Caution Signs for the Market

08/11/2015 8:00 am EST

Focus: STOCKS

Dennis Slothower

Chairman and CIO, Alpine Capital Management

We are witnessing a massive meltdown in the commodities market and high-yield bond market and that has always been a precursor to big problems for the stock market, cautions Dennis Slothower, editor of Stealth Stocks.

Naturally, the Fed’s response is simply to rig the GDP numbers with another accounting method. We’re doing exactly what China does to make its economy look better than it really is.

This rigging of the GDP by the Fed will probably be the excuse it uses to justify an impending interest rate hike in September. No bones about it: September is a month in which to proceed with extreme caution.

What has been particularly undercutting the stock market this year has been the relentless plunge in the commodity markets.

We saw a plunge in commodity prices before the great financial crisis of 2008 and we are watching the exact same thing happen again right now.

The Bloomberg Commodity Index is down a whopping 26% over the past 12 months...and recently hit a 13-year low.

The Reuters/Jefferies CRB Index is also now testing the lows of the 2008 financial crisis. This is telling me that something is very wrong with our economy.

This commodity crash is hitting the commodity-producing nations hard, which is why we are seeing a global slowdown.

Why should you care? The stock market is pretending this doesn’t matter. But they are missing the boat.

Trends in the US dollar influence commodity prices—which in turn influence bonds—which in turn influence stocks. By watching which way commodity prices go, you can have a pretty accurate picture of what will happen to bonds.

Since the early 1970s, every major turning point in long-term interest rates has been accompanied by or preceded by a major turn in the same direction in the commodity market.

My studies tell me that we will not see inflation as long as commodity prices are falling like a rock. The plunge in oil prices over the past 12 months has caused high-yield bond funds to remain in a bear market.

That is why my canary in the coal mine is the high-yield bond market. If that market should fall, which we are seeing now, the canary is struggling for breath, which tells me that stocks are not too far behind.

I recently checked over my data for the past 80 years. What I’ve uncovered is downright scary: every major downturn in the stock market has come either after or at the same time as a major downturn in the bond market.

While a falling dollar moves the CRB Index higher (inflationary), a rising dollar pushes the CRB Index lower (deflationary).

Connecting the dots—commodities, bonds, US dollar—tells me that the US economy is suffering from deflation.

Economists know how to get us out of an inflationary period, but no one has any idea how to bring us out of a deflationary period.

The last deflationary period we had was the Great Depression of the 1930s...and it took a world war to get us out of that funk.

However, the Fed wants us to believe that the economy is strong based on manipulated GDP numbers.

Looking at its distorted statistics, the Fed might very well come to the conclusion that September will be a fine time to raise rates. Oh, what fools these mortals be.

Historically, September has been the second-weakest month of the year, behind the month of May. Not all Septembers are poor months, but I am very concerned about this one coming up.

My biggest concern is that the Fed has already begun to build the case for higher interest rates. That’s in spite of a 29% plunge in the CRB Index over the past 12 months.

Seems crazy, doesn’t it? I still can’t get my head around how the Fed is seriously considering this option. The Fed is not coming to grips with reality.

Here’s what I see happening: the US dollar will get stronger, commodity prices will continue to fall, and stocks will follow.

This is the scenario that has played out over and over and I don’t see a reason why it won’t happen again should rates raise. Hold on to your hats...the next few months might be rough.

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