week of March 1990. The two chartson the left (the Deutsche mark on the upper left and the CRB Index on the bottomleft) have been rising for several months. Both areas benefited from a sharp drop inthe U.S. dollar (not shown) during that time, which boosted inflation pressures inthe states. At such times, traders can buy individual commodity markets (such asgold and oil) or the CRB Index as a hedge against inflation. Or they can buy foreigncurrency futures, which also rise as the U.S. dollar falls. If they prefer the short sideof the market, they can sell the U.S. Dollar Index short and benefit directly from adeclining American currency.
FIGURE 12.10A COMPARISON OF THE FOUR FINANCIAL SECTORS REPRESENTED BY THE FUTURES MARKETSAS 1989 ENDED AND 1990 BEGAN: CURRENCIES (UPPER LEFT), COMMODITIES (LOWER LEFT),BONDS (LOWER RIGHT), AND STOCKS (UPPER RIGHT). BY INCLUDING ALL FOUR SECTORS,FUTURES MARKETS PROVIDE A BUILT-IN ASSET ALLOCATION FORUM. FOREIGN CURRENCIESAND COMMODITIES WILL USUALLY RISE DURING DOWNTURNS IN THE BOND AND STOCKMARKETS.Deutsche Mark Futures
CRB Index
NYSE Stock Index Futures
Treasury Bond Futures
THE VALUE OF MANAGED FUTURES ACCOUNTS
219
The two charts to the right of Figure 12.10 (NYSE stock index futures on the upperright and Treasury bond futures on the lower right) have been dropping for essentiallythe same reasons that commodities and foreign currencies have been rising—namely,a falling U.S. dollar and renewed inflation pressures. Futures traders could have chosen to liquidate long positions in bonds and stock index futures during that periodand concentrate long positions in commodities and currencies. Or they could havebenefited from declining financial markets by initiating short positions in interest rateand stock index futures.By selling short, a trader actually makes money in falling markets. The nature offutures trading makes short selling as easy as buying. As a result, futures professionalshave no bullish or bearish preference. They can buy a rising market or sell a fallingmarket short. The upshot of all of this is an amazing number of choices availableto futures traders. They can participate in all market sectors, and trade from boththe long and the short side.-They can benefit from periods of inflation and periods ofdisinflation. The futures markets provide an excellent environment for the applicationof tactical asset allocation, which refers to the switching of funds among various assetclasses to achieve superior performance. The fact that futures contracts trade on only10 percent margin also makes that process quicker and cheaper. Given these facts,professionally managed futures funds would seem to be an ideal place for portfoliomanagers to seek diversification and protection from inflation.THE VALUE OF MANAGED FUTURES ACCOUNTS
Over the past few years, money managers have begun to consider the potential benefits of allocating a portion of their assets to managed futures accounts to achievediversification and some protection against inflation. Attention started to focus onthis area with the work of Professor John Lintner of Harvard University. In the springof 1983, Lintner presented a paper at the annual conference of the Financial AnalystsFederation in Toronto, Canada.The paper entitled "The Proposed Role of Managed Commodity-Financial Futures Accounts (and/or Funds) In Portfolios of Stocks and Bonds" drew attentionto the idea of including managed futures accounts as a portion of the traditionalportfolio of bonds and stocks. Since then, other researchers have updated Lintner'sresults with similar conclusions. Those conclusions show that futures portfolios havehigher returns and higher risks. However, since returns on futures portfolios tend tobe poorly correlated with returns on bonds and stocks, significant improvements inreward/risk ratios can be achieved by some inclusion of managed futures. Lintner'spaper contained the following statement:Indeed, the improvements from holding efficiently selected portfolios of managedaccounts or funds are so large—and the correlations between the returns on thefutures-portfolios and those on the stock and bond portfolios are so surprisingly low(sometimes even negative)—that the return/risk tradeoffs provided by augmentedportfolios, consisting partly of funds invested with appropriate groups of futuresmanagers (or funds) combined with funds invested in portfolios of stocks alone (orin mixed portfolios of stocks and bonds), clearly dominate the tradeoffs available fromportfolios of stocks alone (or from portfolios of stocks and bonds). . . . The combinedportfolios of stocks (or stocks and bonds) after including judicious investments inappropriately selected . . . managed futures accounts (or funds) show substantiallyless risk at every possible level of expected return than portfolios of stocks (or stocksand bonds) alone.
