by Kevin Klombies, Senior Analyst

Friday, August 24, 2007

Chart Presentation: Crash Thoughts

The charts show the S&P 500 Index from 1993- 94, the S&P 500 Index from 1986- 87, and the New Zealand dollar futures from 2006 into 2007.

We are particularly fond of ‘crash tops’ for a number of reasons. Perhaps the most important would be the opportunity for financial gain or, perhaps, the ability to reduce potential losses if such a top can be identified before hand.

Most traders and investors recall the 1987 stock market crash quite clearly. What many might not realize is that the 1994 correction was virtually identical in structure. It has long been forgotten simply because on a percentage basis the correction was quite small.

What 1987 and 1994 had in common was the removal of a whole year of stock market gains. The correction in 1994 wiped out all of the gains in the SPX that had accumulated since the spring of 1993 while the more damaging 1987 ‘crash’ eliminated the entire bull market that had built after the autumn of 1986.

In both instances the ‘time’ to return to the long side came once the 50-day exponential moving average (e.m.a.) line crossed down through the 200-day e.m.a. We have recently shown that this also marked the bottom after the 1998 equity markets correction associated with the Asian crisis and collapse of LTCM.

The key to going long on the moving average line ‘cross’ is that once the lines have crossed the equity markets have to hold the lows.

We mention all of this because even though the correction in the forex markets for the Australian dollar, New Zealand dollar, and even the euro/yen cross may have felt like a ‘crash’ it really wasn’t. The New Zealand dollar remains far above its late-summer 1986 trading levels and the moving average lines are not even close to crossing. This doesn’t mean that the commodity currencies can’t rally or even swing up to resume the rising trend but it does mean that the correction was not deep enough or long enough to make the kind of post-crash bottom that often serves as a reasonable entry point.




Equity/Bond Markets

We take issue with two words in the statement above- may and could. Fukui states that Japan’s low interest rates policy ‘may’ spur risky investment and that distortions and misallocations ‘could’ occur. Perhaps he was on holidays earlier this month…

To get a true sense of just how manic the markets are one only has to look at the Chinese equity indices. We show Hong Kong’s Hang Seng Index, the SPX, and the Nikkei 225 Index. The Shanghai SE Comp. barely budged during the recent rout and the Hang Seng is already close to the July highs. The SPX is above the 200-day e.m.a. line while the Nikkei is, as usual, bringing up the rear.

The chart shows Japanese bank Mitsubishi UFJ (MTU) and the ratio between the Nikkei 225 Index and the Japanese 10-year (JGB) bond futures.

In general MTU is supposed to do better when the Nikkei/JGB ratio is rising although for the past year it has been trending lower as the spread between long and short-term Japanese yields has tightened.

Quickly… below is a chart of Johnson and Johnson (JNJ) and the ratio between crude oil and the TBonds futures.

We have used the crude oil/TBonds ratio on many occasions since the spring of 2006. The idea is that when it peaks the equity markets tend to bottom. The modest rise in oil prices yesterday was just enough to hold the ratio at the rising support line. We have yet to see the kind of strength in JNJ that would indicate that similar to last summer the worst of the pressure has now passed.