If the trend that has dominated the markets for close to 30 years has not changed then is it such a stretch to assume that the trends that went with it have also not changed?
Our point today has to do with the chartbelow which compares the U.S. 30-year T-Bond futures and the ratio between equities (S&P 500 Index- SPX) and commodities (CRB Index- CRB).
The TBonds bottomed in price in late 1981 and have been trending higher ever since. In the interim the markets have changed themes on many occasions including a number of ‘hot’ commodity trends, a few ‘Asian miracle’ trends, some tech and telecom, and long periods of strength for the financials, consumers, and pharmas.
We argued (and argued) through 2002 and 2003 that the commodity sector had been left behind during the Nasdaq’s 15 months of fame and that this was the one sector that was due for a catch up rally. In other words relative prices had become overly skewed in one direction which would lead to a period of dollar weakness and commodity price strength.
We go that part of it right- which was nice- but missed a rather important detail. We expected that the dollar would weaken while the commodity cyclicals strengthened so that the markets would return to balance but didn’t foresee that the commodity trend would pass neutral and drive to levels as excessive on the upside as they were to the down side.
In any event the TBonds continue to trend higher and when the TBonds are trending higher the ratio of equities to commodities should also be trending higher. The twist, obviously enough, is that the SPX/CRB ratio has been declining since the Nasdaq peaked in 2000.
One of our more extreme and seldom mentioned views is that the S&P 500 Index ‘should’ be trading between 2000 and 2500. One might counter that this is unlikely given current corporate profit levels but the point is that markets tend to shift between consumer-driven and capital spending-driven themes. When Asian growth is driven by capital spending the U.S. is dominated by consumer spending and vice versa. Corporate profits ‘limp’ higher through consumer spending themes and drive higher during capital spending themes. The U.S. has just concluded a consumer spending theme so, in our view, much better days lie ahead. To get the SPX/CRB ratio back ‘on trend’ will require not only a significantly stronger stock market but also a sustained period of dollar strength.
Equity/Bond Markets
This following is more of a thought than a view. The markets tend to flock towards momentum and in the process push prices too far for too long. The Nasdaq rose from 1500 in September of 1998 to 5000 in March of 2000 and then fell to 1500 once again by September of 2001. Some portion of the ascent was justified- the news, after all, was very supportive- but much of it was momentum-driven speculative trading. Our point? We suspect that the weakness in the financials has less to do with long-term shareholders getting out and more to do with momentum-driven speculators shorting the heck out of the stocks in the hope that they can create their own reality. It is as difficult to buy a bank today as it was to short something like Qualcomm or Yahoo back in late 1999 or early 2000 but we suspect that over time it is the right thing to do. A very quick rule of thumb might be to look at something like Citigroup if, as, or when it punches up through its 50-day e.m.a. line (currently way up around 7.50 but falling at a rapid pace).
Anyway…below we show the ratio between Japanese bank Mitsubishi UFJ (MTU) and the gold etf (GLD) along with the sum of 3-month euribor (Euro-denominated debt futures) and euroyen (Japanese yen-denominated debt futures).
The quick point is that the downside pressure began back in late 2005 when European and Japanese interest rates began to rise and this pressure showed up in the falling trend for the MTU/GLD ratio. Since European and Japanese yields have dropped sharply over the past few months (as euribor and euroyen prices have risen) it is only a matter of time until the MTU/GLD ratio snaps upwards.
Quickly… the MTU/GLD ratio is testing support along with the SPX/TBonds ratio. Chart below.
Quickly as well… another odd day yesterday with the TBonds falling while gold prices rise relative to copper prices. The chart atbelow shows that the TBonds trend quite closely with the gold/copper ratio and both are at levels that we might term ‘through the roof’. In a normal market the peak for the gold/copper ratio will be 5:1 so the closer copper gets to moving below 1.00 the greater the chances of an eventual decline back below 500 for gold futures prices.