COMMODITIES AND ASSET ALLOCATION
WHY ARE FUTURES PORTFOLIOS POORLYCORRELATED WITH STOCKS AND BONDS?There are two major reasons why futures funds are poorly correlated with bonds andstocks. The first lies in the diversity of the futures markets. Futures fund managersdeal in all sectors of the futures markets. Their trading results are not dependenton just bonds and stocks. Most futures fund managers are trend-followers. Duringfinancial bull markets, they buy interest rate and stock index futures and benefitaccordingly. During downturns in bonds and stocks, however, their losses in thefinancial area will be largely offset by profits in commodities and foreign currencieswhich tend to rise at such times. They have built in diversification by participatingin four different sectors which are usually negatively correlated.The second reason has to do with short selling. Futures managers are not tiedto the long side of any markets. They can benefit from bear markets in bonds andstocks by shorting futures in these two areas. In such an environment, they can holdshort positions m the financial markets and long positions in commodities In thisway, they can do very well during periods when financial markets are experiencingdownturns, especially if inflation is the major culprit. And this is precisely whentraditional bond and stock market portfolio managers need the most help.The late Dr. Lintner's research and that of other researchers is based on the trackrecords of Commodity Trading Advisors and publicly-traded futures mutual fundswinch are monitored and published by Managed Account Reports (5513 Twin KnollsRoad, Columbia, MD 21045). The purpose in mentioning it here is simply to alert thereader to work being done in this area and to suggest that the benefits of intermarkettrading, which is more commonly practised in the futures markets, may somedaybecome more widely recognized and utilized in the investment community.Let's narrow the focus and concentrate on one portion of the futures portfolio the traditional commodity markets. This book has focused on this group's importanceas a hedge against inflation and its interrelationships with the other three sectorscurrencies, bonds, and stocks. The availability of the widely-watched CommodityResearch Bureau Futures Price Index and the existence of a futures contract on thatindex have allowed the use of one commodity index for intermarket comparisonsUtilizing an index to represent all commodity markets has made it possible to lookat the commodity markets as a whole instead of several small and unrelated partsSerious work in intermarket analysis (linking commodity markets to the financialmarkets) began with the introduction of CRB Index futures in 1986 as traders beganto study that index more closely on a day-to-day basis.Why not carry the use of the CRB Index a step further and examine whether ornot its components qualify as a separate asset class and, if so, whether any benefitscan be achieved by incorporating a basket approach to commodity trading into themore traditional investment philosophy? To explore this avenue further, I'm goingto rely on statistics compiled by Powers Research Associates, L.P. (30 MontgomeryStreet, Jersey City, NJ 07306) and published by the New York Futures Exchange in awork entitled "Commodity Futures as an Asset Class" (January 1990).COMMODITY FUTURES AS AN ASSET CLASSThe study first compares the returns of the four categories (government bonds, corporate bonds, U.S. stocks, and the CRB Index) from 1961 through 1988. US stocks arerepresented by the S&P 500 Index and U.S. corporate bonds by the Salomon Brothers
WHAT ABOUT RISK?
221
Long-Term High-Grade Corporate Bond Index. Government bonds use an approximatematurity of 20 years. The commodity portion is represented by a return on the CRBIndex plus 90 percent of the return on Treasury Bills (since a CRB Index futuresposition only requires a 10 percent margin deposit). Table 12.1 summarizes some ofthe results.Over the entire 30-year period, U.S. stocks were the best overall performer(1428.41) whereas the CRB Index came in second (1175.26). In the two periods beginning in 1965 and 1970 to 1988, the CRB Index was the best performer (974.70and 787.97, respectively), while U.S. stocks took second place (766.78 and 650.69,respectively). Those two periods include the inflationary 1970s when commoditiesexperienced enormous bull markets. In the fifteen years since 1975, stocks regainedfirst place (555.69) while corporate bonds took second place (338.23). The CRB Index slipped to third place (336.47). Since 1980, corporate bonds turned in the bestreturns (300.58), with stocks and government bonds just about even in second place.The CRB Index, reflecting the low inflation environment of the 1980s, slipped to last.During the final period, from 1985 to 1988, stocks were again the best place to be,with bonds second. Commodities turned in the worst performance in the final fouryears.Although financial assets (bonds and stocks) were clearly the favored investmentsduring the 1980s, commodities outperformed bonds by a wide margin over the entire30-year span and were the best performers of the three classes during the most recent20- and 25-year spans. The rotating leadership suggests that each asset class has "itsday in the sun," and argues against taking too short a view of the relative performancebetween the three sectors.WHAT ABOUT RISK?Total returns are only part of the story. Risk must also be considered. Higher returnsare usually associated with higher risk, which is just what the study shows. Duringthe 30 years under study, stock market returns showed an average standard deviationof 3.93, the largest of all the asset classes. (Standard deviation measures portfolio variance and is a measure of risk. The higher the number, the greater the risk.) The CRBIndex had the second highest with 2.83. Government and corporate bonds showed
