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08/19/2008
Chart Presentation: KO/SPX We start off today with a chart-based comparison that shows one of the reasons we continue to like the share price of Coca Cola (KO).
The chart at top right compares the U.S. Dollar Index (DXY) futures with the ratio between Coca Cola (KO) and the S&P 500 Index (SPX) from early 1993 through 1997.
The argument begins around the start of 1994 as the dollar began to decline. The offset to dollar weakness through the first half of 1994 was general strength in the KO/SPX ratio. In other words as the dollar moved lower the share price of Coke began to outperform the broad market.
Chart Presentation: Major Trend Change We have a tendency to be early- often egregiously so- with our markets views because we are continually looking out over time in an attempt to discern what will happen ‘next’. As best we can, however, we try to be consistent so if we like or do not like something today there is a better than even chance that we will hold the exact same view tomorrow.
We mention this because we have been receiving a disconcertingly large number of emails asking us when it will be safe to return to the commodities markets.
Chart Presentation: Trends After a sharp gain on Wednesday commodity prices cooled somewhat yesterday as the U.S. dollar continued to strengthen.
U.S. inflation for the year ending in July rose at the fastest pace in 17 years but bond prices were stronger as Europe’s economy contracted for the first time since the introduction of the euro almost a decade ago.
Chart Presentation: 1982 Over the past 25 years there have only been two prior instances when there have been 12 consecutive months of year-over-year declines in U.S. petroleum consumption. The first was June 1982 through May of 1983 while the second occurred between September 1990 and August 1991.
Average monthly U.S. petroleum consumption, according to the Energy Information Administration, has been lower than the month a year previous from August of 2007 through July of 2008.
Chart Presentation: Large Cap, Small Cap If you don’t know where you are going then one path is as good as another. Today we will attempt to explain where we believe the market is heading so that we can spend a bit more time appreciating the journey instead of fighting the trend. Our view is that the issue is less whether the equity markets are going up or down and more that the markets are as skewed in one direction as they were in the other back in 2000. The chart below shows the ratio between the S&P 500 Index (SPX) and the NYSE Composite Index (NYSE). The SPX represents ‘large cap’ while the NYSE represents ‘small cap’.
Chart Presentation: Repeating Cycles We start things off today with the comparative chart at right that includes the biotech etf (BBH), airline AMR, refiners Valero (VLO), gold miner Barrick (ABX), and natural gas producer Chesapeake (CHK).We have argued in the past that the markets have been working through roughly 6-month trends. The first half of the year has focused on the broad energy theme while the second half of the year has featured strength in a variety of non-energy sectors.
Chart Presentation: Correction Aug. 8 (Bloomberg) — Crude oil fell, heading for its fourth decline in five weeks, as the dollar gained the most in more than seven years against the euro, reducing the appeal of commodities as an inflation hedge. Aug. 8 (Bloomberg) — Currencies across South America fell as a slide in prices of such commodities as soybeans, copper and oil erode the region’s export revenue. Aug. 9 (Bloomberg) — U.S. stocks rose, sending the Standard & Poor’s 500 Index to the largest weekly rally since April, as retailers, automakers and restaurants climbed on speculation earnings will improve as oil retreats.
Chart Presentation: History Repeating In yesterday’s issue we focused on two ideas. The first idea was that the equity markets had started to shift back towards the commodity cyclical sectors in a manner that suggested that there was an expectation that the dollar would weaken to re-energize the commodity-based trend. The second idea was that from a number of perspectives the U.S. dollar had reached levels very similar to those of August, 1995 which just happened to be the last time the U.S. Treasury intervened on behalf of the dollar.
Chart Presentation: Trend Test Let’s cut to the heart of the matter. Our view is that the U.S. dollar is going higher. The markets, on other hand, were trading yesterday as if the dollar was going to stall at or near the 200-day e.m.a. line which would, in turn, swing commodity prices back to the upside. The chart at top right compares the U.S. Dollar Index (DXY) futures with the CRB Index.
