by Kevin Klombies, Senior Analyst

Tuesday, April 1, 2008

Chart Presentation: April Fools

Our sense is that our work today should be especially relevant and timely given that it is April Fools Day. Perhaps we should just change the day to April IMRA Day and be done with it.

Aside from that we start the week feeling somewhat uncharacteristically chipper. We wouldn’t go so far as to write that we feel terrific and most definitely we wouldn’t use the word ‘ebullient’ but ‘chipper’ seems about right.

We start off today with a comparison based on the ratio between heating oil futures and the share price of Ford (F). The chart at top right shows this ratio along with the S&P 500 Index (SPX) from 1980 into early 1984 while the chart below covers the time frame from early 2006 forward.

In yesterday’s issue we mentioned that Ford’s stock price turned higher close to 9 months before the S&P 500 Index reached its lows in the early 1980’s. Even close to three decades ago the most important factor for F was the trend for energy prices so when heating oil futures peaked in late 1981 the share price of Ford began to rise. In fact, by the time the SPX finally snapped upwards in the late summer of 1982 F’s stock price had almost doubled.

The chart at top right shows that the heating oil/F ratio peaked well ahead of the SPX but as the ratio topped and turned lower the SPX was setting a rising trend line that it would rather dramatically snap back up to between the second half of 1982 and mid-1984. In other words when energy prices finally turned lower in 1981 it helped create a rising equity markets trend that was hidden by the effects of the recession for a number of quarters.

The heating oil/F ratio peaked in the summer of 2006 as the SPX pushed down below the 200-day e.m.a. line but as energy prices declined the broad market lifted higher. By mid- 2007 the ratio turned from roughly flat back into a rising trend which was mirrored by the declines in the SPX.

Our point is that the equity markets may respond immediately- as they did in 2006- or lag far behind- similar to 1982- but the key to a better equity market trend still lies with lower energy prices. With that in mind we move to the second page.



Equity/Bond Markets

At right we show crude oil futures and the stock price of Johnson and Johnson (JNJ). We could have easily used something like Wal Mart or Genentech but this will do nicely.

Whether to the minute or even to the day the basic point is that there are stocks capable of showing strength when crude oil prices begin to weaken. JNJ, for example, rose from below 62 to close to 66 as energy prices declined in March and then began to ‘flag’ lower once crude oil futures found support at the 99- 100 level.

The same was basically true for Ford (below right) which we show along with heating oil futures.

Ford rose from 5 to 6 on energy price weakness and then began to tail lower as energy prices rebounded.

The two points that we are trying to make are as follows. First, there is a bullish equity markets outcome but it is based on weaker energy prices. Second, whether oil prices break 100 today or go on to 150 later this quarter the argument will not change. When energy prices weaken certain stocks will do better.

Below we show a comparison between FreePort McMoRan (FCX) and the ratio between the World-ex USA Index and the Dow Jones Industrial Index. The ratio represents ‘everything else’ compared to the 30 U.S. large cap stocks that make up the DJII.

From the peak in relative strength by the U.S. large caps in 2000- 2001 the markets broadened out into the small and mid-caps and then into the foreign markets as the dollar began to decline. This trend gained momentum until by 2006 prices in Asia began to rise almost parabolically leading into the excesses of the Chinese stock market last year. Our view is that when the metals trend represented by the share price of FCX turns lower the U.S. large caps will once again return to a state of relative strength.