TABLE 12.1YEARLY RETURNS: BONDS, EQUITIES, AND COMMODITIES (ASSUMING A $100 INVESTMENT IN EACH CLASSDURING EACH TIME PERIOD)
1960-19881965-19881970-19881975-19881980-19881985-1988
Govt.Bonds
Corp.Bonds
U.S.Stocks
CRBIndex
442.52423.21423.58314.16288.87132.79
580.21481.04452.70338.23300.58132.32
1428.41766.78650.69555.69289.27145.62
1175.26974.70787.97336.47153.68128.13
COMMODITIES AND ASSET ALLOCATION
the lowest relative risk, with standard deviations of 2.44 and 2.42, respectively Itmay come as a surprise to some that a portfolio of stocks included in the S&P 500Index carries greater risk that an unleveraged portfolio of commodities included inthe CRB Index.Other statistics provided in the study have an important bearing on the potentialrole of commodities as an appropriate diversification tool and as a hedge againstinflation. Over the entire 30 years, the CRB index showed negative correlations of-0.1237 and -0.1206 with government and corporate bonds, respectively, and asmall positive correlation of 0.0156 with the S&P 500. The fact that commoditiesshow a slight negative correlation to bonds and a positive correlation to stocks thatis close to zero would seem to support the argument that commodities would qualifyas an excellent way to diversify portfolio risk.A comparison of the CRB Index to three popular inflation gauges-the Consumer Price Index (CPI), the Producer Price Index (PPI), and the implicit GNPdeflator—over the 30-year period shows that commodity prices were highly correlated to all three inflation measures, with correlations above 90 percent in all casesThat strong positive correlation between the CRB Index and those three popularinflation measures supports the value of utilizing commodity markets as a hedgeagainst inflation.
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FIGURE 12.11THE EFFICIENT FRONTIERS Of FOUR DIFFERENT PORTFOLIOS. THE LINE TO THE FAR RIGHTINCLUDES JUST BONDS AND STOCKS. THE LiNES SHIFT UPWARD AND TO THE LEFT AS COMMODITIES ARE ADDED IN INCREMENTS OF 10 PERCENT, 20 PERCENT, AND 30 PERCENT. THEEFFICIENT FRONTIER PLOTS PORTFOLIO RISK (STANDARD DEVIATION) ON THE HORIZONTALAXIS AND EXPECTED RETURN ON THE VERTICAL AXIS. (SOURCE: "COMMODITY FUTURES ASAN ASSET CLASS," PREPARED BY POWERS RESEARCH ASSOCIATES, L.P., PUBLISHED BY THENEW YORK FUTURES EXCHANGE, JANUARY 1990.)Domestic Assets Efficient Frontier (1961-1988)
PUSHING THE EFFICIENT FRONTIER
The efficient frontier is a curve on a graph that plots portfolio risk (standard deviation) on the horizontal axis and expected return on the vertical axis. The efficientfrontier slopes upward and to the right, reflecting the higher risk associated withhigher returns. Powers Research first developed a set of optimized portfolios utilizing only stocks and bonds. By solving for the highest expected return for each levelof risk, an efficient frontier was created. After determining optimal portfolios usingonly bonds and stocks, commodity futures were added at three different levels of commitment. The result was four portfolios-one with no commodities, and three otherportfolios with commodity commitments of 10 percent, 20 percent, and 30 percent.Figure 12.11 shows the effects of introducing the CRB Index at those three levels ofinvolvement.Four lines are shown in Figure 12.11. The one to the far right is the efficientfrontier for a portfolio of just stocks and bonds. Moving to the left, the second linehas a CRB exposure of 10 percent. The third line to the left commits 20 percent tocommodities, whereas the line to the far left places 30 percent of its portfolio in theCRB Index. The chart demonstrates that increasing the level of funds committed tothe CRB Index has the beneficial effect of moving the efficient frontier upward and tothe left, meaning that the portfolio manager faces less risk for a given level of returnwhen a basket of commodities is added to the asset mix. Statistics are also presentedthat measure the change in the reward to risk ratios that take place as the result ofincluding commodities along with bonds and stocks. To quote directly from page 8of the report:Note in all cases, the addition of commodity futures to the portfolio increased theratio, i.e., lowered risk and increased return. The increase grows as more commodity futures replace other domestic assets...the more of your portfolio allocated tocommodity futures (up to 30 percent) the better off you are.
