With the S&P 500 back at itsall-time highs, gold stopped lagging behind. However, how long can thisunsustainable growth last?
TheFOMO Rally
While the S&P500 has demonstrated a resounding ability to shake off bad news, anepic divergence has developed between positioning and economic expectations.And while ‘fear of missing out’ (FOMO) keeps sentiment near the high-end of itsrange, Q3 DP growth is projected near the low-end of its range.
For example, while the Atlanta Fed’sthird-quarter GDP growth estimate was north of 5% in early September, the bankreduced the estimate to 1.3% on Oct. 5. Moreover, with the outlook even worsenow, the Atlanta Fed cut its Q3 GDPgrowth estimate to 0.5% on Oct. 19.
Source: Reuters
Moreover, Unilever CEO Alan Jope toldBloomberg on Oct. 21:
“Peak inflation will be in the first halfof 2022, and it will moderate as we move towards the second half…. We continueto responsibly take pricing, and that’s in relation to the very high levels ofinflation we’re seeing.”
TheS&P 500 Ahead of a Deep Correction?
Furthermore, I highlighted on Oct. 21that rising commodity prices over the last month should filter into theCommodity Producer Price Index (PPI) and headline Consumer Price Index (CPI) inthe coming months.
I wrote:
Thecommodity PPI is a reliable leading indicator of thefollowing month’s headline Consumer CPI. And if the former stays flat for thenext three months (which is unlikely) – referencing releases in November 2021,December 2021 and January 2022 – the readings will still imply year-over-year(YoY) percentage increases in the headline CPI in the 4.75% to 5.50% range.
Furthermore, this is an extremely conservative forecast since the commodity PPI hasincreased month-over-month (MoM) for the last 17 months. Thus, it’s more likely that the headlineCPI rises above 6% YoY than it falls below 4% YoY.
To that point, Union Pacific Railroad – ashipping company that operates 8,300 locomotives in 23 U.S. states – releasedits third-quarter earnings on Oct. 21. And with freight revenue up by 12% andaverage revenue per car up by 9%, EVP KennyRocker said that the results reflected “strong core pricing gains andhigher fuel surcharge revenue.”
More importantly, though, with the inputsurge intensifying “over the last 30 days,” the cost-push inflationary spiralremains alive and well, and it signals something important.
Source: Union PacificRailroad/ The Motley Fool
Finally, the reason why inflation is soimportant in terms of its direct effect on the general stock market and itsindirect effect on the PMs is due to the composition of the S&P 500. With information technology andcommunication services stocks accounting for roughly 39% of the S&P 500’smovement, deflationary assets have been the go-to source for returns since 2009.However, if the “transitory” narrative suffers a painful death, a materialunwind could ensure.
Please see below:
To explain, the “Deflation basket” (thedark blue line) has materially outperformed the “Inflation basket” (the lightblue line) since the global financial crisis (GFC). Thus, if surging inflationencourages a reversion to the mean, immense volatility could strike the S&P500.
The bottom line? With investorsprioritizing FOMO over fundamentals, the general stock market’s recent uprisinghas helped uplift the PMs. However, with the Fed losing its inflation battleand the USD Index poised to benefit from more hawkish momentum over the nextfew months, a profound correction of the S&P 500 will only enhance the U.S.dollar’s already robust fundamentals. Moreover, with the PMs often movinginversely to the U.S. dollar, their performance should suffer along the way.
In conclusion, the PMs declined on Oct. 21, asthe USD Index regained its mojo. Furthermore, the front-end of the U.S. yieldcurve surged (2-year yield up by 21% rounded), and the U.S. 10-Year Treasuryyield closed at its highest level (1.7% rounded) since Apr. 4. Thus, while thePMs borrow confidence from the S&P 500, their fundamentals are actuallydeteriorating rather quickly.
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Przemyslaw Radomski, CFA
Founder, Editor-in-chief
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