by Kevin Klombies, Senior Analyst

Tuesday, May 29, 2007

Chart Presentation: 1989?

Much of today’s issue will be based on the chart which shows the ratio between the stock prices of Caterpillar (CAT) and Coca Cola (KO).

CAT tends to trade with the commodity cyclical theme while Coke represents consumer growth. While both can rise and fall together as a reflection of the overall trend of the broad market large swings in relative prices tend to represent the strength or weakness in the trend for commodity prices.

The CAT/KO ratio made major tops in the summer of 1988 and then again during the spring of 2006. Today’s argument is that there are a number of similarities between the cycle the reached a peak in mid-1988 and the one that topped out during the second quarter of last year.

Before moving forward we should point out that the 1988 peak in the relative price of CAT to KO preceded the bull market top in the S&P 500 Index by two years (mid-1990) and the ensuing 1991 recession by roughly 2 1/2 years.

Below we show two comparative charts. The first features the CRB Index and Japan’s equity market from 1988 into 1990 while the second compares the CRB Index to China’s equity market from late 2005 to the present time period.

The CRB Index peaked in mid-1988 at the top for the CAT/KO ratio in the midst of a very strong trend for Asian growth. The Nikkei began to accelerate upwards towards the end of 1988 on the way to the eventual peak in January of 1990.

Our argument here is that the strength in the Chinese equity market today appears to be similar to that of the Nikkei in 1989. In both instances the parabolic rise in Asian equity prices followed the cycle top in commodity prices.

If we take this comparison literally then the Chinese equity market should be bought on any correction back to the 50-day e.m.a. line (blue-green line on chart) with a major price top expected around the start of this year’s fourth quarter.




Equity/Bond Markets

We have included two comparative views of the stock price of Caterpillar (CAT), Coca Cola (KO), and AMR. The top chart is from late 1986 into early 1991 while the lower chart shows the time frame from the second half of 2004 forward.

The argument was that when commodity prices reached a peak in the summer of 1988 the equity markets responded by pulling the ratio of CAT to KO downward. After a few months of consolidation the Japanese equity market began to rise before eventually reaching a top at the start of 1990.

We wanted to show the charts of CAT and KO individually and then add another ‘look’ by including the chart of airline stock AMR.

Notice that from mid-1988 through into the summer of 1990 the stock price of CAT simply chopped sideways. Our point is that the decline in the CAT/KO ratio was more to do with a rising trend for KO than absolute weakness in CAT.

The current situation does appear to be quite similar with CAT falling from 80 down to 60 before pushing back up towards the old highs. Meanwhile KO is gradually moving higher.

The airlines were very strong through much of 1989 with AMR rising rapidly into the autumn until the failed employee-led buy out of United Airlines pulled the entire sector lower. Similar to 1989 we have a positive trend for KO and AMR and what appears to be range trading for CAT.

The chart below compares the CRB Index with the ratio between the Amex Oil Index (XOI) and the S&P 500 Index (SPX).

The basic argument here is that as long as the oils are rising relative to the broad market the trend for commodity prices (CRB Index) is positive. Our macro argument is that commodity prices topped out in 2006 so the rally that began in January is against the major trend. The point is that if the CRB Index is going to resolve lower one of these days it should do so in large part through weakness in energy prices and underperformance by the stock prices of the major oil producers.