Chart Presentation: Relative Prices As expected the Fed held the funds rate flat at 2.0%. At present the markets expect that the funds rate will drift a bit higher before year end with roughly 60% odds that it will be at 2.25% or 2.50% by mid-December. We return to the same two charts that we showed yesterday. The only difference today is that we are including a chart of the U.S. Dollar Index (DXY) futures below.
Chart Presentation: Relative Prices There are no good days or bad days in the markets; merely days when your thesis is right or wrong with the trend. From our perspective yesterday was a very good day, however, simply because we have been dollar positive, commodities negative, and have favored U.S. large caps in the consumer non-cyclical and health care sectors.
Chart Presentation: Copper Aug. 1 (Bloomberg) — Copper fell the most in three weeks as a rally in the dollar and expanding inventories of the metal increased concern that demand is waning. In general copper and crude oil prices trend together and, in general, copper tends to lead crude oil at major trend change points. In general Asian and emerging equity markets do better when copper is stronger than crude oil.
Chart Presentation: Views Our view is that the U.S. equity markets will remain under pressure through into the fourth quarter and then explode to the upside through 2009 making new all time highs and possibly moving above 2000 within the next 18 to 24 months. Our view is that the U.S. dollar is making a bottom and will resolve up through 80 (U.S. Dollar Index) on the way back above 100.
Chart Presentation: NDX Overview Yesterday was a bit of a strange day. It started off in North American trading with what appeared to be a break through support for copper futures and ended with a wild rally for the commodity-related equity sectors. The Amex Oil Index, for example, rose a sparkling 5.8% while the Airline Index declined by very close to 5%.
Chart Presentation: Overview July 29 (Bloomberg) — The dollar advanced to a one-month high versus the euro and the yen as a report showed U.S. consumer confidence increased this month, reducing concern the world’s largest economy may fall into a recession. The currency rose earlier as Merrill Lynch & Co.’s plans to sell $8.5 billion of stock and liquidate bonds raised speculation Wall Street may have seen the worst of the credit crisis.
Chart Presentation: Twelve Months Later It was our intention at the end of last week to start things off today with a comparative view of the S&P 500 Index and crude oil futures. We were going to hammer on the point that as long as oil prices do not push on to new highs the financial sector should be ready to move past the recent state of crisis.
Chart Presentation: Backwards It was our intention at the end of last week to start things off today with a comparative view of the S&P 500 Index and crude oil futures. We were going to hammer on the point that as long as oil prices do not push on to new highs the financial sector should be ready to move past the recent state of crisis.
Chart Presentation: GM The chart below compares the stock price of General Motors (GM) with the ratio between the CRB Index and crude oil futures. The ratio rises when crude oil is weaker than general commodity prices and declines when crude oil is strong on a relative basis.
Chart Presentation: Trend Thoughts With the markets fairly active of late we are going to revert to a reasonably long-term perspective today. For one reason or another the more volatile the daily action the more likely we are to get ‘macro’ with our work.
Below we show a chart comparison between copper futures and corn futures from 1994 through into 1999.
The argument is and has been over the years that the grains rally once copper prices reach a peak.
Chart Presentation: Trend Checks A 3 point decline in crude oil prices yesterday helped offset negative earnings reports to lift the U.S. equity markets and dollar. The Airline Index (XAL) flew to more than a 22% gain. Intermarket analysis is based on the premise that one market impacts another. Strong crude oil prices lead to higher refined products prices which in turn leads to greater demand for ethanol which pushes grains prices higher.
Chart Presentation: Assorted Thoughts We have argued from time to time that when the S&P 500 Index trends lower through the first few weeks of a new quarter the pivot back to the upside is usually found somewhere around the 22nd to 25th day of the month. In other words with the equity markets weak to start the third quarter this year a more positive trend would be expected to show up some time this week.