SUMMARY
This chapter has utilized ratio analysis to better monitor the relationship betweencommodities (the CRB Index) and bonds and stocks. Ratio analysis provides a usefultechnical tool for spotting trend changes in these intermarket relationships. Trendlineanalysis can be applied directly to the ratio lines themselves. A rising CRB/bond ratiosuggests that commodities should be bought instead of bonds. A falling CRB/bondratio favors long commitments in bonds. A rising CRB/bond ratio is also bearish forequities. Rising commodities have an adverse impact on both bonds and stocks. TheCRB/bond ratio usually leads turns in the CRB/S&P 500 ratio and can be used as aleading indicator for stocks.The commodities included in the CRB Index should qualify as an asset classalong with bonds and stocks. Because commodity markets are negatively correlatedto bonds and show little correlation to stocks, an unleveraged commodity portfolio(with 10 percent committed to a commodity position and 90 percent in Treasurybills) could be used to diversify a portfolio of stocks and bonds. The risks usually associated with commodity trading are the result of low margin requirements (around10 percent) and the resulting high leverage. By using a conservative (unleveraged)approach of keeping the unused 90 percent of the futures funds in Treasury bills,much of the risk associated with commodity trading are reduced and its use by
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portfolio managers becomes more realistic. The high correlation of the CRB index toinflation gauges qualify commodities as a reliable inflation hedge.Futures markets—including commodities, currencies, bonds, and stock indexfutures—provide a built-in forum for asset allocation. Because their returns are poorlycorrelated with bond and stock market returns, professionally managed futures fundsmay qualify as a legitimate diversification instrument for portfolio managers. Thereare two separate approaches involved in the potential use of futures markets by portfolio managers. One has to do with the use of professionally managed futures accounts,which invest in all four sectors of the futures markets—commodities, currencies,bond, and stock index futures. In this sense, the futures portfolio is treated as a separate entity. The term futures refers to all futures markets, of which commodities areonly one portion. The second approach treats the commodity portion of the futuresmarkets as a separate asset class and utilizes a basket approach to trading those 21commodities included in the CRB Index.
13Intermarket Analysisand the Business Cycle
Over the past two centuries, the American economy has gone through repeated boomand bust cycles. Sometimes these cycles have been dramatic (such as the Great Depression of the 1930s and the runaway inflationary spiral of the 1970s). At othertimes, their impact has been so muted that their occurrence has gone virtually unnoticed. Most of these cycles fit somewhere in between those two extremes and haveleft a trail of fairly reliable business cycle patterns that have averaged about fouryears in length. Approximately every four years the economy experiences a period ofexpansion which is followed by an inevitable contraction or slowdown.The contraction phase often turns into a recession, which is a period of negative growth in the economy. The recession, or slowdown, inevitably leads to thenext period of expansion. During an unusually long economic expansion (such asthe 8-year period beginning in 1982), when no recession takes place, the economyusually undergoes a slowdown, which allows the economy to 'catch its breath' beforeresuming its next growth phase. Since 1948, the American economy has experiencedeight recessions, the most recent one lasting from July 1981 to November 1982. Theeconomic expansions averaged 45 months and the contractions, 11 months.The business cycle has an important bearing on the financial markets. Theseperiods of expansion and contraction provide an economic framework that helpsexplain the linkages that exist between the bond, stock, and the commodity markets.In addition, the business cycle explains the chronological sequence that developsamong these three financial sectors. A trader's interest in the business cycle lies notin economic forecasting but in obtaining a better understanding as to why these threefinancial sectors interact the way they do, when they do.For example, during the early stages of a new expansion (while a recession orslowdown is still in progress), bonds will turn up ahead of stocks and commodities.At the end of an expansion, commodities are usually the last to turn down. A betterunderstanding of the business cycle sheds light on the intermarket process, and reveals that what is seen on the price charts makes sense from an economic perspective.Although it's not the primary intention, intermarket analysis could be used to helpdetermine where we are in the business cycle.225
