Commodity good news

The FTSE 100 continues to take the brunt of the equity selloff as commodities, in particular oil carry on taking the force of the negative sentiment. The S&P 500 once again came to the rescue and steadied European markets later in the day. The FTSE 100, at 6450, is close to the bottom end of a trading range that has extended at least 18 months. On Wednesday night the Vix rose sharply, closing above 18, also at the top end of its yearlong trading range, with the odd exception. Time will tell if this combination will see the FTSE 100 stabilize once again.

 What is this fall in commodity prices telling us? Is it a sign that underlying economic growth is far weaker than we believe?  Here we look back in history at other moments in time when commodity prices have fallen, and see the impact it has had on equity markets. Remember that many seasoned investors are concerned this recovery in equities, that has now lasted 6 years, is becoming long in the tooth. Anecdotal evidence continues to suggest fund managers remain positive on equities but remain cautiously positioned as valuations have become stretched as a rerating rather than earnings has driven a lot of the recovery in equity prices, particularly in Europe. 

The charts below, the top one being the CCI commodity index and the one below the S&P 500, reveals how the S&P 500 performed post the sharp sell off in commodity prices in the early 1980’s.  After the initial sell off commodity prices remained overall fairly stable until 2000 when they suddenly spiked as growth in China and India took off. As we can see from the charts the S&P 500 with the odd exception, particularly 1987, went on a 15-year bull run during this period.

 A pick up in individual income is what many economists believe is needed to drive inflation higher, as citizens will have greater disposable income to invest back into the economy. A fall in commodity prices benefits companies and individuals alike providing that income boost. As much as investors look for the negatives in falling commodity prices, it could, as we believe, be the catalyst for the inflation driven recovery central bankers hope for.

 

Posted on December 11, 2014 .