Chart Presentation: What If Today’s topic is something of a ‘what if’. By this we mean that the markets are currently set up for one of two very different outcomes so the theme is ‘what if’ the one we are expecting to transpire actually occurs.
Below we show a chart of crude oil futures from March of 2006 through June of 2007. The focus here is on the decline for crude oil prices through the second half of 2006 followed by a sharp trend reversal back to upside in January of 2007.
Chart Presentation: Rotation We very much like animals so we hesitate to return to one of our oft-repeated topics in a manner reminiscent of beating a dead horse but to the extent that this seems timely... we are going to do so anyway. Our apologies to our equine readership.
The premise is that the markets have shown a tendency to make dramatic trend changes in the first month of a new quarter.
Chart Presentation: Trend Check Goodness... we never would have believed that the markets could rejoice because crude oil futures prices were only 134. How times have changed.
Energy prices continued to decline and the equity markets snapped higher with much of the strength concentrated into those sectors that have fared the worst recently. Wells Fargo gained 32% while General Motors, Ford, and the Airline Index were all up 16% to 18%.
Chart Presentation: Equities Lead The only problem that we had with the decline in crude oil prices was that it was a ‘Tuesday’. We have noted on many occasions in the past that sharp price declines tend to take place on Tuesdays and have been followed in most cases by strength later in the week. All things considered we would prefer to see crude oil prices move lower towards the end of the week but we will take what we can get.
Chart Presentation: Cycle Peaks For many years we used the stock price of Phelps Dodge to represent the trend for the base metals so we were less than pleased when it was taken over by FreePort McMoRan in 2007. Since late last year we have been showing Canada’s Duvernay as a surrogate for the natural gas trend but that came to an end yesterday following a take over offer from Royal Dutch Shell.
Chart Presentation: Summary We are going to attempt to quickly summarize one of the points that we have been working on of late. To start with we show 3-month euribor futures below. European short-term interest rates began to rise in late 2005 as euribor prices turned lower.Below we show Citigroup (C) and the ratio between Japan’s Mitsubishi UFJ (MTU) and the gold etf (GLD).
Chart Presentation: MTU/GLD July 10 (Bloomberg) — Japan’s wholesale inflation rate rose to a 27-year high in June as companies raised prices to counter record oil and commodity costs. Producer prices climbed 5.6 percent from a year earlier, after a revised 4.8 percent gain in May, the Bank of Japan said in Tokyo today.
Chart Presentation: 1987 Comparison Chart-wise one can trace downward pressure on the financial sector back to the start of central bank interest rate increases in both Europe and Japan. Our view is that the trend for short-term European interest rates remains one of the keys for the markets through the balance of the year.
Chart Presentation: Ratio Adjustment July 8 (Bloomberg) — Crude oil fell more than $5 a barrel, the biggest decline in three months, as signs that the global economy may slow prompted investors to sell commodities.
July 8 (Bloomberg) — Soybeans fell for a second straight day on speculation record energy prices have slowed the global economy, prompting investors to sell commodities.
Chart Presentation: Themes We are going to return to one of our recurring themes today. At right we show a chart of oil refiner Valero (VLO) from October of 2006 through into March of 2008.
What interests us about the chart is the way VLO trended higher through the first half of 2007. Many will argue that commodity prices trade simply on fundamentals but each time we view a chart that shows a trend running almost perfectly through one or two calendar quarters we suspect that there is a bit more to the markets than merely supply and demand.
Chart Presentation: The Dollar July 3 (Bloomberg) — The euro fell the most against the dollar in more than two months after European Central Bank President Jean-Claude Trichet signaled that he may not increase interest rates again.
Chart Presentation: Oil Lags July 2 (Bloomberg) — The euro may be nearing an “explosive breakout,” reaching record levels against the U.S. dollar, according to a Citigroup Global Markets Inc. research note. The point that we have been trying to make over the last few days is that the euro has reached a decision point of some importance and that an ‘explosive breakout’ would tend to support the rising commodity theme with particular emphasis on gold prices.
