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.

We find it somewhat interesting that the start of declining energy consumption in both 1982 and 1990 preceded the start of significant equity bull markets by only a month or two. The stock marketturned higher in August of 1982 and again in October of 1990. It appears that this time really is different.

We are going to quickly show two markets comparisons from the 1982 time frame. At top right we feature a chart of the S&P 500 Index (SPX), the CRB Index, and 3-month eurodollar futures. Eurodollars, similar to TBills, are priced at a discount to 100 so a yield of, say, 15% would go with a price of around 85.

The point here is that the equity market turned lower at the same time as commodity prices. The equity ‘bear’ ran from late 1980 into the summer of 1982. Stock pricesdeclined in large part because Fed Chairman Volcker was attempting to squeeze inflation out of the system by holding short-term interest rates‘high’ even as commodity prices declined. We will return to this point on the next page.

The chart below compares the SPX with the U.S. 30-year T-Bond futures from early 1981 through the end of 1982.

We can (and have) argued that the recovery for stock prices in 1982 really began back in late 1981 after the bond market bottomed. However, even with Treasury prices well off the lows as long-term interest rates declined the stock market floundered until… the TBonds snapped out of the trading range set around the moving average lines. As bonds broke to the upside the stock market made a hard pivot. One day the S&P 500 Index was making new lows in a trend that felt like it would never end and a day later it was exploding to the upside. Why? Because 3-month eurodollar futures had started to rise even as the TBonds broke up through resistance. Fair enough.

The second chart below compares 3-month eurodollar futures and the Fed funds rate from the March of 2000 into March of 2001.

The point here is that the markets always lead. Eurodollar futures prices began to rise sharply into December of 2000 and a month later the Fed made its initial cut to the Fed funds rate.

The European Central Bankis acting quite ‘Volcker-ish’ as it fights inflation through an economic down turn. Given that they have a single mandate- to hold inflation below 2% in the euro-zone- this makes sense although we suspect that eventually someone will point out that inflation below 2% is not too far away from outright deflation.

In any event the point is that in 1982 the equity markets remained under pressure as commodity prices declined until bond prices turned smartly higher. We doubt that the ECB will start to reduce interest rates until the markets tell them that it is time to do so which brings us to the chart below right. The trend for 3-month euribor futures remains ‘down’ and this trend has gone with or actually created the downward trend for the financials that shows up through the ratio between Mitsubishi UFJ (MTU) and the gold etf (GLD).

There are two potential outcomes to consider. Either cyclical growth kicks back in with a vengeance as commodity prices and eventually real estate prices drive higher (along with interest rates) or the cyclical slow down is real enough to drive bond prices upwards. Below we show the TBond futures along with Short Sterling futures (3-month British sterling debtfutures). From current levels it wouldn’t take much more than a push above 94.7 by Short Sterling and a concurrent break back up through 122 by the TBond futures to give credence to a repeat of sorts of the August 1982 scenario.