James Paulsen: A (stock market) leadership change?

A (stock market) Leadership Change?

by James Paulsen, Chief Investment Strategist,

Most investors are understandably focused on whether the Federal Reserve will raise interest rates today and what this may imply for the recent stock market correction. However, underlying recent ! nancial market volatility and this Fed drama is perhaps marking a major change in stock market leadership. We believe commodity prices are in the process of bottoming after trending lower during the last four years of this recovery. The current stock market correction and the first Fed hike in interest rates may be marking an important shift in economic pricing power from consumer prices to lower stage industrial prices. A shift in economic pricing power from consumers to producers has traditionally altered stock market leadership away from domestic toward international stocks and from consumer to industrial stocks.

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Are commodity prices bottoming?

As we examined in an earlier research note (see the Economic and Market Perspective from August 25, 2015), a signi! cant collapse in commodity prices during the middle of an economic recovery is actually quite common. Chart 1 shows the S&P GSCI Spot Commodity Price Index since 1970. The collapse in commodity prices since last summer is similar to past recoveries and like then, it does not suggest economic growth is about to slow.

In three of the last four recoveries (i.e., the late-1970s, 1980s and 1990s recoveries), commodity prices su! ered a severe decline ā€œduringā€ an ongoing economic recovery. In each of these cases, the economic recovery persisted well beyond the bottom in commodity prices. Indeed, in the past, once commodity prices bottomed, the pace of economic growth accelerated and the recovery did not end until commodity prices had substantially recovered. For example, in the late- 1970s recovery, commodity prices bottomed in July 1977 and the recovery did not end until January 1980. Similarly, commodity prices bottomed in July 1986 but the economic recovery continued until July 1990. Finally, commodity prices bottomed in early 1999 but the recovery did not peak until March 2001. As shown, a signi" cant decline in commodity prices usually points to stronger rather than weaker future economic growth. Moreover, once commodity prices do finally bottom, they have typically risen throughout the balance of the economic recovery.

stock market leadership

Although most believe oil prices (and overall commodity prices) are continuing to collapse, chart 2 suggest they have been in a bottoming process since early this year. While the spot price of WTI crude oil did collapse last year, it is currently about $45, a level it first reached in mid-January. We suspect the commodity markets are about to embark on a multi-year advance which will likely alter leadership in the economy and in the stock market.

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