by Kevin Klombies, Senior Analyst, TraderPlanet.com
In yesterday’s issue we started off by commenting that in a perfect world the S&P 500 Index made its momentum bottom on October 10th and its first test of the lows- along with its closing low- on October 27th. We then noted that if all went well a meaningful recovery would begin some time around ten days to two weeks from now. An explanation, we imagine, is in order.
From time to time we launch into the topic of ‘crash tops’ which, of course, has little to do with the current situation given that this is hardly a top. However, the broad concept applies equally to momentum or liquidity-driven tops and bottoms so this will be today’s focus.
When a market makes what we tend to call a ‘crash top’ it starts by driving up to a momentum peak. From there the market sells off- usually quite briskly- before pushing back once or twice towards the highs. The entire process from momentum peak to final rally takes roughly 28 to 34 trading days.
At right we have included four charts of the S&P 500 Index (SPX). The top chart if from 1987, the next from 1994, then 1998, and finally the current time period.
The stock market broke sharply lower in 1987, 1994, and 1998. Aside from that the one thing that these three time frames had in common was that following the initial bounce there was a retest of the lows that served as the launching pad for a prolonged period of recovery. We have noted on the charts that the test of lows occurred between 27 and 33 trading days after the momentum bottom was reached.
As of the end of trading yesterday 22 trading days had elapsed since the S&P 500 Index made its momentum bottom on October 10th. In other words if history were to be kind enough to repeat… we are still one to two weeks away from the start of a broad recovery.
Obviously 28 to 34 trading days is a general guideline. It could be that the markets will work through a bottom faster or slower than this and it could also be that this is not the final bottom. However, we will argue that if the SPX shows enough strength later this month to push above the 50-day e.m.a. line (blue-green line on the chart) then as long as it remains above this line we will have to view the equity markets trend as positive.
We have been focusing on the equity/commodity (or commodity/equity) ratio for the past few months. We should probably explain why we believe that this is so important.
At right is a comparative view of, from top to bottom, the stock price of Schering Plough (SGP), Sprint Nextel (S), and the ratio between the S&P 500 Index (SPX) and Dow Jones AIG Commodity Index (DJCI).
We could have used Glaxo Smithkline (GSK) instead of SGP but, either way, the broad point remains the same.
From 1990 into 1999 the trend favored equities over commodities and from 1999 into 2008 the trend reversed so that commodities were stronger than equities. If one is in the Jim Rogers commodity-bull camp then the ratio of equities to commodities will continue to decline for years to come and, if so, then the trend for pharma, telecom, autos, etc. will remain thoroughly negative.
We, on the other hand, take the other side of the trade and argue that the current state of crisis marks the end of the almost decade-long run of relative strength by commodities. In other words we look for the SPX/DJCI ratio to resolve higher leading to better share prices for both SGP and S over time.
Quickly… below we show two chart comparisons of the U.S. 30-year T-Bond futures and the product of crude oil times natural gas futures prices. The argument- and we have done this on many occasions- was that similar to 2000 the peak for energy prices was reached a full year AFTER the bond market began to rise in price. The first bond market top of significance was reached in late 2001 when energy prices finally moved to a bottom. The question today is… have energy prices hit bottom? If not then bond prices could very easily push on to new highs well into 2009 in a manner somewhat similar to the second half of 2001.
