Chart Presentation: Cyclical Pressures

In a perfect world one would always be long those sectors that are pushing interest rates higher and always be short- or at least not long- those sectors that are pulling interest rates lower. We would do much better with our analysis if we worked harder to remember our own advice here.

The markets remain in a sort of balance with the December Fed funds futures trading at 94.81 suggesting that if the markets have a ‘lean’ it is towards flat to lower interest rates by the end of the year. The upward pressures from rising commodity prices have been offset by the downward pressures from a softer U.S. housing market along with the attendant risks associated with subprime mortgages.

Into 2000 interest rates were being driven higher by the tech and telecom sectors so at top right we show the stock price of Nortel along with the Fed funds target rate (in black) and 3-month TBill yields (in red).

Nortel (NT) corrected back to its 200-day e.m.a. line in the spring of 2000 and then rallied to new highs through the summer before breaking back to and then through the moving average line. This marked the end of the positive trend and ultimately the peak for short-term interest rates.

It often feels as if the markets are ‘fast’ but with the benefit of hind sight we can show that NT broke the moving average line in late September, TBill yields began to decline towards the end of November, and the Fed finally cut the funds rate to offset the impending capital spending implosion at the start of January in 2001.

In the current cycle the commodity sector has driven interest rates higher with much of the pressure coming from metals and energy prices. At bottom right we show copper futures times nickel futures along with the Fed funds rate and 3-month TBill yields.

Our point is that the product of copper and nickel corrected back to the 200-day e.m.a. line in January and after rising to new highs in a most Nasdaq-like fashion into May corrected back to the moving average line in July. If this support line is broken in a manner similar to NT in the autumn of 2000 then in due course the markets should begin to pull interest rates lower followed a few months later by the Fed.

The chart shows 3-month eurodollar futures, the U.S. Dollar Index (DXY) futures, and the ratio of the stock price of Coca Cola (KO) to copper futures.

The ratio of Coke to copper has been declining since 1998. If one believes that the rise in commodity prices is part of a long-term trend then one should be long the metals. On the other hand if one believes that cyclical markets tend to ‘boom and bust’ then perhaps there is some merit in liking consumer names like KO.

The last time the KO/copper ratio bottomed was in 1994- 1995. This also marked a bottom for the dollar and a bottom for short-term debt prices (top for short-term interest rates). Our view is that the dollar is at a bottom (more or less) and short-term debt prices are going to resolve higher so we are biased towards KO.

If a weaker dollar and rising short-term yields goes with better copper compared to the large-cap consumer names then a stronger dollar and lower yields should go with strength in the non-commodity stocks. Below we show Anheuser Busch (BUD) along with the spread between the DXY and TBill yields.

In early 1995 the DXY minus TBill yields pivoted upwards and in due course BUD resolved to new highs. The current situation is similar with BUD consolidating below 55 as the dollar trends lower and yields rise.

In general the cyclical markets do tend to trend higher and lower together but there is just enough of a disconnect between tech and telecom compared to copper and gold prices to keep us positive on names like Cisco and Intel. Below we show the sum of Cisco and Nortel compared to the sum of copper and gold to make the point that even with metals prices running towards the 2006 highs the tech and telecom names are still doing well enough to make us believe that the markets do not anticipate new imminent highs for metals prices.