For the past year or three we have been arguing in favor of the U.S. dollar, Japanese yen, and large cap consumer and pharma stocks. We have been negative on commodity prices, commodity cyclicals, and commodity currencies. Our ongoing argument has been that asset prices will begin to rise around the middle of 2009 after the U.S. dollar has reached some sort of top and that the trend will be driven by relative strength in non-energy prices.

The problem that we have at present is that the weaker the equity markets get the more inclined we are to be positive simply because, over the long run, that seems to make sense to us. It may not make sense to the momentum-driven computer trading programs that hammer the equity index futures lower on a daily basis but, we suppose, that is what makes life so interesting.

Our point- believe it or not- is that we were not looking to turn equity markets positive for at least another month or two but the harder prices decline the greater our interest in trying to construct an argument that will support rising equity prices from current levels.

Belowwe compare 10-year U.S. Treasury yields (TNX) and the sum of copper and crude oil futures (copper in cents added to three times crude oil in dollars) from 1998- 99.

The argument is that yields turned higher in 1998 while energy and metals prices did not swing upwards until February of 1999. Specifically… the start of a rising trend for crude oil and copper began when 10-year yields broke up through the 200-day e.m.a. line.

Below is a comparison between the Philadelphia Semiconductor Index (SOX) and China’s Shanghai Composite Index from the current time frame. We are ‘mixing and matching’ here as we replace 10-year yields with Chinese equities and substitute energy and metals prices for the Semiconductor Index.

Regardless of what happens today, next week, or even next month if 10-year U.S. Treasury yields climb above 3.25% and the Shanghai Comp. pushes above 2500 we would expect to see strength in cyclical asset prices in a manner similar to energy and metals prices back in 1999. From our point of view the details are quite bullish even if the timing of the turn remains something of a mystery.



Equity/Bond Markets

Here is what bothers us: while we are sure that it gets mentioned here and there we honestly can’t recall reading or hearing about a major company reporting stronger than expected earnings based on lower input costs. Note that we used the term ‘expected earnings’ because we are not referring to actual earnings.

The point is that rising raw materials prices benefit the producers of raw materials. Fair enough. Falling raw materials prices would then be a positive for the users and a negative for the producers. Once again… fair enough. Our problem is that the markets seem to feel that falling input costs (commodity, labor, transportation, etc.) are a negative for every company in every business.

In any eventbelow we compare the Canadian dollar futures with the ratio between the pharma etf (PPH) and the Amex Oil Index (XOI).

The Cdn dollar has been trending with the S&P 500 Index. Why? Because the stock market only rises- apparently- when commodity prices are stronger. On the other hand the pharma sector tends to do better than the oil sector when the Cdn dollar is weaker so, we suppose, the argument would be that money is prepared to move back towards the commodity producing sectors if the Cdn dollar is stronger and over to the defensive sectors if the Cdn dollar is weaker. Given that the Cdn dollar is still holding above the lows of last autumn (.7700) the markets are simply selling everything ‘just in case’.

Quickly… we have been arguing in favor of Wal Mart for quite some time. The absolute performance has been somewhat dismal but it is a rocket on a relative basis. The ratio between WMT and the SPX is now clearly ‘through the roof’.

The ratio between Japan’s Nikkei 225 Index and the S&P 500 Index rose rather sharply yesterday after the Nikkei rose slightly over night while the SPX tanked to new lows. Obviously the Nikkei might well play ‘catch up’ today but for the moment the Nikkei/SPX ratio has pushed back to the highs set during the summer of 2008. The ratio rises when there is downward pressure on Japanese bond prices.

The point? The JGBs down below 138 and the Nikkei/SPX ratio above 11:1 would do wonders for our Asian growth or ‘Japan’ theme argument.