Chart Presentation: Reverse Engineering Our recent argument has been that as we enter a new quarter the euro has reached a critical decision point. After working through a consolidation the euro is set to accelerate to the upside or fail to the down side. We have argued that commodity prices in general and gold prices in particular tend to trend with the major European currencies so the fate of the broader commodity trend hangs in the balance.
Chart Presentation: Redux Below are the same two charts that we included in yesterday’s issue. It isn’t that we can’t come up with something new- that is rarely a problem for us- but rather that we feel that we should make this point at least one more time before moving on to something else.
Chart Presentation: 1987 Comparison June 27 (Bloomberg) — Crude oil rose above $142 a barrel for the first time as falling stock markets spurred investment in commodities.
Oil has climbed 48 percent this year as the U.S. dollar declined against the euro and the MSCI World Index of global equity markets dropped 12 percent. Oil may extend gains if the European Central Bank boosts rates on July 3, further weakening the U.S. currency.
Chart Presentation: Encouraging We have written on occasion that we didn’t think that the equity market’s correction had fully run it’s course and that we expected the S&P 500 Index to make bottom between 1280 and 1290. By closing yesterday at 1283.15 in the face of additional bond markets strength a tentative case can be made that a bottom is within reach. Of course all bets are out the window if crude oil prices continue to spike higher.
Chart Presentation: Third Quarter Shift Below we show a comparative view of the 10-year U.S. Treasury yield index (TNX) and the CRB Index from the spring of 2006 through into August of 2007. Around the end of the second quarter in 2006 10-year Treasury yields reached a peak along with commodity prices. In other words the trend for both interest rates and commodity prices peaked around the end of June.
Chart Presentation: 2-Year Lag The Fed funds futures argue that there is a 90% chance of no change in the funds rate today with a 10% chance that the target rate will be raised to 2.25%. In other words we would expect the Fed to hold the funds rate at 2.0%.
Chart Presentation: The End of the Quarter In general we tend to look for indications of a change in trend around the end of the third week in the first month of a new quarter. In other words around the 22nd to the 25th day of next month. On the other hand there is the possibility that the juggernaut commodity trend could break as early as this week so we thought we would return to a chart comparison that supports this eventuality.
Chart Presentation: Correction June 23 (Bloomberg) — Crude oil fell in New York trading after Saudi Arabia pledged to increase production next month and militants in Nigeria called a cease-fire in their attacks on oil pipelines and vessels. We have included three comparative charts that show the S&P 500 Index (SPX), the Amex Oil Index (XOI), the ratio between the share prices of Caterpillar (CAT) and Pepsi (PEP), and CAT.
Chart Presentation: Cycle Comparison June 19 (Bloomberg) — Crude oil fell more than $4 a barrel, the biggest drop in 11 weeks, on speculation demand will decline, after China said it will raise fuel prices starting tomorrow. Today’s argument begins with a chart ‘detail’ that we do not have the room to show.
Chart Presentation: The SPR The U.S. Strategic Petroleum Reserve was authorized by Congress in 1975 following the Arab oil embargo of 1973- 74. The reserve consists of four underground storage facilities within naturally occurring salt domes on the Gulf coast in Texas and Louisiana and has current storage capacity of 727 million barrels of oil. As of this week the reserve holds 705.7 million bbls.
Chart Presentation: Looking Ahead One of our arguments of late has been that the markets have shown a tendency to change trends at the start of the year and at the midway point so as we approach the end of this month it is time to start thinking about what might happen next. Below we have included a comparison between the sum of copper and crude oil futures along with the sum of the U.S. 30-year T-Bond futures and the U.S. Dollar Index (DXY).
