Inflation-deflation regimes inside the stock cycle

Two regimes inside one stock cycle

A multi-year equity cycle that already contains a primary bull and bear can be split further into an inflationary phase and a deflationary phase.

The outer frame is the four-year stock cycle, a recurring primary bull-and-bear sequence used to date equity-market phases. Market-regime classification then assigns the current stretch of that cycle to one of those two inner phases.

Dating the deflationary and inflationary phases

The deflationary phase is dated from a commodity-price peak and rising recessionary pressure. It is located in the late bear and the early-to-middle bull, and interest-sensitive and other defensive groups are assigned to it.

The inflationary phase is dated from absorbed spare capacity, a commodity rally, and a trough in interest rates. It is located in the late bull and the early bear, and earnings-driven groups and resource producers are assigned to it.

Intermarket analysis reads the same regime through commodities, bond yields, and equity-group ratios together, rather than from equities alone.

Group indexes instead of single names

Industry rotation is the shift in emphasis between those two sets of groups as the phase changes. The deflation-group index averages electric utilities, property and casualty, preferred stocks, and savings and loans. The inflation-group index averages gold, aluminum, miscellaneous metals, and domestic oils.

A multi-group average is preferred because one stock or one industry can be driven by unrelated special factors.

A ratio that dates the swing

A ratio of the inflation-group index to the deflation-group index, the inflation-deflation ratio, is used to mark cyclical swings between those forces. A rising ratio favors inflation-sensitive groups versus deflation-sensitive groups.

Both baskets can still rise together, as in late 1982, or fall together, as in late 1974. A rising ratio still favors inflation-sensitive groups versus deflation-sensitive groups in either case.

Ratio advances are expected to coincide with rising bond yields and commodity prices, and the ratio is shown as broadly aligned with bond yields.

What a ratio low implied for leadership

In the charts shown, the deflation basket had been the stronger trend while the inflation basket had moved sideways for four years. Long-term momentum on the deflation basket was stretched and rolling over, while momentum on the inflation basket was oversold and rising.

Lows in the inflation-deflation ratio were shown ahead of peaks in a broad equity composite. After those lows, leadership was described as more selective because many interest-sensitive groups had already peaked or were peaking.

Long-term momentum is a slow oscillator on the group baskets or their ratio. It is used only as confirmation and can arrive too late to help with timing.

A map used to judge maturity

The split is not treated as universal, because many stocks do not fit either bucket. The same map is still used to judge how mature a bull or bear already is.