by Kevin Klombies, Senior

We still can’t figure out whether being away last week was a serious mistake or absolutely perfect timing. What we have realized, however, is that watching CNBC does absolutely nothing for the quality of one’s life.

There really is only one issue of importance today. Will Friday’s bank bail out plan mark the bottom for the financials? If it does- and we are going to assume that it will prove to be a success- then we truly have some interesting times ahead.

We start off today with a chart of Merrill Lynch (MER) from 1998 into 1999. Today is obviously not exactly like 1999 but the comparison is compelling in a number of ways.

In terms of ‘timing’ we might prefer that the pivot came a few weeks from now but late September is still reasonably close to the October bottoms that the markets are fond of making. In 1998 during the Asian crisis the stock price of MER made a hard turn back to the upside in early October.

Our point has less to do with MER and more to do with what happened afterwards. To explain we have included a comparison at bottom right of the Nasdaq Composite Index and the spread or difference between the U.S. Dollar Index (DXY) and the U.S. 30-year T-Bond futures.

For the next while- weeks or more likely months- we will be focusing on the dollar and the long end of the Treasury market. Both can rise or fall from current levels so, in a sense, there are four potential outcomes. The dollar and bonds can rise, they both can decline, the dollar can rise while bonds decline, and the dollar can decline while bond prices rise. Each outcome favors a different markets sector.

After the financials turned higher in the autumn of 1998 the spread between the dollar and the TBonds rose. In other words the dollar was strong and the bond market was weak. A weak bond market tends to favor the cyclical sectors while a stronger dollar favors the techs. The major trend coming out of 1998 was dollar strength and bond price weakness which translated into a very robust recovery and eventual bubble for the tech and telecom sectors.

We are not suggesting that 2009 will resemble 1999 although that is possible if the DXY minus TBonds spread continues to rise. Instead we are attempting to make the fairly simple point that it is very likely that ‘a’ trend will develop through the final quarter of this year that could easily dominate the markets right through into 2010.


Equity/Bond Markets

If the dollar and the bond market rise then this tends to be a positive for the consumers, health care, and financials. If the dollar rises while bonds decline then cyclical will do better with an emphasis on the non-commodity sectors. If the dollar declines while bond prices rise then gold tends to do very well while if the dollar and the bond market move lower in tandem then the commodities in general and typically the base metals and energy sectors will shine. We will show chart comparisons through the week to help with the explanation.

Turning to a different argument we show China’s Shanghai Comp. from the summer of 2007 along with a chart of Japan’s Nikkei 225 Index from 1989 into 1991.

The point is that the S&P 500 Index bottomed in October of 1990 at the peak for crude oil prices some nine months AFTER the Nikkei had turned lower. If history had repeated exactly the SPX would have bottomed in early July as oil prices turned to the down side some nine months AFTER the start of the negative trend in Chinese shares. The next point is that it was always unlikely that the SPX would turn higher until the Shanghai Comp. made a bottom- which it should now have done- while the final point would be that if history repeats the Shanghai Comp’s rally will most likely die out once it reaches its 200-day e.m.a. line.

Quickly… we spent quite a bit of time on the bond market prior to last week. The idea was that a break to new highs for the TBonds could be equity markets’ positive while weakness from current levels for the TBonds could also swing the stock market higher. At the end of last week stocks rallied as the TBonds sold lower in a manner similar to the four cases marked on the chart below.

Quickly once again… Genentech (DNA) rose to very close to 100 and then corrected about 10% lower back to 90. The pattern is similar in some ways to IBM in early 2007. Ideally one wants to be long those stocks or sectors that make new highs the fastest because they tend to be the relative strength leaders. If DNA pushes back above 100 later this year then we should take some instruction for IBM’s chart at look for a push on towards the 120- 130 level over time.