In yesterday’s issue we showed the two charts below and commented that we now had two very good reasons to be somewhat less positive on the long end of the bond market. We were careful NOT to write that we were negative- only that we should be less positive.
We are pointing out the distinction because it is somewhat important. Our view is that this the kind of market where relationships are capable of moving well beyond past extremes.
Below we have included a chart of oil refiner Valero (VLO) and the ratio between crude oil futures and gasoline futures. When the ratio of crude oil to gasoline is ‘high’ it means that the refiners’ margins are slim to none so… the higher the ratio the more downward pressure on VLO.
In recent cycles the ratio has reached a peak around .41:1. In other words with gasoline futures around 1.10 one would expect crude oil futures prices at 45 or lower. Obviously the ratio is ‘through the roof’ which helps explain why VLO’s stock price has fallen from close to 80 down to well below 20. In the past the 30-10 bond price spread would peak around ‘5’ at copper price bottoms and the gold/copper ratio would top around ‘5’ at bond price peaks but… this is hardly a normal cycle. This is why we are only shifting to a ‘less positive’ view on long-term Treasury prices.
We could probably come up with any number of critical questions with regard to the markets but the one that has our attention at the moment has to do with ‘when’ the markets will return to a stronger or positive cyclical trend.
The obvious answer would be something between ‘most certainly not now’ and ‘sometime next year or the year after (if ever)’ but we are not referring to when the economy will recover but rather when the stock market will begin to discount a recovery. There is a difference after all.
The chart that got us pondering this issue is shown below. The chart features copper futures and the ratio between Intel (INTC) and the S&P 500 Index (SPX).
While cyclical is cyclical to have a huge rise in one cyclical sector you generally need to see negative or stagnant growth in another. In other words the airlines are cyclical but they tend to rise on oil price weakness. Tech and commodities are both cyclical but one will do better when the other is weaker. The strength in Intel relative to the SPX from 1995 into 2000 was a function of the weakness of copper prices while the strength in copper from 2001 into 2006 was partly the result of the weakness in tech.
The idea was that the early recovery in copper futures from 2001 into 2003 appeared similar to the base that the INTC/SPX ratio has made from 2006 into 2008. With that in mind we have included two charts at right. The top chart shows the Nasdaq Composite Index and the VIX from the end of 1998 into 2004 while the lower chart includes copper futures and the VIX from early 2005 to the present day.
We have lined up the peak for the Nasdaq in 2000 with the 2006 highs for copper. In other words regardless of what copper did between 2006 and 2008 the cycle peak was actually made back in 2006. If so… then this becomes somewhat interesting. Why? Because the sharp rise in the VIX two and a half years after copper’s price peak lines up with the final decline in the Nasdaq in the autumn of 2002 (along with a pike top in the VIX). The point? Strangely enough… we might be closer to a cyclical bottom than most believe possible.
