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The Goldilocks Paradigm

Tickers in this article: DCM

NEW YORK (TheStreet) -- "This world is clearly emerging before our eyes. The shifts ahead, the opportunities ahead are massive." - Carly Fiorina

The correlation between stocks and commodities continues to move lower into negative territory. As U.S. equities are hitting new all-time highs, commodity prices are at their lowest levels of the year. Taking a look at the DB Commodities Tracking Index Fund makes this very clear year to date. This is a dramatic shift from the prevailing relationship and deflationary environment that existed from late 2008 through the end of 2012.

In a deflationary environment, equities tend to be positively correlated with commodity prices and negatively correlated with bonds. As such, rising commodity prices and interest rates are generally viewed as bullish for equities while lower commodity prices are generally viewed as bearish for equities. Beginning in February, this relationship started to breakdown, as commodity prices and interest rates moved lower while stock prices continued to march higher.

The fear of deflation was subsiding but we weren't necessarily moving back to a more normal, inflationary environment in which stocks and bonds tend to move together. We were somewhere in the middle, in what some might call a "Goldilocks" economy. Neither "too hot" nor "too cold," with moderate economic growth and low inflation. Before 2013, the mid-to-late 1990's were shining example of this type of economy and naturally, stocks flourished during these years.

Also important to the Goldilocks thesis is that it creates an environment that allows for an extended period of easy monetary policy. This is what we are seeing today as the Federal Reserve continues operate with loosest monetary policy in history more than four years into the economic expansion.