Chart Presentation: Clearing

At right we have included a comparison between Intel (INTC), the Japanese yen (JPY) futures, the sum of the share prices of DR Horton (DHI) and Hovnanian (HOV), and Canadian natural gas producer Duvernay (DDV).

The NASDAQ peaked in the spring of 2000 before ultimately bottoming out in the autumn of 2002. In terms of ‘time’ it took the tech and telecom sectors a good 2 1/2 years to wash out or ‘clear’. The topic today is how long it takes a market to ‘clear’ once it turns negative.

A number of non-commodity sectors turned negative in early 2004 when strength in the commodity markets began to accelerate along with short-term interest rates. Intel was one of the stocks that peaked around that time only to bottom in mid-2006 once interest rates had stopped rising.

The Japanese yen pushed on for another year before reaching a peak in early 2005. Two and a half years later- in mid-2007- it bottomed and turned higher. It is now trading above the moving average lines with the 50-day e.m.a. line above the 200-day e.m.a. This ‘crossing’ of the moving average lines of often referred to as the Golden Cross because it signifies a major change in trend.

The U.S. home builders (DHI plus HOV) peaked roughly eighteen months after Intel and six months after the yen. The intensity of the problems facing the major banks this quarter is helping to push interest rates lower which, at least in the long run, will help the real estate market.

Natural gas prices along with the stocks in this sector peaked around the start of 2006. In terms of ‘time’ it still appears that the natural gas sector could remain negative through the first half of 2008.

The basic point is that it seems to be taking about two and a half years for many sectors to ‘clear’ once the trend turns negative. From this perspective we still believe that it makes sense to be focusing primarily on those stocks and groups that clearly turned positive in mid-2006 and are holding reasonably well through the current turbulence.

We admit to being somewhat intrigued by the home builders but the argument is that they could be next year’s stocks. We expect to be ramping up our focus on this group closer to the end of the year, however.

Equity/Bond Markets

One of our favorite topics years ago was the ‘decade-long trend’. We argued that the commodity markets peaked around 1980, the Nikkei in 1990, followed by the NASDAQ in 2000. The idea at the time was that equity markets should bottom out around the end of the third quarter in 2002 with the commodity cyclicals being the most likely candidate to return to strength this decade.

The point that we wish to make today is that even if the commodity markets are set to steam on to new highs into 2010 there is still a reasonable chance that the trend will first have to weather a fairly serious test.

At right we show cocoa futures and platinum futures from 1977- 1980. The charts show that through the end of 1977 the price of cocoa (along with a number of commodity futures) fell quite sharply but eventually the wash out rolled into an accelerating trend for metals prices that stretched into 1980.

The chart below right compares the S&P 500 Index with the Nikkei 225 Index between 1987 and 1990. In this instance the Nikkei’s rising trend was tested by the 1987 stock market collapse. Once the dust had settled the trend returned to positive with the Japanese stock market almost doubling in price into 1990.

The chart below compares the NASDAQ with Hong Kong’s Hang Seng Index between 1997 and 2000. Weakness in Asian shares through the end of 1997 and into the autumn of 1998 helped to slow the rise of the tech and telecom sectors.

The point is that in each of the last three decades there was a period of rather intense cyclical weakness around the end of the ‘7’ year and into the ‘8’ year. If history were to repeat the dominant theme- China, perhaps, or commodity prices- will have to weather a similar test over the next few quarters.