, which pulls interest rates lower. The close link between rates and stocks may also explain why bond yields have so far resisted the upward pull of rising commodity prices. Another depressant on bond yields may be deflation pressures from Japan.
JAPAN DEFLATION PULLING RATES LOWER... There's a great debate going on as to whether the U.S. market is being threatened by deflation. However, there's little doubt that deflation exists in Japan -- which is the world's second largest economy. The final two charts show a close link between falling U.S. rates and a falling Japanese stock market. It's not too hard to imagine that Asian deflation is also exerting a downward pull on U.S. rates (since global rates are also linked). That may also explain why U.S. rates are resisting the upward pull of rising commodity prices.
WHY THINGS ARE DIFFERENT THIS TIME... Throughout the three-year bear market, many of the traditional rules of bear market behavior have been broken. This bear has lasted longer and fallen harder than anything seen in the post-war era. It's the first time we've seen three consecutive down years since the 1930s. We continue to believe "deflation" is the culprit. Even the Fed mentioned the threat of deflation in their November minutes -- which had a lot to do with lowering rates a half point. Whether the U.S. is in a deflation is open to debate. There's little doubt, however, that Asian deflation exists. And that may be where the answer lies. Since all global markets are linked, it's hard to imagine that we're not being infected by some Asian deflation. That's why this week's breakdown in the dollar -- and upside breakout in gold -- is so intriguing. It may actually be hinting that a falling dollar is counter-acting deflationary pressures. Maybe that's what the Fed had in mind all along. We're concerned, however, that a breakdown in the dollar could have a negative impact on stocks. The final two charts compare the Dollar Index (through Thursday evening) with the S&P Index (through Friday's close). Prior to July, both had been dropping together. The July bottom in dollar (and five-months of dollar stability) helped launch the stock market rally. A new low in the dollar could cause the stock market rally to falter as well.
December 17, 2002
John J. Murphy, CNBC-TV's technical analyst for many years, and Greg Morris offer money managment and market services at MURPHYMORRIS.COM , email address orders@murphymorris.com.