by Kevin Klombies, Senior Analyst,

Our lives would most certainly be easier (read: less stressful) if we were only concentrating on one market. If all we had to do is argue whether the S&P 500 Index, for example, should go higher or lower then we could probably write the IMRA once a week or once a month.

The current markets situation is challenging for a number of reasons so we find it passing strange that we manage to feel as if we are getting steam rolled even though the majority of our views have been correct. To explain we have included at right a chart comparison of, from bottom to top, the spread or difference between the biotech etf (BBH) and Potash Corp. (POT), the spread or difference between the Dow Jones Industrial Index (DJII) and Canada’s TSX Comp. (TSX), the spread between the SPX and the Amex Oil Index (XOI), the ratio between the SPX and the CRB Index, the U.S. Dollar Index (DXY) futures, and the share price of Wells Fargo (WFC).

We have argued that the biotechs should outperform the commodity stocks, the DJII should rise relative to the TSX, the SPX should strengthen relative to the oils, equities should be better than commodities, the dollar should be move upwards, and Wells Fargo should help to lead the equity markets into a recovery. In other words… all six of these views are moving in the expected direction.

So why do we feel as if we are wrong? Mostly because the equity markets are weaker than we anticipated. Mostly because the process of getting all the pieces of the puzzle into line is taking as long as it is and has. Mostly because there is little satisfaction in being correct in the view that stocks such as Wal Mart, Johnson and Johnson, Genentech, Coca Cola, etc. will outperform the broad market only to see them decline on an absolute basis even as they rise through the roof on a relative basis.

We commented this week that if history were to repeat the U.S. equity markets would turn higher in a week or two. It usually takes 27- 34 trading days to set a bottom and through yesterday only 23 days had elapsed. Given that the S&P 500 Index closed right on the lows yesterday our sense is that this is looking more and more like 1982. In 1982 the SPX broke all support, declined for 7 trading sessions- flushing out all of those who were hoping and praying for support to hold- and then pivoted upwards into a rampaging bull market.

The point? We are going to hold to the argument that a rally is due later this month even if yesterday’s closing lows are broken in the interim.


Equity/Bond Markets

Very few U.S. stocks were higher yesterday although stranded in a sea of ‘red’ we couldn’t help but notice that, for a change, both General Motors and Ford were ‘green’. So… we will start off with another autos-based argument.

The chart at right compares the S&P 500 Index and the ratio between heating oil futures and the share price of Ford (F) from 1981 into 1984.

The idea is that the trend for the equity markets should turn positive- even if equity prices continue to decline for some time- once the ratio between heating oil and Ford finally turns lower. The ratio peaked in late 1981 (almost 3 full quarters before the SPX finally pivoted upwards) and declined through into late 1983.

The problem with ratios is that there is both a numerator and a denominator. The ratio between heating oil and Ford can only peak and turn lower if Ford stops falling at a faster pace than energy prices. In other words even with crude oil prices declining from 147 to 55 the ratio has pushed higher simply because the autos were even weaker than energy prices.

The point? Even if the SPX continues to decline one of the first signs of an emerging positive trend should be weakness in the heating oil/Ford ratio. For as negative as yesterday’s session might have appeared there were a few minor positives scattered here and there.

One of our recurring arguments is shown below. The chart compares Wells Fargo (WFC), Carnival (C), and the ratio between the Amex Oil Index and S&P 500 Index (XOI/SPX).

The point is that for as weak as oil prices have been the oil stocks have still been far ‘too strong’. The rising trend for the XOI/SPX ratio from October into November even with falling oil prices has added considerable pressure to non-energy cyclicals and helped to delay the recovery. We still want to see the XOI/SPX ratio weaken… appreciably.