by Kevin Klombies, Senior Analyst

Monday, June 30, 2008

Chart Presentation: 1987 Comparison

June 27 (Bloomberg) — Crude oil rose above $142 a barrel for the first time as falling stock markets spurred investment in commodities.

Oil has climbed 48 percent this year as the U.S. dollar declined against the euro and the MSCI World Index of global equity markets dropped 12 percent. Oil may extend gains if the European Central Bank boosts rates on July 3, further weakening the U.S. currency.

The markets remain mired within a circle that feels, at times, somewhat never ending. The European Central Bank continues to fight inflation even as equity prices decline and by holding or widening the spread between European and U.S. interest rates the euro rises against the dollar. As the dollar declines commodity prices rise which, in turn, adds to inflationary pressures. Rinse and repeat.

The ECB meets this Thursday and it is generally expected that it will raise short-term interest rates from 4.0% to 4.25%. Through last week the euro had entered the early stages of an upward acceleration apparently pointed at the 1.70 level.

At top right we show the S&P 500 Index from 1987 while below right we feature the euro futures from the current time frame.

The argument is that the chart of the euro is somewhat similar to the U.S. equity markets leading into the crash in 1987.

The SPX ramped higher into the spring of 1987 and then made three quick bottoms below the 50-day e.m.a. line before pushing on to new highs into August. Following the August peak the SPX made three almost identical dips below the moving average line before collapsing.

The euro’s chart is a bit choppier than the 1987 SPX but the point is that following the first peak in November of last year the euro chopped back and forth through the 50-day e.m.a. line into February before surging powerfully higher into April. After another series of corrections below the moving average line the euro swung higher last week and for all intents and purposes appears to be at a similar juncture to last February.

We are not sure whether it would take a miracle or not but it will most likely require something unexpected and definitely dramatic to break the euro’s momentum at this stage. However… the stock market’s crash in 1987 did not begin until early in a new quarter and that is exactly the position that the euro will be towards the end of this week.





Equity/Bond Markets

Third chart below shows the ratio of equities (S&P 500 Index) to long-term Treasury futures (U.S. 30-year T-Bond futures) from 1987 while below right we have included a chart of commodity prices (CRB Index) divided by equity prices (S&P 500 Index).

The 1987 stock market crash was, in a sense, a rebalancing of prices that had diverged to an extreme. Through the first nine months of 1987 equity prices surged while bond prices declined creating a ‘bubble-like’ chart pattern for the ratio of equities to bonds.

The current situation is not equities versus bonds but rather commodities versus equities. The ‘bubble’ began around the end of the third quarter last year as the CRB/SPX ratio began to ramp higher. Similar to 1987 the divergence has now run a full three quarters.

Quickly… below we show the U.S. 10-year T-Note futures from 1987 and the stock price of General Electric (GE) from 2008. The argument is that chart-wise GE appears very similar to the bond market into October of 1987.

The point is that through 1987 traders were selling bonds and buying stocks until the divergence became so great that equity prices collapsed while bond prices soared. This year traders are selling equities and buying commodities based in part off of the certainty that the U.S. dollar will continue to decline. The chart of the euro on page 1 suggests that the trend is either set to accelerate to new extremes based on the euro moving to new highs next month or… the entire house of cards is set to collapse. The chart below shows that GE has been declining for nine months in a manner similar to the T-Note futures from January through September of 1987. We can see how the commodity/equity trend could, in theory at least, come to an abrupt end but we suspect that it would take something- a surprise Fed rate hike, a surprise ECB rate reduction, the release of crude oil from the Strategic Petroleum Reserve, or even a hard intervention on behalf of the dollar by the U.S. Treasury- to make it a reality.