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INTERMARKET ANALYSIS AND THE BUSINESS CYCLE
Some understanding of the business cycle (together with intermarket analysis ofbonds, stocks, and commodities) impacts on the asset allocation process, which wasdiscussed in chapter 12. Different phases of the business cycle favor different assetclasses. The beginning of an economic expansion favors financial assets (bonds andstocks), while the latter part of an expansion favors commodities (or inflation hedgessuch as gold and oil stocks). Periods of economic expansion favor stocks, whereasperiods of economic contraction favor bonds.In this chapter, the business cycle will be used to help explain the chronologicalrotation that normally takes place between bonds, stocks and commodities. AlthoughI'll continue to utilize the CRB Futures Price Index for the commodity portion, therelative merits of using a couple of more industrial-based commodity averages will bediscussed such as the Spot Raw Industrials Index of the Journal of Commerce Index.Since copper is one of the most widely followed of the industrial commodities, itspredictive role in the economy and some possible links between copper and the stockmarket will be considered. Since many asset allocators use gold as their commodityproxy, I'll show where the yellow metal fits into the picture. Because the bond marketplays a key role in the business cycle and the the intermarket rotation process, thebond market's value as a leading indicator of the economy will be considered.THE CHRONOLOGICAL SEQUENCES OF BONDS,STOCKS, AND COMMODITIESFigure 13.1 (courtesy of the Asset Allocation Review, written by Martin J. Pring, published by the International Institute for Economic Research, P.O. Box 329, WashingtonDepot, CT 06794) shows an idealized diagram of how the three financial sectors interact with each other during a typical business cycle. The curving line shows thepath of the economy during expansion and contraction. A rising line indicates ex-
GOLD LEADS OTHER COMMODITIES
227
pansion and a falling line, contraction. The horizontal line is the equilibrium levelthat separates positive and negative economic growth. When the curving line isabove the horizontal line but declining, the economy is slowing. When it dips belowthe horizontal line, the economy has slipped into recession. The arrows representthe direction of the three financial markets-B for bonds, S for stocks, and C forcommodities.The diagram shows that as the expansion matures, bonds are the first of thegroup to turn down. This is due to increased inflation pressures and resulting upwardpressure on interest rates. In time, higher interest rates will put downward pressureon stocks which turn down second. Since inflation pressures are strongest near theend of the expansion, commodities are the last to turn down. Usually by this time,the economy has started to slow and is on the verge of slipping into recession. Aslowdown in the economy reduces demand for commodities and money. Inflationpressures begin to ease. Commodity prices start to drop (usually led by gold). At thispoint, all three markets are dropping.As interest rates begin to soften as well (usually in the early stages of a recession),bonds begin to rally. Within a few months, stocks will begin to turn up (usually afterthe mid-point of a recession). Only after bonds and stocks have been rallying forawhile, and the economy has started to expand, will inflation pressures start to buildcontributing to an upturn in gold and other commodities. At this point, all threemarkets are rising. Of the three markets, bonds seem to be the focal point.Bonds have a tendency to peak about midway through an expansion, and bottom about midway through a contraction. The peak in the bond market during aneconomic expansion is a signal that a period of healthy noninflationary growth hasturned into an unhealthy period of inflationary growth. This is usually the pointwhere commodity markets are starting to accelerate on the upside and the bull market in stocks is living on borrowed time.GOLD LEADS OTHER COMMODITIES
FICURE 13.1AN IDEALIZED DIAGRAM OF HOW BONDS (B), STOCKS (S), AND COMMODITIES (C) INTERACTDURING A TYPICAL BUSINESS CYCLE. (SOURCE: ASSET ALLOCATION REVIEW BY MARTIN J.PRING, PUBLISHED BY THE INTERNATIONAL INSTITUTE FOR ECONOMIC RESEARCH, P.O. BOX329, WASHINGTON DEPOT, CT 06794.)
