Chart Presentation: September

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The month of September is shaping up to be somewhat challenging for the cyclical sectors. The 'stop' on this particular observation is 30-year Treasury yields rising above 3.0%.

The arguments are as follows:

First, trends tend to run quarter to quarter. In the absence of something rather unexpected (like a sharp drop in the weekly U.S. jobless claims numbers below 350,000) we should expect 'more of the same' until some time early in October.

Second, the seasonal trend tends to create the impression of weaker growth into the autumn and robust strength into the spring. The pivot points are typically October and November for the lows and May and June for the highs. From year to year the seasonal trend will impact the markets in different ways depending on the market's view on the benefits of growth. If, for example, the primary concern is inflationary pressures then slower growth can be a positive. Most of time, however, cyclical and bear market bottoms are made in the month of October.

Below is a chart of the sum of 3-month and 10-year Treasury yields. Notice that the lows for interest rates were made around the end of the third quarter in 2009, 2010, and 2011. This is a fine example of the seasonal trend at work.

The point is that there is a reasonable chance that September is going to be a gloomy month as we work towards a cyclical bottom into the final quarter of this year.

Our thought is that pressures through September will come from a weakening trend in China. We will attempt to show why on the following page.

Next is a comparison between the Shanghai Composite Index and the Baltic Dry (Freight) Index. The Dry Index represents ocean freight costs for dry bulk cargo and this is often a reasonable surrogate for the vibrancy of global trade.

The argument is that the Baltic Dry Index has settled back to the lows made in late 2008. A similar decline by the Shanghai Comp. would pull it back towards the 1700- 1800 level.

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Equity/Bond Markets

The chart just below compares the ratio of the pharma etf (PPH) to the S&P 500 Index (SPX) to the sum of the Canadian dollar (CAD) futures and the Australian dollar (AUD) futures.

Let's set the premise.

The commodity currencies (CAD plus AUD) trend with commodity prices. When the currencies are strong and rising it means that money is moving towards the kind of themes that dominated the past decade. These themes are... energy and basic materials.

The offset to this trend is represented by the health care sector including the drug stocks.

The commodity cyclicals go with rising interest rates as well as a weaker U.S. dollar.

The pharma stocks do better with declining interest rates and a stronger U.S. dollar.

Below is a chart of the sum of copper (in cents) and crude oil (in dollars times 3) as well as the cross rate between the Aussie dollar and Cdn dollar.

The AUD/CAD represents the relative strength of 'China'. China may be a bit narrow but the argument is that Australia is leveraged to commodity prices and geographically closer to China. Canada, on the other hand, is also leveraged to commodity prices but is more closely tied to conditions in North America.

Both the CAD and AUD trend with commodity prices but the AUD will tend to be stronger when Chinese growth is viewed as positive. For much of the past decade the underlying or dominant trend within the markets has been based on economic expansion in China which has tended to push the Aussie dollar higher.

So... let's put together a bit of an argument. Notice that the AUD/CAD cross rate has been declining through the month of August.

The weaker AUD/CAD suggests that economic activity in China may be slowing. Obviously this is a small sample size but the direction of the flow of money over the past few weeks certainly hints at this kind of outcome.

If China is slowing then the AUD/CAD should decline. The sum of the CAD and AUD should also decline as both currencies resolve to the down side led by weakness in the AUD.

If the commodity currencies are weaker then the pharma stocks should continue to outperform the broad U.S. stock market.

If trends run from quarter to quarter with cyclical bottoms made in the autumn then the window for some kind of sell off for crude oil and copper would extend from roughly today through into the middle of October.

The point? Unless 30-year Treasury yields show an inclination to move above 3.0% it makes sense to remain defensive through the balance of the current quarter.

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About the Author

Kevin Klombies is a prolific writer and market analyst. After graduating in 1980 from the University of Saskatchewan with a Bachelor of Commerce degree (Honours) in Finance/Economics, he was a broker for about 16 years for Wood Gundy Inc./CIBC Wood Gundy (changed name around 1990) Private Client Division.

While at Wood Gundy, he began to create the intermarket work that would later become the IMRA newsletter. He recalls starting with a DOS version of Metastock that he used to print out charts, drawing lines on them with a pen and ruler and taping them together upside down (at times).

The first market review that he put together was in 1988 and was based on annual percentage changes in U.S. M1 versus the equity markets. It ended up going from desk to desk right to the Bank of Canada, which said there was, in fact, no relationship between money supply growth and the equity markets (“which probably explains why I have so little respect for central banks,†he says).

Klombies says his broker career was uninspiring, mainly because he spent way too many hours running charts and too little time prospecting for business. He found that what he liked best was analyzing the markets and what he liked least was selling, marketing, and client service. So he eventually left the business and continued to work on the analysis while doing some trading and consulting.

He has been featured on a number of web sites, interviewed by Reuters TV in London and marketed by Agora Inc. (Daily Reckoning, etc.), but the majority of what he does is done privately and quietly.

KevinKlombies

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