Commodities and Interest Rates Key Watch Points for Aging Bull Market

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The following is a summary of our recent The Big Picture broadcast, which can be accessed on our site here or on iTunes here.

Many technicians and strategists Financial Sense has spoken with recently have indicated we’re now in the final phase of the bull market.

What does this mean for our investments and what should we watch going forward? This time on The Big Picture, we try to answer these questions and provide some insight into where markets are headed.

Stocks Headed Higher

The final phase of a bull market can be very powerful and explosive. We may see stocks move quite a bit higher from current levels.

This may all take place against a backdrop of additional Fed rates hikes, noted Jim Puplava. We’ve discussed the “three steps and a stumble” rule on the show before. Legendary technician Edson Gould notes that every time the Fed raises rates three times in a row, the market pulls back.

This time around, we’re starting at a very low base, however. The Fed Funds rate is at 1 percent right now after the latest hike.

“If you study inter-market relationships, believe it or not, what you generally see in that final phase is … rising interest rates go hand-in-hand with rising stock prices and also rising commodity prices,” Puplava said.

If we are in final phase of an economic cycle, then as the economy begins to heat up, inflation begins to heat up because energy prices and commodity prices are rising, Puplava noted. This likely translates into further Fed rate hikes.

Because of this dynamic and the low-interest rate level we’re at right now, this bodes well for the market.

What to Watch for

Pay attention to commodities, and especially copper and oil, along with interest rates, Puplava stated.

Copper and oil are important because of the fundamental role they play in the economy.

“If the economy picks up, as I expect, in the second and third quarter, then I would expect to see higher oil prices and copper confirm that trend,” he said. “We’re about 3 years into this cycle, and even though markets are considering two more rate hikes this year … as soon as June … I think they’ll be somewhat cautious, and see how this rate hike plays out.”

The economy should be able to handle two more rate hikes, Puplava stated. But it will be interesting to see if strength holds at that point, as in other cycles, seasonal weakness beginning in the fourth quarter carried over into the first quarter. If that plays out here, we may see it reflected in the first-quarter GDP numbers coming out in April.

We’re probably tracking closer to 1 percent rather than 2 percent GDP growth, Puplava added. Towards the end of the fourth quarter this year, we should see some weakness emerge not only in the stock market but in also in leading economic indicators, he stated.

“I don’t think the risk of recession is a 2017 issue,” he said. “The risk of a recession is a 2018 issue.”

We’re starting to see three things develop with LEIs right now: inflation and interest rates are on the rise, and we’re going to see earnings on the rise as well.

Earnings are likely going up based on two sectors: energy and financials.

“That should be enough to fuel stock market prices higher,” Puplava said. “The next catalyst for the market has to come from corporate earnings … either increased earnings from energy and the financial sector … or if we get a corporate tax cut.”

End-of-Year Danger Zone?

By the time we see the third rate hike this year, the seasonality that we see in Q4 may begin to weigh on the market.

Puplava will be watching for deterioration in the advance/decline line as fewer stocks participate. This would indicate that leadership in the market is beginning to narrow.

“The end game is 2018,” Puplava said. “Once you get past 1.5 percent on the Fed Funds rate, I think the Fed is going to have a lot of difficulties getting the Fed funds rate over 2 percent.”

At that stage, Puplava expects a pickup in energy, materials, cyclical stocks, and consumer discretionary.

We should first see the bond market top out, which we’ve likely already seen. Next, the stock market should reach a top, which Puplava expects toward the end of the year.

Lastly, toward the end of a bull market, energy begins to lead with higher energy prices being reflected not only in inflation in the economy, but also rising interest rates, and also a movement into consumer staples, Puplava noted.

“I would look for rising energy prices and rising consumer staples to confirm we’re closer to the end,” he said.

Puplava isn’t fully invested in stocks at this point, and he’s observed a divergence between hard and soft data.

“Depending on the accounts, we’re (invested) 70 to 80 percent in stocks, or 20 to 30 percent in bonds right now,” he said. “Right now, the hard data does not reflect the optimism we’re seeing in the soft data.”

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