Traders oftentimes will look at different markets from the one they are trading to get a gauge on what may be looming ahead. The US Dollar is oftentimes cited as a leading indicator to the US Equities market. The price of Gold is sometimes looked at as a market consensus on inflation. Besides intermarket relationships, there are intermarket spreads that traders keep an eye on.
In the energy markets, the crack spread (2 parts Gasoline plus one part Heating Oil minus 3 parts Crude) is observed with keen interest. Bond traders like to focus on the spread between the 10-Year Treasury and the 2-year Note. But what is often overlooked are more subtle intermarket spreads such as the Breakfast Spread. What people are eating for breakfast has some significant predictive power to what may be happening to the S&P 500.
The Breakfast Spread is the closing price of Pork Bellies (read: bacon) plus the closing price of Eggs minus the closing price of Coffee. What we’d like to see, in normal times, is that folks eat the eggs and bacon, and consume a proportionate amount of coffee. When this balance breaks down, look out for some major selloffs in US stocks. Below is a chart that was created in R depicting the price of Pork Bellies, Eggs and Coffee, along with a calculation that plots the Breakfast Spread.
We can see that the price of bacon and eggs remains steady, albeit volatile. The price of coffee, however, has some substantial spikes about once or twice a decade. The resulting impact on the Breakfast Spread is a reading below 100. This happened in 1978, 1985 and 1998 – all a couple years ahead of a major market selloffs. The indicator takes a different turn in predicting the the selloff of 2008. Instead of registering a sub 100 reading, it registers a 100 plus reading, meaning that people are not drinking enough coffee with their breakfast, which can only lead to trouble long term.
Where do we stand now? Well the indicator is clearly forming a descending triangle and that can only mean one thing in the next year or two – an ugly market selloff. You’ll know when your co-workers starts skipping breakfast but not the coffee, or maybe they have a proper breakfast and drink two cups of coffee instead of one.
There is still much research to be done in this exciting field. Could we use the price of orange juice to further enhance the Breakfast Spread? What about butter? I don’t know where to get butter data, but it’s gotta be out there somewhere. In any case, it may be prudent to protect one’s long portfolio with a little insurance, just in case.