by Kevin Klombies, Senior Analyst

Thursday, October 4, 2007

Chart Presentation: Cat Scan

The theme that we will be working with on today’s first two pages is essentially that the S&P 500 Index goes down with the commodity cyclicals and up with the consumers. To start with, however, we would like to re-visit the argument that the trend for stocks like Caterpillar is similar to that of crude oil.

Below we have included comparative charts of crude oil futures, the ratio between the stock price of Caterpillar (CAT) to Pepsi (PEP), and the stock price of CAT. The chart below starts in March of 2006 and runs into January of 2007 while the chart below right begins in May of this year and runs to the end of trading yesterday.

The premise is that once the stock price of CAT reaches a top along with the CAT/PEP ratio the trend for ‘commodity cyclical’ turns negative and continues negative until CAT and the ratio finally reach bottom.

We note that for several months last year, however, crude oil prices continued to rise even as CAT declined. Any time a security or market moves higher within a negative trend its creates a more dramatic decline as prices swing back to the trend line.

Our sense is that similar to last year the trend underneath crude oil turned negative as prices pushed up above 70 and now we are wallowing through the phase when oil prices push well above the falling trend line. Many of the non-commodity cyclicals- including the major U.S. airlines- didn’t kick into gear last year until early September once crude oil prices had fallen below the 200-day exponential moving average line (red line on chart).



Equity/Bond Markets

Below are two comparative charts that feature the S&P 500 Index (SPX), Caterpillar (CAT), and the pharma etf (PPH). We could use any number of consumer-oriented issues but the PPH will serve our purpose for now.

The idea is that the SPX goes down with CAT and up with the PPH. It breaks lower from the highs when the commodity cyclical stocks start to weaken and then after making a bottom it starts the recovery with the consumer/pharma issues.

In May of 2006 the stock price of CAT peaked along with the SPX and then after bottoming into June and July the PPH turned higher even as CAT continued to decline. The SPX corrected with CAT and then recovered with the PPH.

The trend this year has been almost identical. The SPX topped out in July when CAT reached a peak and then declined into August. Now the PPH is on the rise as CAT chops sideways above its 200-day e.m.a. line.

If the trend continues in the same manner as last year CAT will resolve lower while the consumer and pharma sectors continue to rise. In trading yesterday, for example, CAT was lower by 1.08 while the PPH was higher by .72. This sort of action keeps the CAT/PEP ratio shown on page 1 in a nice downward trend.

One feature that we noticed last year was the delay or lag between the start of weakness in crude oil prices and the beginning of sustained strength in the airlines. Continental (CAL) was an early winner followed by AMR as prices rose sharply in early September.

JetBlue trailed the group as its stock price remained negative until the end of the third quarter. Once October began, however, it pivoted nicely higher from the low 9’s to close to 17. The peak for the airlines was made at the bottom for crude oil prices in January which turned the market back towards stocks like CAT. An interesting trend and one that reminds us of the directions on a shampoo bottle- rinse and repeat.