There are- quite obviously- any number of reasons to be bearish with regard to the equity markets these days. In fact when we did a quick poll of a few retail brokers last week asking them what was the one thing that they simply could not get their clients to do the overwhelming response was ‘buy equities’. So… given our tendency towards contrariness we will take the other side of the trade today by showing a number of pro-equity arguments.

At top right we show the U.S. Dollar Index (DXY). The argument that we made several months ago was that the dollar has a trading range between roughly 81 and 105 so when it moves below or above that range… bad things happen. The chart below right shows that when the dollar moved above the channel top in 2000 the S&P 500 Index flipped into a bear market. Something similar happened (chart below) in 2007 when the dollar fell below the 81- 82 level.

The idea here is that similar to late 2002 the dollar moving back into the 81- 105 trading range would serve to swing the trend for the S&P 500 Index back to positive.



Equity/Commodity Markets

At right we have included two comparative views of the share price of Citigroup (C) and the spread or difference between the yield on 10-year U.S. Treasuries and that of 3-month TBills.

The 10-year minus 13-week yield spread reflects the shape or slope of the yield curve. When the spread is below the ‘0’ line it means that long-term yields are lower than short-term yields and this tends to act as a rather significant brake on the U.S. economy. Conversely when the spread is high and rising it means that the monetary ‘accelerator’ is wide open which means that in due course economic activity will expand.

The second chart below makes an interesting point. The lows for Citigroup were reached at two junctures in 2002. The first low was made AFTER the yield spread had peaked and around the time that it declined back through the 200-day e.m.a. line. The second low was reached when the yield spread line stopped declining and started to rise once again. In other words… after the yield spread turned negative in 2000 it pushed higher through 2001 and then began to decline in 2002 as long-term yields moved lower relative to short-term yields. The stock market found support as the yield spread moved through the moving average line and then found even better support once the bond market had peaked in price so that the yield spread began to rise. The current situation is shown below right and we will argue that it gives us reason for hope. The spread peaked at 3.5% earlier this year, fell below the 200-day e.m.a. line and even made a small attempt to turn higher.The chart below compares the S&P 500 Index with the ratio between the Morgan Stanley Consumer Index and Cyclical Index. The ratio of ‘consumer’ to ‘cyclical’ peaked at the stock market’s bottom in 2002 somewhat north of 1.2:1 and recently moved back above 1.2:1 as the equity markets reached bottom in November. The argument has been that the trend for the broad U.S. stock market will turn upwards once cyclical stocks- commodity-related or otherwise- start to outperform the consumer defensives.