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By: Chris Rowe — May 3, 2016

This is the Whole Ball Game

Our Current Stock Market StanceUntil we see more confirmation of strength, we maintain our bearish stance.   This may seem confusing to those who’s money I manage because we do have bullish positions.  But our bullish positions at Rowe Wealth Management are largely in defensive sectors (as well as exposure in tech and commodity-based sectors) and we have a significant cash position, depending on the investment model used for the particular client.

Although we have seen signs of increasing strength, our long-term indicators are still weighted to the downside.  In the meantime, we must note that we did recently see significant increasing strength in the short-term and intermediate-term.  That strength subsided as stocks continue to dip, today.  But we will be on alert since, historically, such dramatic short-term strength sees follow-through into a longer-term trend of strength.   Until we see that follow through, we must stick to our bearish guns. 

 

This is the Whole Ball Game

This market's recent evolution comes down to one thing:  Inflation.

Understand what's going on with U.S. inflation and you'll understand what's going on in most financial markets (stocks, bonds, commodities, currencies.)

2016-01-27_12-11-53If you don't have a basic understanding of these intermarket relationships then your performance will likely suffer.

Instead of focusing on the direction of the general stock indexes, it's best to think about which sectors will shine.  And right now, inflationary sectors, like precious metals, are the shiniest.

This was first identified in one of our programs, TAM Tools, when the ranking of the Precious metals sector went from dead last (46th) to first place, In January, and stayed in that upper range.

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This institutional sector analysis tool of ours discovers "the what", in order to identify profit opportunities.

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We care little about "the why" because it's more important to make money than to know why things are happening.

But considering the major impact the current changes will have on your investment account, I'll summarize the inflationary cause and effect...

Start simply:

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(http://www.usinflationcalculator.com/inflation/current-inflation-rates/)

The consumer price index is the most widely followed monthly indicator of inflation.  A quick glance at the table, above, shows 12-month inflation rates going from negative in most of 2009 to positive in 2010 and above the Fed's comfort zone of around 2% through most of 2011.

Gold advances when investors see/expect future inflation.

Gold is viewed as a hedge against declining purchasing power.  Even though inflation was negative in 2009, this meant the Fed would try to spark inflation with lower interest rates.

From late 2008 - 2011, the price of gold tripled and the NYSE Arca Gold Miners Index (the index that can be purchased through "GDX") quadrupled.

As you can see in the table, inflation started to taper and then it dropped.

Compare the 12-month rate hitting 1.5% in March 2013, to that of March 2012 when it was at 2.7%.

With the inflation change, the price of gold and gold stocks tanked.  But in January of this year, everything changed.

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The CPI table showed 12-month inflation as almost non-existent through 2015 as gold prices bottomed out.

But then, with a sharp spike in January and February, to 1.4% and 1.0%, respectively, gold to popped 23%.

We covered inflation rates and we covered how that affects precious metals. Now let's discuss the sweet spot gold is in...

Inflation has jumped but it's still much lower than the Fed is happy with (2%).  So when inflation does what it's been doing, people look for ways to hedge against inflation (gold) but still can't see the Fed stepping up to take action to fight it off (fighting inflation).

Again, the Fed wants to see 2%.  We still have a somewhat sluggish economy and earnings, in the long-term picture.  So investors can sit and fight about whether the Fed will raise rates or not and how that will affect "the stock market".

But the way to play the stock market is to understand how the inflation picture affects specific sectors.  Because whatever the S&P 500 does, you can see one sector up 20% and another down 20%, depending on that story.

If the Fed raises interest rates, it would eventually (not necessarily immediately) have negative impact on the Materials sector (XME), on Gold stocks (GDX) and on the Utilities sector (XLU).  You'd also see weakness in bond prices and bond funds.

But, although they experience short-term dips, all of those sectors are gunning higher.

The mistake being made by many investors right now is to think that because we are seeing a spike in inflation, the Fed can or must raise rates.  But the fact of the matter is, with inflation rates still relatively low, albeit spiking, the interest rate sensitive sectors I've just mentioned are the strongest areas of the market.

Even if rates start to advance, there is a lagging affect on commodities, just like a drop in interest rates doesn't just immediately turn a long-term bear market into a bull market.

As you monitor the sectors of the stock market, be sure to have another couple of screens open where you're monitoring inflation and interest rates.  That will be a great way to find the market's rhythm.

Best

Chris Rowe

Chairman, True Market Insiders LLC

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