We went to some lengths yesterday to write that we really weren’t that bearish with regard to the equity markets. Our view is that the S&P 500 Index will remain essentially flat into mid-year before rallying strongly during the second half of 2009. We wondered during early trading yesterday as we watched the major U.S. financials head towards oblivion whether it might have made sense to wait a few more days before making these observations but.. then again… it isn’t much of a conviction if one day’s worth of trading can alter it.
From time to time the equity markets really seem to key off of the commodity markets and we will argue that this is one of those times. We start off today with a comparison between the U.S. Dollar Index (DXY) futures and the CRB Index. Below right we show a shorter-term perspective of this chart comparison.
We would very much like to make three points here today. Chances are we won’t but that is our intention. The first point is that the trend for the equity markets turned lower in early 2006. The second point is that the dollar’s free fall below roughly 82 helped pump the CRB Index far ‘above trend’ through late 2007 and well into 2008. The third point is that the CRB Index is either at or is very close to the downtrending channel bottom.
Our sense is that the equity markets will remain reasonably flat through the first half of this year because it is our conviction that the U.S. dollar is going to resolve higher. Since a rising dollar puts downward pressure on the commodity markets this will be something of a negative for equities but… and this is the important part of the argument… there is a difference between downward pressure and lower prices. If the CRB Index is essentially at or near the channel bottom then the markets have absorbed the lions’ share of the damage that will be attributed to falling commodity prices. On the other hand if our currency view is correct it will be another quarter or two before the U.S. dollar makes its next peak and starts to turn lower. When that happens we should expect to see strength in the commodity currencies (i.e. the Cdn and Aussie dollars) followed by the start of a broad recovery in cyclical growth. All in all, we suppose that puts us into the equity markets bullish camp.
Here is the problem. We are arguing that the equity markets should be stronger through the second half of the year but we do the IMRA on a daily basis. We spent much of 2002 arguing that the equity markets were going to pivot higher around the end of the third quarter so it has been our experience that if we get too far ahead of the markets we tend to either run out of things to show or write or we get bored.
However… we still feel as if we have some work left to do as we sketch out our expectations for the next number of months. At right we show the S&P 500 Index (SPX) and the product of the CRB Index (commodity prices) times the U.S. 30-year T-Bond futures from 1981 into 1983 while below right we feature the same comparison for the current time frame.
At times- and, once again, we will argue that this is one of those times- the equity markets lock into the combination of commodity prices and bond prices. Typically commodities and bonds trend inversely so the weaker commodity prices get the higher bond prices will move. We have argued that equities are part financial- similar to bonds- and part cyclical- similar to commodities.
The idea here is that the next equity bull market will begin in earnest once the CRB Index times TBond futures is ready to not only rally but move back above its 200-day e.m.a. line. This is exactly what happened in August of 1982. In the current situation (chart below right) the CRB times TBonds is just beginning to flatten out (hence our page 1 topic today) so our sense is that it will hold below the moving average line for a number of months which will serve to limit the extent and duration of the rallies for the SPX. Once we get into the second half of the year, however, we expect to see the trend for the equity markets improve considerably.
Below we show a chart comparison between Johnson and Johnson (JNJ) and the ratio between the share price of JNJ and the U.S. 30-year T-Bond futures. The very quick point is that JNJ is now very close to the bottom end of its trading range with respect to TBond futures prices. If the relationship holds and history repeats the share price of JNJ should slowly resolve up to and then onto new highs.