by Kevin Klombies, Senior Analyst, TraderPlanet.com
Oct. 7 (Bloomberg) — Yum! Brands Inc., the owner of the Pizza Hut, Taco Bell and KFC chains, said third-quarter profit rose 4 percent on higher sales at its international divisions including China.
Oct. 7 (Bloomberg) — Alcoa Inc., the largest U.S. aluminum producer, said third-quarter profit fell 52 percent because of falling prices, slumping demand in North America and costs to shut down a Texas smelter.
We have been arguing in favor of the U.S. dollar (and the yen from time to time) along with the consumer and health care sectors for quite some time. After the close yesterday a commodity cyclical company- Alcoa- reported earnings 16 below consensus expectations while a consumer company- Yum- beat expectations by 4 cents.
There are a few similarities between the current time frame and post-1995 so we have included a chart at right that runs from mid-1993 through into late 2000.
The chart compares, from bottom to top, ocean freight rates for dry bulk cargo (Baltic Freight (Dry) Index), copper futures, the ratio between Phelps Dodge (PD- now owned by FreePort McMoRan) and the S&P 500 Index, and the ratio between pharma giant Merck (MRK) and the SPX.
The Baltic Freight Index peaked in May this year just under 11,800 and is last seen close to 2,900. In other words ocean freight costs are now close to 25% of the levels seen only five months ago. The point, however, is that the last time shipping rates declined in a similar manner was 1995.
The Baltic Freight Index peaked in 1995 along with copper prices. From 1995 through 1998 the trend for commodity prices was generally lower as the stock price of copper miner Phelps Dodge steadily underperformed the broad U.S. stock market (even though PD was actually quite strong on an absolute basis into 1997).
Through this time frame the stock price of Merck rose relative to the SPX which helps explain why we continue to argue in favor of the pharma sector.
The cycle finally came to an end during the Asian/Russian/Brazilian crises in late 1998 and early 1999. By that time the MRK/SPX ratio had reached a peak and the markets were ready to return to the commodity theme.
Equity/Bond Markets
We argued when crude oil was 100 that it was too high and held that view when it was 147.
Even today with crude oil prices closer to 90 it remains our conviction that oil prices simply have not fallen far enough to swing the non-energy sectors higher.
The question is… how far will oil prices have to decline to turn the trend? Our view is that we will have to see the lows of late last year taken out. The good news is that this would only take something south of 86-87 which is reasonably close to current levels.
The chart below compares crude oil futures, the stock price of Canada’s WestJet (WJA) Airlines, and the ratio between the share price of Coca Cola (KO) and the SPX.
If WJA represents the negative trend for energy-using sectors then the trend turned lower towards the end of last year when crude oil prices rose up from around 86- 87. In the mean time the KO/SPX ratio has pushed to new highs which- as we have argued on many occasions- is typically an indication that oil prices are headed lower.
Below we show Goldman Sachs (GS), the SPX, and the yield index for 3-month TBills. The quick point here is that TBill yields fell below 1% in March and then pushed back towards 2% as the equity markets recovered only to bust back below 1% in mid-September. If the equity markets are going to rally any time in the near future we would expect to see TBill yields rising back above 1%. We remain somewhat encouraged in these trying times that GS continues to hold well above the September lows.
Below is a chart of Wells Fargo (WFC) and the price spread or difference between the biotech etf (BBH) and Potash Corp. (POT). The very quick point here is that we still believe that WFC is going to lead the equity markets to the upside so which means that in general we also look for the biotechs to rise relative to the commodity sector. The last two sessions have not been kind to the biotechs, however.
