by Kevin Klombies, Senior Analyst

Thursday, October 18, 2007

Chart Presentation: Cycle Tops

We almost always get into trouble when we start counting tradingdays in an attempt to pick a top or a bottom. We keep trying, however, because we enjoy the challenge and remain ever hopeful.

The quick break in the Indiastock marketon Wednesday was certainly encouraging although we noted yesterday that the China-relatedshares on New York were extremely strong. On the other hand the argument was that a top would be reached around the end of this week so the faster the ascent today and tomorrow the better.

The question is, however, whether a top in the price of Chinese shares would be a positive or negative for the U.S. equity markets. Our thought is that will be positive for the very simple reason that concurrent with the last upside blast by the Shanghai SE Composite Index towards the end of July the SPX broke to the down side.

The chart below shows that the down side break in the SPX in July could be due in part to the shift in capital towards China. If there is not enoughmoney out there to float all the boats then weakness will develop in the equity markets of those countries serving as the source of that capital. In other words Japan and the U.S.



Equity/Bond Markets

The chart below compares Wal Mart (WMT) to the Shanghai Comp.

We have shown on many occasions in the past that the quick rally in theshare pricesof WMT last May went directly with a rather large decline in the Chinese stock market. Capital is flowing away from the U.S. and Japan towards all of the smaller markets but we notice that when the Chinese equity market starts to tire- as it did last May- the net result can be positive for the SPX.

The basic relationship is much larger and more complex than merely Wal Mart versus China. To explain we have included two comparative charts below of WMT and the product ofcrude oilpricestimes the Australian dollar futures.

We have combined oil prices and theAUD together in an attempt to show the broad cyclical trend. The highs for this combination were reached at the end of 1996 and as thecommodity cyclical sectors turned lower the offset was a concurrent rising trend for WMT. Once begun this trend lasted for close to two years culminating with a crisis in Asia created by the relentless exodus of capital and sub-10 oil prices.

From early 1999 to the present day the trend has been dominated by oil prices rising relative to the broad commodity indices along with negative trends for the U.S. autos as well as the airlines. WMT’sstock pricehas declined from a peak of around 70 at the end of 1999 down to what we hope turns out to be a triple-bottom in the 42- 43 range. To turn the trend positive we have to get to the end of the commodity cycle with a down turn in the Aussie dollar and lower crude oil prices.