We are currently in Stage 5 of the Business Cycle.

Economists use numerous regularly released surveys, statistics 
and reports to try and predict the future direction of the 
economy. But if you wish to use phases of the economy to help 
guide your investment strategy, perhaps the most reliable and 
most available parameters are the financial markets themselves. 
Asset prices tend to incorporate the markets best guess of future 
events and anticipate movements in the economy. Stock prices tend 
to lead an economic recession by about six months, and an 
economic expansion by about four months. The business cycle is 
not and exact science and is best used as a confirmation to what 
you see in price. For example if we are in stage one and high 
yield bonds and financials are trending up you might want to 
participate in those sectors. Or if we are in stage five and 
stocks are bullish, which is contrary to what the business cycle 
anticipates, it might be wise not to use leverage. Please visit 
this link for a full explanation of the business cycle and its 
various stages.

Below is a snap shot of the most recent business cycle. Bonds 
have broken out of their trading range but as you can see the Fed 
Funds rate (light blue) is still relatively low. Also note that 
the bull run of the 1990s took place with a Fed Funds rate, and 
bond yields higher then current levels. The rate is now slightly 
higher then it was in 1992.

[Image: http://www.cetcapital.com/blog/images/10yearApril06.jpg ]

[Image: 
http://www.cetcapital.com/blog/images/bondbreakoutApril06.jpg ]

Stage 5 is a period in which the Fed raises interest rates in an 
attempt to slow business activity and curb inflation. This, in 
turn, causes bond yields to increase.

Interest rates have been rising in the United States since 2004 
and they recently began heading higher in Europe as well. The US 
Federal Reserve raised interest rates for the 15th time in a row 
at the end of March, 2006. Borrowing costs rose a quarter of a 
percentage point to 4.75%. Rates have increased from 1% over the 
past 19 months and are now at their highest level since April 
2001. The European Central Bank (ECB) also raised interest rates 
by a quarter of a percentage point to 2.5% - the second change in 
rates in four months. In a historic policy change, the Bank of 
Japan (BOJ) on 3/9/2006 scrapped its five-year-old super-loose 
monetary policy and returned to a more conventional regime, but 
said it would still keep short-term interest rates around zero 
for some time. Japan is the second biggest economy in the world, 
and their move to a tightening policy will pressure our bond 
yields higher, as seen last week.

The Semiconductor Cycle is usually a good proxy for the general 
markets trend relative to the business cycle. When the Index and 
its 50-day moving average cross the 200-day moving average, a 
change in trend is usually confirmed.

[Image: 
http://www.cetcapital.com/blog/images/Wilsh7yearApril06.jpg ]

The interest-sensitive Dow Utility Average tends to lead trend 
changes in the broader averages. It has recently breached its 
200-day moving average for the first time since April, 2004.

[Image: 
http://www.cetcapital.com/blog/images/utilitiesApril06.jpg ]

During Stage 5, stocks top out and begin the early phase of their 
bear market in anticipation of declining earnings. The bearish 
influence of falling bond prices (higher yields) pulls interest 
sensitive stocks downward. Eventually, the rest of the stock 
market will also begin to weaken. This downturn in the stock 
averages will often be accompanied with an upturn in certain 
tangible asset stock groups, such as energy and gold mining 
shares. Energy stocks usually lead the stock market near the end 
of an economic expansion, which is usually associated with rising 
oil prices. A spike in oil has preceded virtually every recession 
over the past 30 years. The below charts illustrate the uptrend 
in both stock and commodities.

[Image: 
http://www.cetcapital.com/blog/images/wish10yearApril06.jpg ]

[Image: 
http://www.cetcapital.com/blog/images/CRB10yearApril06.jpg ]

[Image: 
http://www.cetcapital.com/blog/images/CRB5yearApril06.jpg ]

The Fed target interest rate is highly correlated with the CRB, 
and commodity prices have a greater than 90% correlation with 
three important inflation measures (PPI, CPI, GNP deflator). 
Commodities during Stage 5 continue to enjoy increased valuation, 
as there is some considerable time lag between changes in 
interest rates and its affects on business activity. Rising 
interest rates also pull the dollar higher.

I am not a big fan of making market predictions. CET Capitals 
beliefs are focused around price trends and momentum strength. As 
of lately the markets have been moving up on strong volume and 
are moving in a contrary direction to what the business cycle is 
suggesting should happen. Based on where we are in the business 
cycle I would not recommend using leverage currently.
 

Damian Campbell is President and head money manager of 
CET Capital, a Registered Investment Advisory firm. He 
oversees the testing and execution of all CET Capital 
investment programs. Please visit us on the web at 
http://www.cetcapital.com or call toll free 888-884-6468.