Understanding the Current Economic Landscape and Stagflation

Is Stagflation Emerging in Today's Economy?

To start, I want to clarify that I am not an economist, but I aim to share an insightful perspective on the current economic situation.

The charts we have can tell a compelling story about pricing trends and economic conditions. Through my analysis, I will weave together a narrative regarding the potential for stagflation that has been a topic of discussion for some time.

Take the Goldman Sachs Commodity Index, for instance. Analyzing the price action over recent months has given me a lot to think about. The index appeared to reach its peak in April of the previous year, but it also hit a low point in the month of September.

During that time, the narrative was largely centered around a soft landing for the economy, with growth stocks leading the charge and commodity prices stabilizing.

Fast forward to now, and we see a significantly more volatile price action. Notably, entering the start of next year, prices have begun to rise once again.

Our Real Motion Indicator indicates that the index is gaining momentum, which is an encouraging sign. Additionally, the Leadership Indicator suggests that this index has significantly outperformed the SPY since mid-December, indicating a strong trend!

We also observe that the current phase appears to be one of accumulation. The 200-day moving average (DMA) is comfortably sitting above the 50-DMA. But what does that imply?

If we observe a golden cross, where the shorter-term average crosses above the longer-term average, we could witness a bullish trend for the commodities index for the first time since late 2022.

In that previous period, the slope of the 50-DMA was descending; current trends, conversely, show an upward trajectory.

A crucial element to consider is the recent rise in yields. Looking at the chart of the Federal Funds Rate, we see that yields peaked at just under 5% early last year before beginning to decline.

Since then, interest rates have also dropped by approximately one point, with the current Federal Funds rate estimated to be around 4.70%.

While I may not be an economic expert, I can't help but ask some key questions based on these insights. If the yields have peaked and the commodities price index is climbing, what could this indicate?

1. If the Federal Reserve chooses to maintain its current stance, we might see commodities stay resilient and continue rising. However, the equities market seeks lower rates, suggesting that stock market gains might be limited.
2. Conversely, if commodity prices increase significantly and the Fed responds by raising rates, this could lead to turmoil within the markets and might not effectively curtail rising commodity prices.
3. Finally, should the Fed opt to lower rates—though this seems unlikely at present—the economy might struggle, leading them to ease rather than tighten policy, potentially fueling inflation further.

If we were not observing notable increases across categories like energy, gold, silver, and agricultural commodities such as soybeans and corn, the signs might suggest a vibrant economy that is on a stable path.

However, while it's premature to draw definitive conclusions, one potential scenario looming over us is stagflation as we move forward. In such a case, the Federal Reserve would face a complicated situation, leading to significant price increases in commodities and potential sell-offs in the equity markets.

This outlook represents an armchair economist’s view, relying on proven technical analysis—suggesting that as market conditions evolve, so too must our strategies.

Current Market Observations

Understanding the market dynamics is essential when it comes to decision-making.

Key Indexes to Watch

• S&P 500 (SPY): Currently, the index is hovering right at the December lows as it awaits crucial economic indicators.
• Russell 2000 (IWM): The weekly outlook appears stable, yet we are keeping a close eye on the 200-DMA near 215.
• Dow (DIA): This index has unfortunately broken below the December lows, with 410 representing a significant level to watch.
• Nasdaq (QQQ): Notably, it has recently broken below the 50-DMA for the first time since September.
• Regional Banks (KRE): Holding under 55 raises concerns, but surpassing 60 would alleviate those worries.
• Semi-conductors (SMH): The critical level stands at 237, serving as a significant marker for market positioning.
• Transport (IYT): Maintaining support while below resistance at 70 is crucial as we monitor market behavior.
• Biotechnology (IBB): The key point at 130 is essential for this sector's stability.
• Retail (XRT): The index has dipped under the December lows and needs to maintain around 76 to signal resilience.
• iShares iBoxx High Yield Corporate Bond ETF (HYG): A pivotal area to hold is around 78.00, as it influences broader market trends.

Frequently Asked Questions

What is stagflation?

Stagflation is an economic condition characterized by stagnant economic growth, high unemployment, and high inflation.

Why should we be concerned about stagflation now?

Current indicators suggest rising commodity prices while economic growth may slow, creating a potential environment for stagflation.

What do rising yields mean for the economy?

Rising yields often indicate higher borrowing costs, which can dampen economic growth and dampen stock market performance.

How can we prepare for potential stagflation?

Investors may consider diversifying portfolios towards commodities and sectors that typically perform better during stagflationary periods.

What are some indicators of an upcoming economic downturn?

Key indicators include rising unemployment, decreasing consumer spending, and a significant drop in commodity prices.

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