Aug. 20, 2016, Weekly Summary: Inflation, Deflation, and Earnings Yield
Inflation, Deflation, and Earnings Yield
The the Pring Deflation Index tracks sectors that benefit from deflation, such as banks, insurers, and utilities, while the Pring Inflation Index tracks sectors that benefit from inflation, such as mines and energy stocks.
The first chart, shows the strong positive correlation of the S&P 500 with the Pring Deflation Index for most of the last 30-years. Only between 1998 and 2001, did a negative correlation develop, which coincided with the ‘irrational exuberance’ of the tech bubble. At the moment, the SPX continues to track synchronously with the financial sectors. This is more proof that we are still in a FED supported rally.
The next chart, shows a similar positive correlation between the S&P 500 and the Pring Inflation Index, but this time, there are three periods (pink arrows) during which the correlation turned negative: the 1998- 2000 part of the tech bubble: the 2007-2008 part of the housing crash, and 2011 to the present.
During the latter part of the tech bubble (1998-2000), the SPX disconnected from the inflation sensitive sectors (mining and oil), then reconnected during the last year of the tech bubble. Will the same thing happen again (blue question marks on chart above)? The similarities are there.
The chart below, shows how the broader S&P earnings yield had a negative correlation to the S&P 500 for most of the tech bubble (1995-1999). The same negative correlation has existed since 2011 until today, which is a slightly longer period than the last time. Here again, we have similarities with the tech bubble.
The question now is; how much further will the bubble inflate before we get a result similar to 2001? If inflation rears its head like it did in 2009-2011, the FED, being desperate to demonstrate success, is sure to release the rate-hike dogs which would pop the bubble they created. This bubble has been created and sustained by the FED’s actions, and it will be the FED’s actions that kill it. We have no-way of timing this disaster, therefore we continue to hedge.
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Source: Nicholas Gomez
