Why Plunging Commodity Prices Are Ominous For Stock Market (UGA, XLE, USO, SPY, DUG, DBO)
Sy Harding: Consumers understandably like to see prices for commodities decline, the more the merrier, particularly gasoline (NYSEARCA:UGA) and energy costs (NYSEARCA:XLE).
Many analysts also take commodity price declines as a positive for the economy, on the theory that consumers will have more spending money in their pockets, and manufacturers will have lower costs, so hopefully greater earnings.
Investors tend to also take declining commodity prices as a positive for the stock market on the same reasoning.
Unfortunately, history doesn’t confirm the optimism.
As a five-year chart of the CRB Index of Commodity Prices shows, declining commodity prices usually indicate demand for goods is dropping and the economy is in trouble, which in turn is a problem for the stock market.
For instance, the price of oil (NYSEARCA:USO) dropped from $147 a barrel in 2008 to just $35 by early 2009. The CRB Index of Commodity Prices plunged 57%, from 470 to 200 in the same period. Good for the economy and stock market? Not hardly. The severe 2008-2009 ‘great recession’ and severe bear market in stocks accompanied the decline in commodity prices, and saw the S&P 500 (NYSEARCA:SPY) also plunge 57%.
Similarly, in the summer of 2010 the CRB Commodity Index fell 15% from 293 to 248. The economic recovery stumbled, and the S&P 500 also fell 15% in that summer’s market correction before the Fed came to the rescue with QE2.
Last summer the CRB Index fell again, declining 19.5% from 370 to 298. And sure enough, the economic recovery was stumbling again, and the S&P 500 declined 21% in last summer’s correction, before the Fed came to the rescue with ‘operation twist’.
And here we are this spring seeing commodity prices plunging again.
The CRB Index of Commodity Inflation has declined 10% so far from its high in February, and indications are that the economic recovery is stumbling again.
Perhaps more ominous, the CRB Index did not recover much from its plunge of last summer before rolling over again this spring. It has remained in a ‘bear market’, still down 21% from its peak of a year ago, and showing no signs of bottoming. The latest report is that the Producer Price Index, which measures price changes before they reach the consumer level, declined 0.2% in April, its biggest monthly decline since October.
That does not seem to bode well for the economy or the stock market.
Indeed, commodity prices are global in nature, and major stock markets outside of the U.S. are already in quite significant corrections, some in bear markets.
The further declines in the U.S. stock market and oil prices (NYSEARCA:DUG) of the last two weeks have both of them short-term oversold, and next week is an options expirations week and expirations weeks tend to be positive.
So it’s likely the stock market and oil prices (NYSEARCA:DBO) will bounce back some next week – if they’re not sand-bagged by further negative news from the euro-zone.
But short-term bounces notwithstanding, investors would do well to keep their eye on commodity prices.
As noted, the CRB Index of Commodity Prices has declined 10% since its February peak and shows no sign of bottoming, and many major markets around the world are in significant corrections and showing no signs of bottoming. Yet the S&P 500 has pulled back only 4% so far from its recent peak.
Sy Harding is editor of the Street Smart Report, and the free market blog, www.streetsmartpost.com. The Street Smart Report Online includes research and analysis on the economy and markets, and provides charts and buy and sell signals on the major market indexes, sectors, bonds, gold, individual stocks and etf’s, including short-sales and ‘inverse’ etf’s. It provides two model portfolios as guides. One is based on our Seasonal Timing Strategy, one on our Market-Timing Strategy.