by Kevin Klombies, Senior Analyst

Monday, November 5, 2007

Chart Presentation: Comparisons

In mid-1994 the large cap consumer and pharma stocksbegan to strengthen and roughly six months later U.S. interest rates reached a peak concurrent with commodity prices. The commodity sector regained positive momentum before making a second top during the spring of 1996- some 16 months later. This sequence- large cap consumers building relative strength while interest rates rise, a peak in yields and commodity prices, followed by a return to commodity price strength- has been focus of our attention over the past few weeks. Why? Because in many ways the markets are repeating this trend. We show the comparative charts today on page 6.

The large cap consumer stocks began to strengthen at the start of 2006 and six months later interest rates and commodity prices peaked. After a correction the commodity markets have pushed higher and, for all intents and purposes, appear to be set to explode to new highs at any moment. Yet… the large cap consumer and pharma names continue to strengthen and if the sequence covers the same amount of ‘time’ as 1994- 96 the second and final top for commodity prices should occur around 16 months after the end of last year’s second quarter (i.e. about now).

The chart at top right shows copper futures and an overlaid view of the ratio between Morgan Stanley’s Consumer and Cyclical indices (in black) and the U.S.Dollar Indexfutures (in green).

Last July the consumer/cyclical ratio turned higher as copper prices peaked and stocks like Caterpillar (page 7) and First Quantum (page 4) turned lower. The change in trend has been masked by the relentless decline in the U.S. dollar. Notice the divergence between the DXY and the consumer/cyclical ratio since mid-August.

This divergence muddies the waters. It creates the impression of rampant commodity price strength and is sending commodity currencieslike the Canadian dollar on a wild ride (page 5).

The chart at bottom right compares the CRB Index to the ratio between Caterpillar (CAT) and Coca Cola (KO). On the one hand the equity markets began to shift strength back to the consumer stocks months ago but on the other hand the CRB Index is mirroring the trend for the dollar as it pushes higher. Our point is that one of the two sides is ‘wrong’- if commodity prices are as strong and as ‘real’ as they appear then the consumer/cyclical ratio should break lower as the CAT/KO ratio moves higher. Otherwise it still looks as if the commodity markets and U.S. dollar are set to reverse direction this month.



Equity/Bond Markets

The markets are ‘muddy’ in quite a number of ways at present. To show what we mean we have included a comparison between crude oil, the U.S. 30-year T-Bond futures, and the S&P 500 Index from 1990 at right while showing the same comparison for the present time period below right.

One of the key features of the 1990 equity bear market was the inverse relationship between crude oil and bond prices. As oil prices strengthened the bond market pushed long-term interest rates upwards and the equity markets responded by declining.

We have followed this relationship over the past year and a half by using the ratio of crude oil to bond prices (crude oil/TBond futures). The argument was that the ratio should peak at the bottom for the equity market and this worked very well in 2006.

The problem this year is that thebond marketis not trading lower as oil prices rise. In past cycles the bond market ‘vigilantes’ would be selling bonds for fear of futureinflation due to strong energy prices and, while this makes intuitive sense, it just hasn’t been the case in 2007. Instead the bond market has been working to offset the negative economic impact of rising energy prices. The point is that rising energy prices are generally a negative but rising bond prices are a positive. Instead of a clearequity ‘bear market’ we end up with a choppy and overall flat trend for the SPX which, as we mentioned above, has a certain ‘muddy’ feel to it.

We have been focusing on Matsushita (MC) recently. The page 7 chart comparison suggests that it finally broke out of the down trend that began in early 2006 last week (which is ultimately a positive for Mitsubishi UFJ- MTU).

The rally for MC’sstock priceappears to be something of a ‘coming back on trend’ recovery. We show this below to make the tentative case that the 3-month negative trend from June into August has turned into a positive trend that should carry through the month of November.