Lately there has been all sorts of chatter about the collapse of Chinese Iron Ore prices. There can be no denying, the chart looks like death.
A move from 95 to 65 is more than 30%. Given it happened in a little over a month, the decline has been horrific.
What does this mean?
Without checking any of my charts, I expected most global industrial commodities to at least be trending lower along with iron ore. Combined with the recent soft economic releases in the United States, it was easy to envision a scenario where the CRB Spot Raw Industrial Index was down 10-20% from the highs.
Much to my surprise, the chart for US Spot Raw Industrial commodities was nothing as I expected.
After a big Autumn run, the CRB Spot Raw Industrials has barely declined. It is still within spitting distance of recent highs.
Why does this matter?
Recently the Trump reflation trade has tipped from exuberance to disillusionment. A few months ago investors were all bulled up on the prospects of deregulation and tax cuts. As the difficulties for the new President to pass his agenda has become obvious, the market has abandoned this theme quicker than Lindsay Lohan ducks out of her court ordered mandatory AA meetings.
Have a look at this chart from BofA Merrill Lynch that shows the degree to which global fund managers are overweight US equities.
Fund managers, who before the election had been underweight U.S. equities, rushed in to buy American stocks on Trump reflation hopes. But now that this optimism has faded, investors have quickly shifted from overweight to underweight U.S. equities.
The pessimistic attitude towards economic growth and stock market valuations has returned with a vengeance. Suddenly many investors believe the entire global economy is once again headed into the toilet.
I am sympathetic to the notion that Trump reflation hopes were overdone, but I wonder if market participants are now overly pessimistic towards global growth.
Which brings me back to the Chinese Iron Ore price and the CRB Spot Raw Industrials. With all the negativity out there, it’s surprising that CRB Spot Raw Industrials have not followed Chinese Iron Ore lower and confirmed the market’s abandonment of the reflation trade.
What’s going on?
Let’s first have a look at the index components that make up the CRB Raw Industrials.
It’s a hodgepodge of commodities, with some obvious ones (like copper), and some not so obvious ones (hides, hogs, lard?).
The CRB Spot Raw Industrial Commodity index is a strange index to follow, but its value as an economic indicator is underrated.
Equally underrated is the brilliant economist whose work has brought this non-standard index to my attention. Dr. Ed Yardeni is an outstanding strategist who recently created an entire presentation about this indicator – Global Economic Indicators: CRB Raw Industrials & The Global Economy.
Putting it all together.
The CRB Raw Industrial Index is not subject to the day to day whims of the legions of hedge funds jerking around financial asset prices. In this day and age of overly sensitive economic indicators, it is comforting to have something to watch that might give some hints about the true state of the global economy.
When we combine the CRB Spot Raw Industrial Index with the weekly unemployment claims and an economic confidence stat, we get what Yardeni calls his “fundamental stock market” indicator. (I wrote about it here in a piece titled Obi-Ed’s Magical Indicator).
Interestingly, even while investors are becoming increasingly bearish, Yardeni’s indicator has showed no signs of switching.
Here is Yardeni’s stock indicator versus the S&P 500 over the past 8 years.
Given the simplicity of the model, and the fact it does not have interest rates or earnings as inputs, the correlation is amazing.
What does the model say about today’s market?
Even though investors have given up on the Trump reflation trade, Yardeni’s model has not. In fact, it has pushed up to new highs.
Over the years I have learned the hard way not to fade Yardeni’s model. It doesn’t mean stocks cannot decline, but until I see either the industrial commodities roll over (and not just Chinese Iron ore), or employment claims skyrocket, I will avoid calling for a big crash. It’s tough for me to put this down on paper, but really, the proper bet is to assume Yardeni’s model will once again prove correct, and buy stocks.
Thanks for reading,