Investors may want to keep an eye on copper prices (Shutterstock photo)
Human beings have an innate desire to seek order out of chaos and we crave simple explanations for complex things. When a pundit, and I would include myself in that group, says that stocks are higher or lower because of X, Y or Z, it satisfies that need, but it is always an oversimplification.
Fears about interest rates, tariffs or whatever may be the most obvious cause for a drop, for example, but there are multiple influences on every stock and therefore on every index. The main driver of those indexes though, are the prospects for corporate profitability, and the biggest influence on that is economic strength and growth.
At times like this when there is a lot of noise, it is often best to look outside the stock market for indications of that basic strength or weakness.
Commodities are the obvious place to look. Demand for non-agricultural commoditized products, such as metals and energy sources, increases with increased economic activity, but more importantly, most commodity markets are highly speculative. That may annoy the purists, but it means that these markets often give an insight into what those that control the big money are thinking and how they view the prospects for growth.
Oil is the biggest of those markets, but the current focus on supply factors makes it an unreliable indicator of sentiment on the demand side.
The other traditional barometer of opinion, copper, is more reliable right now. As you can see from the chart above, after a strong second half of last year, copper has been declining this year, losing around eight percent from its late December highs. If you are worried about the impact of Trump’s tariffs and trade wars on growth, you should keep a close eye on copper.
If we see further declines this week that push the metal below the previous low around 3.03, it would be a signal of pessimism that would then be reflected in the stock market and, given the nervousness still evident in stock traders, that could easily cause a very sharp selloff.
Another place to look for clues as to underlying sentiment is in the bond market. The yield on the 10 Year Treasury has risen sharply this year as strong domestic data suggested more aggressive moves from the Fed but seems to have found its natural level in the current climate at just below three percent.
That relative stability for a couple of months means that it is possible to see moves from this point as indications of investor sentiment regarding economic conditions rather than just interest rates, so yields should be watched closely. If we break above three percent it would spark a big drop in stocks, but if we continue to drift down towards 2.7-2.8 percent it will be seen as a sign that all is well, and we will head back to new highs.
The third place to look for early indications of market sentiment regarding growth is in high yield bonds. Junk bonds, as they are often known, are a good indicator of the market’s appetite for risk.
As you can see from the chart below, high yield, like copper, has been generally week so far this year, and is a long way from recovering from the big drop last month.
In part that is also due to speculation regarding the Fed’s actions, but it is also true that that is now priced in. Any move from here, therefore, can be seen as an indicator of sentiment and risk appetite, so high yield is another outside market that investors should be watching.
As much as we may want things to be simple, when it comes to the stock market they rarely are. There will, as always, be a lot of noise this week, and a lot of people attempting to simplify those myriad influences on the market. To cut through that, you should focus on other markets that better reflect the long-term driver of stocks such as commodities, Treasuries and high yield bonds and take your cues from there.