by Kevin Klombies, Senior Analyst

Monday, July 28, 2008

Chart Presentation: Backwards

It was our intention at the end of last week to start things off today with a comparative view of the S&P 500 Index and crude oil futures. We were going to hammer on the point that as long as oil prices do not push on to new highs the financialsector should be ready to move past the recent state of crisis. In other words if Bear Stearns was Round 1, the GSE’s (Fannie Mae, Freddie Mac) being Round 2, then the ring card girl announcing Round 3 should be crude oil pricesmoving on to new highs.

To the extent that crude oil futures are NOT in imminent danger of going to new highs we thought that we would do something else instead today and the more we pondered this particular perspective the more intrigued we became by it. Our thought is that this is either a complete waste of time or just possibly an remarkably insightful and somewhat prescient view into the future.

The argument begins with the comparison at right of the S&P 500 Index (SPX) from 1999 into 2005 and the ratio between Japanese bank Mitsubishi UFJ (MTU) and the gold etf (GLD).

We explain where the inspiration for today’s chart-based argument comes from on page 5 with the ‘link’ that gets us from the starting point to this comparison featured on page 2. In a sense we are writing today’s issue backwards.

The argument is that the markets have been working through a correction from late 2005 into mid-2008 that is similar to the bear market for the S&P 500 Index that ran from the peak in 2000 through into the lows set in the spring of 2003. The charts at right have been set up so that the cross over of the 50-day e.m.a. line down through the 200-day e.m.a. line for the SPX in late 2000 is lined up with the similar moving average cross over for the MTU/GLD ratio in the spring of 2006.

The SPX declined steadily from late 2000 into early 2003 as equities declined relative to ‘cash’. The correction from late 2005 into 2008 was somewhat different because equities were not losing ground relative to cash but were instead declining relative to commodity prices. The down trend for Japan’s MTU marked the start of the pressure on the financial sector that eventually led to a delayed collapse during the second half of 2007. However, our point is that in terms of ‘time’ the down trend for the MTU/GLD ratio has run for the same duration as the bear market for the SPX into the spring of 2003.



Equity/Bond Markets

Recently InBev made an offer for Anheuser Busch while Roche made a surprising offer for the remaining shares of Genentech (DNA). In both instances a European company viewed the dollar-based price of a non-commodity company to be attractive.

The chart at bottom right starts with the ratio between Genentech and the euro. The DNA/euro price declined from late 2000 into the spring of 2003 as the SPX trended lower and then declined a second time from late 2005 into mid-2008.

The DNA/euro ratio spiked to the upside recently in a manner similar to 2003. In other words after close to 3 years of trending lower the ratio has broken to the upside and the last time this happened it marked a major change in trend for the S&P 500 Index from ‘down’ to ‘up’. Our thought is that the recent trend shift has less to do with stocksversus cash and more to do with non-commodity sectors relative to commodity sectors.

Below we feature a comparison between the CRB Index and the stock price of DNA. The charts have been shifted or offset so that the late 2001 bottom for the CRB Index is lined up with the mid-2002 lows for DNA.

The CRB Index broke down through the bottom of its rising channel in the second half of 2006 and then snapped rather powerfully back into the channel before pushing on to the channel top at the end of June. Our thought is that DNA may have done much the same thing when it broke below its channel bottom in the spring of 2007. The combination of early weakness in commodity prices, emerging strength in the health care sector, and a surprise bid by Roche has led to a sharp recovery by DNA’s share price back to the bottom of the channel. If DNA were to follow a similar path as the CRB Index into 2009 it would reach somewhere close to 150.