Why be wrong about the markets eventually when one can be wrong almost immediately? In other words… we are going to take another run at the consumer versus cyclical argument right in front of the release of Coke’s (today) and Pepsi’s (tomorrow) quarterly earnings.
The chartbelow compares the share price of Abbott Labs (ABT), the ratio between Johnson and Johnson (JNJ) and copper producer FreePort McMoRan (FCX), and the ratio between the Morgan Stanley Consumer and Cyclical indices.
The basic point is that the consumer/cyclical ratio has risen back to the November peak which was also almost exactly the highs for consumer vs. cyclical in 2000 at the stock market top and 2002 at the stock market bottom. Extremes for this ratio, we will argue, go with extremes for the equity market.
From current levels the ratio can either resolve to new highs or it can reverse to the down side. If it resolves higher then the stock market can and will decline IF the consumer stocks remain flat to lower. We trust that this makes sense. The ratio can rise if the numerator (consumer stocks) moves upwards or if the denominator (cyclical stocks) moves lower.
The problem with the markets- as mentioned in yesterday’s issue- is not that the cyclicals have been weak but rather that the large cap consumer stocks have not been strong. A rising consumer/cyclical ratio based solely on relative weakness by the cyclicals will tend to drive the entire stock market into the dirt.
In the absence of a large-scale recovery in cyclical stock prices (something that we are not looking for until the second half of the year) the only major source of support for the S&P 500 Index would be the consumer/health care stocks so the reaction this week to earnings from Coke and Pepsi should prove to be important.
Below we feature the sum of the Canadian and Australian (CAD plus AUD) dollar futures and the ratio between Caterpillar (CAT) and Pepsi (PEP). IF the commodity currencies continue to decline then the CAT/PEP ratio should move lower in tandem. If the ratio declines simply on CAT share price weakness then the SPX has to be lower. If the ratio declines at least in part on PEP share price strength… then the equity markets have a fighting chance of holding last autumn’s lows through the first half of this year.
Belowis an odd chart comparison consisting of the ratio between the Amex Oil Index (XOI) and S&P 500 Index (SPX) and a MACD indicator for the U.S. crude oil etf (USO).
Below we have included a comparison between Exxon Mobil (XOM) and the South African rand (another commodity-based currency).
The trend for gold prices and relatively stronger major oils (a rising XOI/SPX ratio) turned higher last October. One could argue that even as pressures continued to build on front month or spot crude oil prices the technical condition of the oil trend (i.e. the MACD indicator) began to improve. In other words oil prices began to get ‘less oversold’ in October as the trend for Exxon, the South African rand, gold prices, and the XOI/SPX ratio started to lift.
If the recovery has shown any signs of deterioration (something not evident in gold prices through yesterday) it might have started around the beginning of this week as the rand, Exxon, and the XOI/SPX ratio began to decline (ever so marginally). The USO has also broken to new lows which has flattened out the rising trend for the MACD.
The point? We have argued again and again that a true stock market recovery will only begin once the XOI/SPX ratio starts to decline. The problem- similar to the page 1 argument- is that if this occurs simply on share price weakness from Exxon Mobil instead of a better trend from the consumer/health care/financial sectors then it can hardly be viewed as bullish news.
Quickly… the trend for Wal Mart (WMT) tends to be the inverse of the trend for Asian cyclical strength. In other words when Hong Kong’s Hang Seng Index is stronger than the S&P 500 Index the trend for WMT tends to be neutral or negative. On the other hand when the Hang Seng/SPX ratio is declining- as it did from 1997 through 1998 and from the autumn of 2007 to the present time period… the trend for WMT is positive.