Last week I interviewed Dan Wantrobski from Janney Capital Markets on their long-cycle model, which looks at the historical rhythm between interest rates, equities, and commodities going back to the 1880s.
If the past long-term cyclical correlations between these major areas of the market were to play out as their research suggests, U.S. stocks and interest rates should continue to rise as commodities either fall or underperform.
Here is a simplified view of the cyclical pattern they've identified, which they call "The Market Map" (click image to enlarge):
Source: Janney Capital Markets
Although the chart above represents approximate long-term correlations between stocks, commodities, and interest rates (bonds) and not exact turning points, it is interesting from a “big picture” point of view.
The 60-year cyclical pattern in interest rates has been noted by others. As well, the generally negative correlation between stocks and commodities is fairly well-known; however, combining all three into the above diagram is rather unique and probably new to most as a way to help identify longer-term shifts in the market and between asset classes.
With interest rates and stocks having already put in what appear to be long-term bottoms and commodities also trending downwards from their prior record highs, this long-term cyclical framework suggests that we are somewhere in the “We are here” portion of the chart, coinciding with a transition from a deflationary bear market that started in 2000 to a new secular inflationary bull market cycle.
If we have indeed passed that inflection point, as some of our other contributors have suggested, we should see stocks continue to outperform both bonds and commodities over a longer than expected timeframe.
Dan explained that the three main drivers of these long-term cyclical shifts are valuation, demographics, and credit. Of the three, valuation is probably the most controversial given current prices. Of the 130+ years shown in Janney's long-cycle model, the only time where the market experienced a similar inflection point was during the 1940s, which preceded a multi-decade bull market in stocks well into the '60s. Should we expect the same type of run in stocks from current stretched levels? This seems highly doubtful, especially given that stocks were near all-time valuation lows during the '40s as opposed to today where they stand near the highs.
Given the difficulties in reconciling this as the beginning stages of a long-term secular bull market with current overstretched valuations, there are a couple obvious ways this could play out. Stocks could correct at some point in the near future, which would bring valuations closer to long-term historical averages. Another perhaps unthinkable possibility is that stocks continue to climb higher in the secular bull market scenario to close the gap or eventually overtake the prior valuation highs set during the 2000 tech bubble.
Although the first scenario seems more likely, given the historically unprecedented scale of intervention and active participation by central banks in the stock market today, it does not seem unreasonable to question whether prior valuation records might be broken.
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