by Kevin Klombies, Senior Analyst

Wednesday, December 19, 2007

Chart Presentation: 1990 Comparison

The chart at right compares the S&P 500 Index (SPX) with the ratio between crude oil futures prices and the U.S. 30-year T-Bond futures from 1990- 91. Below right we show the chart of Wells Fargo (WFC) over the same time period.

The argument is and has been that when the crude oil/TBonds ratio peaks- as it did in October of 1990- the equity markets should start to recover. Keeping in mind that the U.S. real estate-driven recession of 1991 had not even begun when the stock price of WFC began to rise in the autumn of 1990 this constitutes a bullish albeit somewhat contrary perspective.

Below we show 1-month LIBOR futures. At a price of, say, 95 LIBOR futures represent bank-to-bank interest rates of 5%.

The European Central Bank is the only member of the G7 not to reduce borrowing rates. On top of this the combination of an impending year end and a credit markets crisis was driving European short-term interest rates higher in a manner somewhat similar to pouring gasoline on an already raging fire.

In a somewhat belated attempt to rectify this problem the ECB added roughly $500 billion to the global banking system yesterday causing 1-month LIBOR futures to rise very sharply. In a market that tends to adjust in price by very small increments a 50 point or 1/2% one-day change is, we understand, without precedent.




Equity/Bond Markets

Our first page argument was that at the peak for the crude oil/TBonds ratio we should be at the bottom for the S&P 500 Index. The problem, of course, was that the credit markets were in such a state of turmoil that the financial sector remained under rather severe pressure.

The present situation is shown at right. The crude oil/TBonds ratio peaked in November marking the start of a rising equity markets trend. The ECB’s efforts yesterday should help calm the credit markets and help support the SPX’s recovery.

Below right is a chart of Well Fargo (WFC) and First Quantum Mining (FM on Toronto). FM is a copper miner with operations in Africa which we use to represent the trend for commodities and non-U.S. equities. We could substitute the Taiwan stock market or the Australian dollar futures for FM without changing the basic argument in any way, shape, or form.

It is our expectation that the crude oil/TBonds ratio has peaked. It is our concern that the markets have one more ‘August’ left to come. Last August the SPX was below the 200-day e.m.a. line and the crude oil/TBonds ratio was declining from the July peak. FM was trading just below its 200-day e.m.a. line and the financials were starting to recover as WFC moved up towards 38. Then… the entire set up fell apart as the banks tumbled to new lows, crude oil prices streaked towards 100, the stock price of FM added a quick 30- 35 points (not an inconsiderable percentage in a short period of time), and the Cdn dollar rose by close to 15%. The markets are once gain set up in a fairly similar position and while, as mentioned, we don’t expect a replay of September and October… we also don’t want to dig in too deeply on the other side just in case.

Quickly… the point or price spread between the 30-year and 10-year Treasury futures has been bouncing from 1 up to just over 5 since early 2006. The spread tends to mirror the trend for copper prices. The spread could easily move back to +5 (a very bullish event for the bond market) if copper prices continue to decline.