Where Are We In the Business Cycle?

Today I want to look at the three major asset classes, bonds ($USB), equities ($SPX), and commodities ($GSG) and how they can help us better understand where we are in the business cycle. John Murphy in his book Trading Intermarket Analysis does a great job at highlighting the relationship between these three asset classes and how they function during the business cycle.

Murphy references the following chart of the business cycle and shows that depending on what stage of the cycle we are in, the assets perform differently. Based on this, and I’ll show the chart further down in the post, it appears we may be entering stage four. I’ll explain why later. Here’s how Murphy describes the cycle, ” The business cycle is shown as a sine wave. The first three stages are part of an economic contraction (weakening, bottoming, strengthening). Stage 3 shows the economy in a contraction phase, but strengthening after a bottom. As the sine wave crosses the center line, the economy moves from contraction to the three phases of economic expansion (strengthening, topping and weakening). ”

im-10-cycleBefore we look at the current market, lets take a look at previous market peaks (no I’m not calling for a market top, keep reading). As Murphy describes, during a normal cycle we will see bond prices top out first and begin a down trend, followed by stocks with commodities being the last to weaken. This is how things played in 2000. As the chart below shows, the top panel is the 30-year Treasury Bond ($USB) which broke its up trend in late 1998 with equities ($SPX) topping out in 2000, followed by commodities ($GSG) in the bottom in early 2001.

2000 top cycle

Next up we have the market peak in 2007.  Price action played out slightly differently leading up the economic cycle peak. While bond prices put in their low in 2004 we began seeing lower highs and higher llows from 2005 through 2007. Equities followed by peaking in 2007 and commodities ultimately toppled over in 2008.

2007 top cycle

So how do things look now? Not too bad. All three asset classes are still in their up trends; however, bonds are well off their highs. The 30-year Treasury bond appears to have potentially topped out last year as it starts to threaten its trend line off the 2007 and 2011 lows. Commodities, while not a great performer during the current bull market, are still in an up trend. And of course equities continue to make higher highs and higher lows with plenty of space between price and its trend line.

This is why I think we may be getting close to stage four in the business cycle. It’s possible we see bonds break their up trend in 2014 and light the match for economic contraction and ultimately a peak in equity prices. But it’s important to remember that the time between the peak in bonds and the top in equities can be years. Look back at the first chart, Treasury’s hit their high nearly two years before equities topped out.

Current cycle

While each market period is unique and involves different forces and economic environments, I think it’s important to watch these three assets and how they are related to one another. Based on the above chart it seems we are still in expansion phase of the economy and the market. I’ll be watching how things progress as we kick off 2014 and how these three assets perform.

Source: Intermarket Analysis (stockcharts.com)

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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Treasury’s Breakdown Against Commodities

While commodities have not been exploding higher this year, they have recently begun to outshine Treasury’s. When looking at the larger picture of the market cycle we can compare the three major pockets – stocks, bonds, and commodities. As John Murphy has written in Trading with Intermarket Analysis and Intermarket Analysis, we normally see Treasury prices fall first, followed by equities and then commodities at the end of a business cycle.

While I’m not calling for the end of a business cycle or for bonds to fall flat on their face, there has been a breakdown in the relationship between 10-year Treasury’s ($ZN_F) and commodities ($CRB). Below you can see the weekly chart of the ratio between the 10-year and the commodities index. It’s been putting in higher lows since mid-2008 as Treasury’s outperform their commodity brethren.

We are still above the long-term trend line connecting the 2008 and 2011 lows, however we are breaking the short-term trend line off the 2011 and the recent 2013 lows. The trend in the Relative Strength Index has also been broken as Treasury’s momentum against commodities weakens.

treasury commGoing forward I’ll be watching to see if commodities dig their feet in to continue to outpace bonds and if RSI is unable to regain the 50 level. If we continue to see yields rise and thus prices fall then we could be signaling the first step to the end of the current cycle as mentioned above. However it’s still early in the ball game to make that type of assumption but that does appear to be what the charts are starting to hint at – we’ll see how it plays out in the coming months.

 
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.