Keystone's Inflation-Deflation Indicator Signals NEUTRAL Territory

In May, Keystone's indicator dropped into Deflation. The stock market rally from June thru the October top boosted the indicator back up thru Disinflation and into the Neutral zone, only to see it fall during the November market selloff, dropping down to 2.9-ish on the verge of deflation. The equities markets selling off occurs in concert with lower Treasury yields and higher note and bond prices since money moves from stocks into bonds. The note price is used for the denominator of Keystone's equation. The 10-year yield is 1.68% with a price at 99.375. The CRB (Commodities Index) languished at 270-ish on the cliff edge during June-July but recovered when Draghi said he would support the euro by all means necessary in late July.  The CRB launched from sub 270 to 320 at the September top, then rolled over as evidence of a weakening global economy occurs. A the market bottom a week ago the CRB was at 291 on the verge of falling into Deflation, but the markets jumped higher with the ongoing relief rally and on Friday pushed up and out of Disinflation into the Neutral territory.  Taking a look at the numbers;

CRB/10-Year Price = 299.07/99.375 = 3.01

Over 4 = Inflation
Between 3 and 4 = Neutral; inflationists and deflationists fight it out
Between 2.9 and 3.0 = Disinflation
Under 2.9 = Deflation

Chairman Bernanke announced QE1 in 2009 and QE2 in 2010 as the country became mired in deflation with Keystone's indicator in the 2.5-2.6 range. The indicator dipped into this area in May of this year but then recovered when the central banksters started talking stimulus from 7/26/12 forward (Draghi's proclamation). The oddity was that the ECB's OMT Bond-Buying program and the Fed's QE3 announcements in early September occurred when the stock market was already elevated; this thru a wrench in Keystone's prognostications at the start of the year.

The prior stimulus measures (QE1, QE2, Operation Twist, LTRO 1 and 2) all occurred when the markets slipped into deflation (under 2.9) so that expected trend was broken with this year's QE orgy rally.  It smacks of desperation, a 'throw the kitchen sink at it' approach. The SPX actually dropped under the levels where QE was announced in early September by both the Fed and ECB.  Bernanke fears deflation since he is a student and scholar of the Great Depression.  Bernanke says the Fed did not act quickly and forcefully enough in the 1930's, hence, he has the nickname Helicopter Ben since he said in a speech a few years back that money should be dropped from helicopters to stop a deflationary spiral.  Japan's deflationary incident is now in its second decade.

Keystone's indicator is now in Neutral territory so the bulls and bears are fighting it out. A move lower is consistent with falling equity markets and a move higher is in concert with rising equity markets.

The pundits talking Inflation are likely premature. Even though the indicator is in Neutral now, it is only by one single hair and Inflation will not be signaled until 4 occurs, a long ways away. Inflation will likely not appear until two, three, or even more years down the road. That will be a new and intense problem, especially hyperinflation, but for now, the disinflationary and deflationary scenario's are far more important. Look at Japan's funk for the last twenty years; deflation can be nasty.  Large-scale layoffs are now occurring in the U.S. with more frequency. The stagnant wage growth screams of deflation.  Technology, computers and the Internet are huge deflationary machines.  Robots continue to replace human's on the job. The coming months will provide epic economic and market drama.

Watch Keystone's formula above, you can plug in the numbers to check on the indicator every few days. Markets are in trouble when the indicator drops under 3.00 into Disinflation.  Markets are going over the falls if 2.90 fails since it indicates a deflationary spiral is occurring and the U.S. is headed straight for a Japan scenario. As long as the indicator stays above 3.0, in the Neutral territory and higher, the bulls are happy. A slip back under 3.0 will have the bears salivating again.