Chart Presentation: 1981-82

We are going to start off with a reasonably ‘macro’ perspective today. Given the sharp intraday swings in the markets of late perhaps anything beyond a single trading day (or hour) should be considered long-term.

One of our views and arguments has been that the recent commodity markets rally is part of a recurring cycle that leads to relative strength tops in the mines and metals about every 13 years. The idea was that the share prices of the major mining companies reached a peak in 1981 followed by a second peak in 1994. A third top in 2007 therefore seemed somewhat reasonable.

The problem is that post-1981 the equity markets moved through a rather significant bear market while the 1995 time frame heralded in one of the most relentless bull market runs in some time. In both instances the mines and metals showed relative weakness for the next five to six years.

We have argued recently that the sharp equity markets decline felt more like a liquidity-inspired crisis similar to 1987 or 1998 than a 2000- 2001 recession prelude. Crisis markets tend to go down quickly and back up almost as fast so getting this one right is going to be important.

However, in case this really is a replay of 1981- 82 we thought that we would show a few of the details that go with the start of a new equity markets cycle.

At top right we show the ratio between FreePort McMoran (FCX) and the S&P 500 Index (SPX) along with 3-month eurodollar futures. The FCX/SPX ratio reached a peak in 2007 and is now declining as short-term interest rates move lower. So far, so good.

The chart at bottom right compares the SPX, CRB Index, and U.S. 30-year T-Bond futures from 1981 into late 1983.

The bond market bottomed in price in 1981 concurrent with the relative strength peak in the mining stocks. A rising bond market tends to represent the leading edge of an equity bull market but the SPX continued lower along with commodity prices into August of 1982. Once commodity prices had bottomed the SPX snapped upwards to rejoin the rising trend that began with the lift in the bond market in 1981. In other words the equity markets are driven by valuation (bonds) and growth (commodities) but in general when the bond market turns higher it marks the start of a bullish equity market trend that may or may be not be fully or partially offset by declining commodity prices.

The chart below compares 3-month eurodollar futures, the S&P 500 Index, and the ratio between the share price of Intel (INTC) and the CRB Index (commodity prices).

Rising 3-month eurodollar prices reflect declining short-term U.S. interest rates. Yields turned lower at the end of 1994 and again in late 2000 but for very different reasons. 1994, as mentioned on today’s first page, marked the peak for the mining sector while 2000 was quite obviously the peak for the tech and telecom sectors.

The Intel/commodity ratio bottomed towards the end of 1994 and then turned higher along with the S&P 500 Index and then it peaked and turned lower in late 2000 as the SPX began to decline. At present the markets have started the third trend change as 3-month eurodollar futures prices streak to the upside. Our view is that this should mark the start of a rising trend for the Intel/CRB ratio although our conviction was given a solid test over the first few weeks of January.

Below we show a chart of the Nasdaq Composite Index and the stock price of the Bank of Montreal (BMO) between 1998 and 2000 while below right we show the ratio between the Nikkei 225 Index and S&P 500 Index along with corn futures from 2006 to the present day.

The markets that we are showing are representative of ‘themes’. A positive commodity cycle tends to be dominated by metals prices during the early stages and then concludes with strength in the grains. We are using the Nikkei/SPX ratio to represent not only the relative strength of the Japanese stock market but also as a surrogate for the negative trend for the financials that began in early 2006.

The BMO was weaker all through the Nasdaq’s rise into March of 2000 as money moved away from the financials and towards the techs, telecoms, and internet stocks. In the present cycle money has been moving away from the financials and Nikkei and towards the commodity markets theme. Yesterday’s rally in the financials and sharp decline in the grains was suggestive of the start of a rather significant trend change reminiscent of March 2000.