by Kevin Klombies, Senior Analyst

Tuesday, August 21, 2007

Chart Presentation: Bonds

The chart at right compares the CRB Index, U.S. 30-year T-Bond futures, and S&P 500 Index from 1980 into 1983.

The last major peak for the commodity markets occurred in late 1980 and was followed by a punishing equity bear market. Given our negative view on the commodity markets we wanted to quickly show why we do not believe that a bear market similar to 1981-82 is likely.

The argument is that the bond market represents the leading edge of an equity bull market while the commodity market represents the trailing edge. A bull market typically starts with rising bond prices and ends with the top in commodity prices. When bond prices and commodity prices are rising in tandem the equity markets tend to be very strong while when bond and commodity prices are falling at the same time the opposite is true.

The problem through late 1980 and into 1981 was that bonds and commodities were falling concurrently as the Fed attempted to break the inflationary trend. The major difference between today and 1981 is the trend for the bond market which turns upwards each time cyclical growth appears set to stall.

The last week or so may have felt a bit like 1987 as the equity markets appeared set to ‘crash’ but, in a sense, today is almost exactly the opposite of 1987.

In mid-1986 commodity prices turned higher and this positive trend continued right through the stock market’s collapse in the autumn of 1987. In mid-2006 commodity prices actually turned lower and it is our argument that this trend will continue right through the autumn of 2007.

At right we show the TBond futures into 2007 and the TBond futures into 1987.

The charts are virtual mirror images which helps to confirm that our view about commodity prices. Bonds peaked in 1986 at the bottom for commodity prices and bottomed last year at the commodity price top. The stock market’s crash in 1987 was a function of the rapid decline in bond prices that went to higher commodity prices while the current example suggests that bond prices should still be heading higher into the fourth quarter of the year. Who knows… perhaps the equity markets will surprise everyone and do a ‘reverse crash’ to the upside this autumn.




Equity/Bond Markets

The charts below compare the SPX today with the SPX from 1987 scaled upside down.

On the first page we noted that since the trend for commodity prices was the opposite of 1987 and the trend for bond prices was also the inverse then perhaps stocks might do a ‘reverse crash’ and soar upwards this autumn.

The idea is intriguing even if it is far fetched. We wanted to show that the sell off during August is creating a bottom for the equity markets that goes with the absolute top for the SPX in August of 1987. Imagine how surprising it would be if the SPX managed to gain a few hundred points between late August and October…

The chart compares the stock price of Ford (F) with the ratio of the Airline Index (XAL) to the SPX.

Quickly… the negative trend began back in 1998 at the bottom for commodity prices and the commodity currencies. The trend should turn positive once energy prices turn lower along with the commodity currencies.

The chart compares the TBond futures with the sum of the Fed funds rate plus 3-month eurodollar futures with the sum shown through two moving average lines.

The argument is that the peak for the TBonds is made once the moving average lines for the sum cross up through ‘100’. For that to happen the yield on eurodollars has to decline below the funds rate and we have shown that this happened last week. Since we are using moving average lines it should take some time before the sum can move above 100 but it still opens up the potential for the TBonds to rise to or through 120 before the next peak is finally reached.