Equity and commodity prices sharply switched roles today. Stocks, which had been plunging, are up over 3% from yesterday’s close at this writing, with commodities (as represented by copper) down a like amount. Gold is also off its highs sharply. Has the major trend changed? Have stocks put in a durable bottom? Has inflation been vanquished?
My answer is no on all counts. It’s common for very sharp asset price displacements to reverse equally sharply. Large and sharp movements tend to attract a lot of hot money, and when too much money moves too fast to one side of the boat, the boat needs to tip the other way. In a world of finite resources it’s not possible for everyone to get rich quick.
I believe the broader trends remain intact. The single best reason for example for stocks to decline in price is that they’re just too high to begin with. In the case of US stocks, the degree of too-highness was far more than than the mere 10% or so seen so far was able to correct. In the case of increasing commodity prices, despite months of hawkish talk, the Federal Reserve has yet to put in place a single rate hike. Fed funds remains effectively zero while consumer price inflation continues to romp unchecked.
The war in eastern Europe – more precisely, the response to it – was the catalyst for the recent spike in commodities and plunge in stocks. The drama caused existing trends to overshoot. This overshoot can correct without affecting the underlying trends, and I’m not aware of any reason for those underlying trends to change yet.
Synthetic Systems forecasts don’t suggest it’s yet time for those trends to reverse yet either. SS does see a setback in gold prices in the near future and even a summer rally in stocks. But it’s important to remember that Synthetic Systems basically tells us what markets should do in the absence of external, noneconomic, impulses. It did not foresee for example the coronavirus induced crash two years ago, and it did not foresee the recent volatility due to war in eastern Europe. Markets did return near their previously forecasted trends after the corona crash though, and a similar outcome is plausible this time, but it may take a quarter or two for SS to fully digest the implications of developments like these. They are, as far as SS is concerned, black swans, and it’s appropriate to take its forecasts with an extra grain of salt until that happens.
For example, gold may or may not fulfill the decline penciled in, which may have already begun. Further declines are plausible on the grounds that the rally of the past few months may have become overdone, but the long term fundamentals for gold – excessive debt, currency debasement, excessively high valuations for financial assets – remain strongly positive. Commodity price fundamentals in general remain positive.
Little is clear through the fog of war. My overall strategy is to remain broadly diversified by retaining at least some exposure to each of the major asset classes, simply underweighting or overweighting as the outlook indicates. I do continue to expect a major trend change in the third and fourth quarters of this year per Synthetic Systems, but we will have further updates before that time arrives.