Chart Presentation: Leading Below we show crude oil futures and the Hang Seng Index from 1998 through 1999 and into early 2000. Below right we show the same comparison from May of 2007 to the present day. The argument here is that the lows for the Hang Seng Index preceded the bottom for crude oil prices by more than six months back in 1998- 1999.
Chart Presentation: Trend Test June 13 (Bloomberg) — China’s stocks had the biggest weekly decline on record, dragging the benchmark index below 3,000 for the first time since April 2007, on concern government policies to curb inflation will hurt profits. Below we show the Hang Seng Chinese Enterprise Index (we could have used the Hang Seng Index or something like the Shanghai Composite Index but this will likely suffice), the stock price of base metals miner Rio Tinto (RTP), and the sum of the Canadian (CAD) and Australian (AUD) dollar futures.
Chart Presentation: Trend Shift We are not, as a general rule, inclined to superstition but we have to admit that each and every time we start to write an issue for a Friday the 13th we feel somewhat uneasy. Fridays are strange markets day at the best of times.
In yesterday’s issue we started on the topic of consumer versus cyclical. The idea was that from time to time- recently this has meant about once per year- the equity markets shift from one theme to another.
Chart Presentation: Comparisons Crude oil prices surged higher yesterday following a surprising decline in U.S. weekly oil inventories. Surprising to some, we suppose, but not to those who read Morgan Stanley’s report last week that called for a spike in the price of oil. The reasoning was that the Middle East has been shipping record volumes to Asia which has led to a 20 million barrel decline in the ‘oil in transit’ pipeline to Atlantic destinations.
Chart Presentation: The Unwind From our point of view yesterday may well have marked DAY 1 of the ‘Great Commodity Markets Unwind’. One of the problems or challenges that comes from comparing the current markets cycle to a previous time period is that history never repeats exactly. There are broad similarities, of course, but always with enough differences to hide the fact that the markets move through broad cycles instead of never ending trends.
Chart Presentation: The Next Theme Our basic view is that regardless of what crude oil prices do this month we expect to see oil prices close to 80 by the final quarter of this year. Between now and the end of the month however... just about anything could happen.
Chart Presentation: Second Half Even though we have included a comparison between crude oil futures prices and the Nasdaq Composite Index into the first quarter of 2000 on a number of occasions (page 7 today) we found Friday’s oil price action somewhat disconcerting. One of our ongoing page 5 arguments- based on the relationship between the stock price of Potash Corp. and crude oil futures- indicated on Thursday that higher oil prices were due but we really expected something a bit less dramatic.
Chart Presentation: JNJ We start out today with a chart of Johnson and Johnson (JNJ). Given the 6 point rise in crude oil prices yesterday there may well be more topical topics to consider but, as usual, when the markets get volatile we tend to get more macro.
Chart Presentation: Sequence We start things off today with a chart comparison of copper futures and the cross rate between the euro and the Japanese yen from 2000 into 2001.
In past issues we have argued that copper prices tend to rise with crude oil and then turn lower a few months in advance of energy prices. Our objective today is to try to cobble together a sequence of sorts to help us struggle through the balance of this year.
Chart Presentation: Currency Musings June 3 (Bloomberg) — The dollar rose to a two-week high against the euro and increased versus the yen as Federal Reserve Chairman Ben S. Bernanke said the central bank is “attentive” to the implications of the U.S. currency’s decline... The Fed is working with the Treasury to “carefully monitor developments in foreign exchange markets” and is aware of the effect of the dollar’s decline on inflation and price expectations, he said.
Chart Presentation: 100 or 150? One of the recurring themes that we have touched on over time has been the tendency for the markets to shift rather intensely from sector to sector every six months. We grant that at any given time any number of stocks or sectors may be rising or falling but there is typically one key or central idea that serves as the focus for capital flows.
Chart Presentation: Big Charts Of all the intermarket relationships that we follow the ones that we like the best are based on one market leading while another lags. These help to remove at least some portion o
