Chart Presentation: Twelve Months Later

Below we feature a comparison between the U.S. 30-year T-Bond futures and the product of crude oil times natural gasfutures prices from 1999 through 2001.

The argument begins with the observation that the bond market began to lift in price in January of 2000 months ahead of the March peak for the Nasdaq and almost exactly one year in front of the eventual highs for energy prices.

Below we show the same comparison running from mid-2006 to the present day.

The long end of the Treasury market pivoted higher in mid-2007 so on occasion we have suggested that the parabolic ramp higher in energy prices through the first half of 2008 was virtually a repeat of the second half of 2000. If history were to repeat then the final top for energy prices should occur around the end of this year’s second quarter. Obviously… so far, so good.

The difference between the end of 2000 and mid-2008 might best be seen through the chart below of short-term European debtprices. In late 2000 3-month euribor futures began to rise as the markets anticipated slower economic growth. We have yet to see a similar outcome this time around as the European Central Bank threatens to raise instead of cut interest rates to ward off inflationary pressures. We would like to see a rising trend for euribor prices and concurrent weakness in the euro relative to both the dollar and yen so that the markets can finally shift away from the strong commodity theme.

July 28 (Bloomberg) — Merrill Lynch & Co. said it will record $5.7 billion of pre-tax writedowns in the third quarter because of additional losses on the sale of collateralized debt obligations. The New York-based firm said today in a statement that it plans to raise $8.5 billion by selling shares in a public offering.

Below we show a comparison between the S&P 500 Index (SPX), crude oil futures, and the ratio between the share price of Coca Cola (KO) and the SPX.

The equity markets bottomed in March at the peak for both gold and crude oil pricesso our starting point on the chart is the March low for the SPX and the concurrent peak for crude oil futures prices.

We have argued that the SPX should bottom at the peak for crude oil and that is what happened- albeit briefly- this past March. Our focus today is on what happened after the SPX bottomed in March because with the benefit of hindsight we know that crude oil prices eventually pushed on to new highs.

The question might be… what if crude oil prices rally and push on to new highs once again?

Notice that the SPX rallied up from the lows in March and then continued to rally right through into May. In other words even with new highs for crude oil prices the U.S. equity market managed to push higher for close to 2 months.

The twist is not that the equity markets rallied but rather HOW they rallied. To explain this we have included the KO/SPX ratio.

As soon as crude oil prices broke to new highs in April the KO/SPX ratio began to decline. The equity markets were rising based on strength in the basic materials or commodity sectors at the expense of the more defensive consumer and pharma stock. Put another way the broad U.S. equity market can most certainly rise on weak crude oil prices AND on strong crude oil prices but recent history has shown that the former tends to lead to a long period of recovery while the latter tends to burn out quite quickly.

Our point? Returning to the KO/SPX ratio the markets appear to be stuck somewhere in the middle. We have yet to see the kind of relative strength for KO that would suggest a negative trend for commodity prices and have not see the kind of weakness that would call for a return to strong commodity prices.

Below right we show Merrill Lynch (MER) and heating oil futures.

We showed this chart a month or two ago to make the case that there was sort of an ongoing ‘proportionality’ between heating oil prices and MER. In other words at various points in time the product of the two totalled ‘150’. When MER was 75 in 2006 heating oil prices were 2.00. When MER rose to 100 heating oil was 1.50. When MER fell to 60 heating oil had risen to 2.50 and when heating oil hit 4.00 we find MER back down at 37.50.

The point if indeed there is one that is that MER trading in the vicinity of 25 would go with heating oil futures closer to 6.00. If heating oil futures have peaked, however, then MER seems reasonably attractive at current levels.