A Cyclical Assessment Of The Markets From John Bollinger

We are getting ever more nervous about the financial markets. A few
of the reasons for this are: gold soaring, crude at new highs,
interest rates trending higher, strong commodities, strong cyclical
stocks, etc. The interesting thing is that all these factors seem
like typical late-cycle market behavior and late-cycle is not the
time to own stocks: it is a time to be selling stocks.

I first learned that there is a relationship betweens stock prices,
interest rates, and commodity prices. In an idealized depiction of
this cycle we start from the bottom of the cycle, and stock prices
start up, followed by a trough in interest rates. Then, interest
rates begin rising also. Next, commodity prices trough, and then
turn higher.

We are now in the main expansion phase of the cycle with all three
elements trending higher. Next, rising interest rates start to
worry stocks, which flatten out. Interest rates continue higher and
stocks turn down in earnest as they begin to sense an economic
slowdown. Demand for money starts to slacken and interest rates
peak. We are now into the down portion of the cycle.

Now interest rates turn down, as the monetary authorities perceive
weakness and commodity prices top out and start to weaken, leading
to the heart of the down-cycle period. Interest rates are now
falling and stocks are beginning to think about a recovery so their
downside momentum wanes. Then, commodities start exhibiting strong
downside momentum, and the trough of the cycle is looming.

Next stocks start to sense the effects of lower interest rates,
trough, and we see the first signs of strength. Interest rates
continue down but the pace decelerates and stocks begin to rally
seriously. Next, interest rates begin to firm up followed by a turn-
up in commodity prices. At this stage of the game, we are back to
where we started and the cycle repeats. Of course, this is an
idealized cycle and we never see anything quite like it in real
life. But, the relationships and ideas do hold together and from
these relationships we can often estimate where we are in the cycle
and estimate how the future is likely to look.

One of the more interesting aspects of this process is that
different groups of stocks tend to behave differently in different
phases of the cycle. Defensive sectors such as health and consumer,
non-cyclicals, tend to be late-cycle performers, while technology
tends to be an early cycle mover. There are other stock market
facets to the puzzle that can be of interest as well. For example,
value typically has an advantage later in the cycle while growth
does better early on. Likewise, smaller stocks tend to do well
early on, and larger stocks later in the cycle.

As a global recession is not in the immediate cards, you can assume
that oil prices will remain high and that a variety of excuses will
continue to be trotted out to explain it. Thus, oil prices will
remain a problem for the foreseeable future . The bottom line is,
that oil stocks remain attractive and can be bought on pullbacks.

As expected, our commodity composite has risen to a new high. Our
composite is an equal-weighted index comprised of the CRB, Moody's,
and Reuters indexes. It is very heavily biased toward industrial
commodities and has relatively little energy exposure. In short, it
is a good, basic, measure of commodity prices. We note that all 3
components recently made new highs and there is very little to
suggest any end to the uptrend as of yet. The inflationary
implications of this are being ignored for now. But they will
become a topic of conversation before we are done with this cycle.


Good Luck MarketTraders