Commodity prices are cooling off — here's why that could be good news for stocks

Published Wed, May 26 20212:31 PM EDTUpdated Wed, May 26 20213:10 PM EDT

Jesse Pound @/in/jesse-pound @jesserpound

The price charts of some key commodities have turned south in recent days, and that could be welcomed news for a stock market trying to break out to new highs. Raw materials, agricultural products and key industrial inputs have spiked this year as the world economy tries to ramp back up from the Covid-19 pandemic, fanning fears about inflation. However, some of that fever appears to have broken in recent days, with the prices of futures contracts for lumber and corn dropping sharply. Evercore ISI's Ed Hyman said the markets were at a "critical juncture" with respect to inflation, and the recent dip in commodities could be a positive sign. "If commodity prices correct ... that will take the edge off the inflation accelerating story, take pressure off the Fed and improve the outlook for economic growth, S & P earnings and equity markets," Hyman wrote in a recent note. "However, if this situation doesn't correct commodity prices because global demand overwhelms, the inflation accelerating story will gather strength." A downward trend in commodities prices being good for stocks is a contrarian take on the typical pattern, which says that rising commodities prices goes hand in hand with an expanding economy, BMO Wealth Management chief investment strategist Yung-Yu Ma said. "That holds in typical times. But … given the stimulus and economic reopening that has taken place, and given the improvement in the labor market that is ongoing and expected to continue to take place, I think there is little concern that there isn't going to be sufficient economic growth," Ma said. "The question now is is inflation, or other actions that inflation could result in such as actions by the Fed, is that going to accelerate or cause problems," Ma added. The S & P 500 is basically flat this month, stuck about 1% below its record high. One way to understand why higher commodity prices would worry equity investors is to think about oil, MJP Wealth Advisors President Brian Vendig said. Crude prices rose about 80% from late October to early March, but West Texas Intermediate futures have mostly been trading in the mid-and-low $60s since. "Oil prices generally increase in a growth environment, meaning people buying more cars or in this environment where there are increases in mobility, as well as industrial production increasing," Vendig said. "But the point that we have to be sensitive about is, if oil prices increase too fast, growth might suffer from a decrease in consumption." The dip in some commodities prices appears to have been spurred in part by rising supply and saber rattling from Chinese regulators about cracking down on speculation. The fall has also come as some Federal Reserve officials hint at adjusting monetary policy if inflation and the economic recovery continue to rise. Those factors may have helped calm some traders who were worried about rising prices. The idea that inflation fears are easing has been reflected in parts of the fixed income market, according to Edward Jones investment strategist Angelo Kourkafas. To be sure, the recent dip in some commodities markets doesn't mean impacted industries are completely out of the woods on inflation. Raymond James analyst Buck Horne said in a note on Wednesday that, while lumber futures have declined, spot prices remain near record highs and strong housing demand should continue to support those prices for the foreseeable future. —CNBC's Michael Bloom contributed to this report.

A worker operates a forklift to move bundles of Hampton lumber for a shipment order at Burton Lumber in Salt Lake City, Utah, on Thursday, May 6, 2021.

George Frey | Bloomberg | Getty Images

The price charts of some key commodities have turned south in recent days, and that could be welcomed news for a stock market trying to break out to new highs.

Raw materials, agricultural products and key industrial inputs have spiked this year as the world economy tries to ramp back up from the Covid-19 pandemic, fanning fears about inflation. However, some of that fever appears to have broken in recent days, with the prices of futures contracts for lumber and corn dropping sharply.

Evercore ISI's Ed Hyman said the markets were at a "critical juncture" with respect to inflation, and the recent dip in commodities could be a positive sign.