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Chart Advisor: Inflationary Cycle

Chart Advisor: Inflationary Cycle

Posted November 26, 2020 at 2:22 am
Gordon Scott

Wednesday, November 25, 2020 Headlines

1. Signs of inflation continue to pop up throughout the market
2. Inflation and the business cycle
3. Dividend stocks in the energy sector

Market Moves

Inflation tends to run complementary with the business cycle. The good news about inflation is that it means generally higher prices for everything, including stocks. The bad news about inflation is that if you aren’t invested in stocks, then you must pay more for everything without having more to pay for it with. Signs of inflation give investors a strong incentive to participate in the market. That notion adds a second reason (beyond a COVID-19 vaccine) for why stocks are rising to new highs.

The chart below displays three very strong indications that prices have risen and will continue to rise soon. Interest rates are historically low and may even be about to make a short-term dip lower. Oil prices are spiking higher on the anticipation of new demand. Lastly, the U.S. Dollar is continuing to fall lower.

All of these imply higher relative, and actual, prices for goods in the market. Astute chart watchers can use this information to help them recognize where markets may be positioned in terms of the business cycle.

Inflation and The Business Cycle

Analysts often generalize about how the market and the economy run in similar cycles. In a model, popularized by analyst and author Sam Stovall, the economic cycle lags the market cycle by six to nine months. As the market rises and falls throughout the cycle, different sectors come into favor among investors.

The chart below is courtesy, but the inflation notations are my own. The concept here is that at certain points in the cycle, prices begin to rise or fall. Chart watchers can tell where they are in the cycle depending on which sectors appear to be favored by investors.

Right now, the evidence is clear that the market is in the latter part of its bull market phase, and it is only natural that we should expect to see strong performance from energy and materials sectors.

When these sectors move higher rapidly (as they are now), investors can naturally expect to see inflation as prices rise on basic materials and energy supplies. When markets are falling, inflation is low and sometimes going lower.

Dividend Stocks in the Energy Sector

The combination of inflation signals and a sector rotation towards energy and materials stocks means that certain stocks may be particularly attractive to investors. The chart below compares the top five dividend-paying large-cap energy stocks. Dividend paying stocks are very attractive to investors when the market experiences lower interest rates. That’s because these dividends represent an alternative to the lower interest rates. It goes without saying that if the energy sector is on the rise, these high-dividend stocks might pay out a handsome return.

The Bottom Line

Signs of inflation abound, and chart watchers should recognize that this means we are leading up to a market top eventually. Until then energy stocks, especially those paying large dividends, should be the focus for most investors.

Originally Published on November 25, 2020

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