by Kevin Klombies, Senior Analyst

Tuesday, August 14, 2007

Chart Presentation: Copper and JNJ

The chart shows the spread or difference between 10-year U.S. Treasury yields and 3-month U.S. TBill yields. When the spread is at, say, 35 it means that 10-year yields are 3.5% higher than TBill yields and when the spread is below the 0 line it indicates that 10-year yields are lower than TBill yields.

When the yield spread is below the ‘0’ line the yield curve is inverted. Recessions tend to follow yield curve inversions although yield curve inversions do not always forecast recessions. The point is that the yield curve has been close to inversion since the middle of 2006 so it should come as little surprise that the U.S. economy is starting to show signs of slowing.

The problem is that the economy is not weak enough to justify a sharp reduction in short-term interest rates and not strong enough to push long-term interest rates higher. Central bankers continue to argue that the subprime crisis is largely contained and can be papered over by adding liquidity into the banking system instead of slashing interest rates and at the same time crude oil prices remain much too close to record highs to truly argue that it is long past time to be worrying about inflation. When all is said and done… the yield spread remains flat.

The chart at bottom compares the stock price of Johnson and Johnson (JNJ) with copper futures.

JNJ tends to do well when interest rates are declining and when copper is strong and pushing it typically means that interest rates are rising.

In the summer of 2006 the stock price of JNJ was around 61 as copper prices pushed up through 3.70. One year later the stock price of JNJ was 61 as copper prices pushed up through 3.70. In a sense almost nothing has happened over the past twelve months even though so much has happened in the interim.

JNJ rose from 61 to 69 and then fell all the way back to 61 while copper prices declined from 3.70 down to 2.40 before moving higher once again. Our view is that if, as, or when copper prices turn lower we should see the equity markets rotate back into stocks like JNJ. A nice close above 63 would do wonders for this particular argument.



Equity/Bond Markets

The chart compares Japan’s Mitsubishi UFJ (MTU), Genentech (DNA), and Alaska Airlines (ALK).

MTU is a Japanese bank, DNA is a biotech, and ALK is quite obviously an airline. The comparison is based on the fact that all three stocks tend to generally trend together and originated with the observation that ALK hasn’t been this ‘beaten up’ since the spring of 2003.

In late April of 2003 the trends for MTU, DNA, and ALK pivoted sharply from negative to positive. From our perspective when three companies in completely different businesses operating in distinctly different geographic regions make concurrent trend changes the reason is typically found ‘else where’. Given that most trends since the end of 1998 have had something to do with the strength or weakness of crude oil prices this is as good a place to start as any.

The chart compares the S&P 500 Index (SPX) to crude oil futures from the autumn of 2002 into the spring of 2004.

Between November of 2002 and March of 2003 crude oil prices pushed sharply higher with the SPX mirroring the trend by moving lower. The strength in oil prices into the spring of 2003 was sufficient to swing the U.S. equity markets lower.

When oil prices broke lower in March of 2003 the SPX began to recover and by late April it was pushing back to the recent highs. One might think that airlines like ALK would rise on the first indication of oil price weakness but the stock held near the lows until oil prices had fallen back close to 25. ALK, MTU, and DNA then pushed higher for close to 12 months with the trends finally turning negative once again when oil prices broke above the 2003 highs at the end of April in 2004.

The point? The recent run from 62 to 78 by crude oil has gone with another period of broad stock markets weakness. It may be that crude oil prices will have to fall back below 65 towards the 62 region before the equity markets start to swing some of the non-energy sectors higher.