Although gold is often used as a proxy for the commodity markets, it should beremembered that gold usually leads other commodity markets at tops and bottoms.Chapter 7 discussed gold's history as a leading indicator of the CRB Index. It's possibleduring the early stages of an expansion to have bonds, stocks, and gold in bull marketsat the same time. This is exactly what happened in 1982 and again in 1985. During1984 the bull markets in bonds and stocks were stalled. Gold had resumed its majordowntrend from an early 1983 peak. Bonds turned up in July of 1984 followed bystocks a month later. Gold hit bottom in February of 1985, about half a year later. Forthe next 12 months (into the first quarter of 1986), all three markets rallied together.However, the CRB Index didn't actually hit bottom until the summer of 1986.This distinction between gold and the general commodity price level may helpclear up some confusion about the interaction of the commodity markets with bonds.In previous chapters, we've concentrated on the inverse relationship between the CRBIndex and the bond market. The peak in bonds in mid-1986 coincided with a bottomin the CRB Index. In the spring of 1987, an upside breakout in the CRB Index helpedcause a collapse in the bond market. A rising gold market can coexist with a risingbond market, but it is an early warning that inflation pressures are starting to build.A rising CRB Index usually marks the end of the bull market in bonds. Conversely,a falling CRB Index during the early stages of a recession (or economic slowdown)usually coincides with the bottom in bonds. It's unlikely that all three groups will berising or falling together for long if the CRB index is used in place of the gold market.
228
INTERMARKET ANALYSIS AND THE BUSINESS CYCLE
ARE COMMODITIES FIRST OR LAST TO TURN?The diagram in Figure 13.1 shows that bonds turn down first, stocks second, andcommodities last. As the economy bottoms, bonds turn up first, followed by stocks,and then commodities. In reality, it's difficult to determine which is first and whichis last since all three markets are part of a never-ending cycle. Bonds turn up aftercommodities have turned down. Conversely, the upturn in commodities precedes thetop in bonds. Viewed in this way, commodities are the first market to turn instead ofthe last. Stocks hit an important peak in 1987. Bonds peaked in 1986. Gold startedto rally in 1985 and the CRB Index in 1986. It could be argued that the rally in gold(and the CRB Index) signaled a renewal of inflation, which contributed to the top inbonds which contributed to the top in stocks. It's just a matter of where the observerchooses to start counting.THE SIX STAGES OF THE BUSINESS CYCLE
In his Asset Allocation Review, Martin Pring divides the business cycle into six stages(Figure 13.2). Stage one begins as the economy is slipping into a recession and endswith stage six, where the economic expansion has just about run its course. Eachstage is characterized by a turn in one of the three asset classes—bonds, stocks, orcommodities. The following table summarizes Pring's conclusions:Stage 1... Bonds turn upStage 2... Stocks turn upStage 3 ... Commodities turn up-Stage 4 ... Bonds turn downStage 5 ... Stocks turn downStage 6... Commodities turn down
(stocks and commodities falling)(bonds rising, commodities falling)(all three markets rising)(stocks and commodities rising)(bonds dropping, commodities rising)(all three markets dropping)
FIGURE 13.2THE SIX STAGES OF A TYPICAL BUSINESS CYCLE THROUGH RECESSION AND RECOVERY. EACHSTAGE IS CHARACTERIZED BY A TURN IN ONE OF THE THREE SECTORS-BONDS, STOCKS,AND COMMODITIES. (SOURCE: ASSET ALLOCATION REVIEW BY MARTIN J. PRING.)
THE ROLE OF BONDS IN ECONOMIC FORECASTING
229
The implications of the above sequence for asset allocators should be fairly obvious. As inflation and interest" rates begin to drop during a slowdown (Stage 1), bondsare the place to be (or interest-sensitive stocks). After bonds have bottomed, and asthe recession begins to take hold on the economy (Stage 2), stocks become attractive. As the economy begins to expand again (Stage 3), gold and gold-related assetsshould be considered as an early inflation hedge. As inflation pressures begin to pullother commodity prices higher, and interest rates begin to rise (Stage 4), commoditiesor other inflation hedges should be emphasized. Bonds and interest-sensitive stocksshould be de-emphasized. As stocks begin a topping process (Stage 5), more assetsshould be funneled into commodities or other inflation-hedges such as gold and oilshares. When all three asset groups are falling (Stage 6), cash is king.The chronological sequence described in the preceding paragraphs does not imply that bonds, stocks, and commodities a/ways follow that sequence exactly. Lifeisn't that simple. There have been times when the markets have peaked or troughedout of sequence. The diagram describes the ideal rotational sequence that usuallytakes place between the three markets, and gives us a useful roadmap to follow. Whenthe markets are following the ideal pattern, the analyst knows what to