Where are we in the commodity inflation cycle? Thats the triple-your-money question
Bannister, Lintner, and Conners of Stifel Nicolaus published a report on Jan 21, 2010 called Macro Update: 1Q10 correction, "growth scare". In the opening lines they predicted an 8-10% correction in the S&P to 1050 or so. Nice call, but...
Thats not the highlight of the summary to me. The highlight of the summary comes late in the document in the form of a discussion of the historical performance of stock indices to commodity indices, specifically the S&P to the CRB Futures index, whatever that is. It shows data in stock index relative to commodity index going bcak to 1870.
Over those ~140 years stocks, of course, have vastly outperformed commodities. In 1870 the ratio is shown as about 0.2, rising to the low teens at the 2000 peak, before falling to around 4 today. So stocks, excluding dividends, have outperformed by about 20 times in 140 years (once this was 60+x). But this outperformance has been cyclic, with several extended periods where commodiies outperformed stocks. Commodities outperformed dramatically from 1907 to 1920 (encompasses WW1), From 1930 to the late 1940's (depression, huge wall street crash, and a war which no doubt drove up commodity prices),from the end of the "go-go" stock market in 1968 until 1980, and again from the peak of the Nasdaq bubble until now and ... and somewhere into the future? So of those 140 years, stocks have outperformed dramatically (extremely dramatically if you consider dividends), but commodities have outperformed over 4 distinct periods totalling nearly half of the period, more than 50 years.
So commodity prices and equity prices seem to be counter-cyclic, which is absolutely fantastic from an investors perspective as it may offer something to move money into when stocks become overvalued. Certainly moving out of stocks and into commodities in 1999/2000 would have done you very well over the last 10 years.
Compared to past commodity-inflation cycles, this one is already fairly advanced. The first two on the chart had world wars to help them along and the one in the 1970s lasted barely longer than this one already has. The cycle in the 1970's bottomed within a few years, this one may have bottomed in 2008/9, but was both deeper and longer from onset to bottom than the 1970s cycle, and was deeper than the Great Depression/WW2 cycle.
So, based on history, it is wrong to think that we are "going to have" inflation or that commodities "are going to start to rise", the commodity inflation cycle we are experiencing now is already advanced in age and severe in scope compared to historical cycles. That, of course, doesn't mean it couldn't go on longer or become more severe, but we are not at the onset of such a cycle, its been going on for a long time now (10 years).
I'll go out on a limb and say that further research may reveal that a nice signal that a new secular bull market in equities is beginning is equity prices beginning to outperform commodity prices. We have not seen that at this time in this cycle. From bottom to top, oil has outperformed the S&P for example, more than doubling while the S&P has not nearly doubled. That would seem to be a sign that a new secular bull in equities may not yet be at hand... (but the next year could, of course, see stalled or deflating commodity prices and an ongoing advance in equity prices).
Also, historically, commodity prices don't deflate for long and post-bubble tend to fall into a trading range higher than the level before the onset of the rise to bubble status, but lower than the bubbe peak. On to the next bubble...
So the biggest and most important question for investors today, in my view, is probably this one:
Where are we in this commodity inflation cycle? Does it become even more dramatic, commodities go higher than stocks even more dramatically (its already as bad as any cycle in the last 140 yhears save the 1907-1920 one), or has the cycle seen its peak? If the former is the correct answer then equities will experience some difficulties. If the latter is correct, holding equities from here may be a good strategy.
And this my fine fellow folks - this apparently counter-cyclic behavior of commodities and equities - may just represent the missing link in a long term, lifetime investment strategy. Asset allocate not between fixed income and equities, but between equities and commodities, or significantly shift equity portfolios towards commodity stocks when it seems like an equity-outperformance cycle is coming to an end. Shift away from commodities or commomdity stocks when it seems like a commodity outperformance cycle is coming to an end.
I wish I could post pictures... in this case they are really worth 1000 words.