We argued (and argued) that the U.S. dollar was going to resolve higher and have been using a level of around 93 for the U.S. Dollar Index as our first target point.
Then we argued that the markets are driven by four combinations of the trends for the dollar and U.S. 30-year T-Bond futures. When the dollar and the bond market are weaker- buy the commodity sector. When the dollar is weaker and bonds are stronger- buy gold. When the dollar is stronger but bonds are weaker- focus on tech. However, when the dollar and the bond market are both in rising trends then one should stick with the consumer non-cyclicals, health care, pharma, and even the financials.
We mention all of this because while our conviction on the U.S. dollar was very strong the bond market was a different story. Many believed, in fact, that bond prices simply had to go lower.. including some very well known commodity bulls and newsletter writers. We suspect that, if asked a week or two ago, they would have said that being short the bond market was absolutely the most sensible trade going. Yet… day after day we kept showing that the only logical direction for the bond market to travel was higher. So far, so good.
At right is one of our favorite bond market charts. It compares the U.S. 30-year T-Bond futures with the SUM of the price of 3-month eurodollar futures and the Fed funds target rate. The SUM is shown using two moving average lines (50-day and 100-day e.m.a.).
The point? Bond market price tops tend to occur when the SUM of the Fed funds rate and 3-month eurodollars rises above 100. Given that we are slowing down the trend somewhat by using moving average lines the SUM not only has to be move above 100 but has to remain there for a few weeks.
What does all of this mean? The first point would be that bond prices in general should continue to rise until the yield on 3-month eurodollars declines below the funds rate. The second point is that in a rising bond and rising dollar market one should lean towards the large cap consumer non-cyclicals, health care, and those financials not hamstrung by the subprime crisis.
The more intense the intraday action in the markets the more likely we are to step back and show macro perspectives. After all, in the space of only a few minutes the S&P 500 Index futures can move higher or lower by 30 or more points which causes the entire equity market to surge or collapse.
Below is a chart of the ratio between oil service giant Schlumberger (SLB) and Wal Mart (WMT).
The ratio has taken some fairly wild swings over the years but the most interesting detail would be that the ratio moved in favor of WMT into 1992, back in favor of SLB into 1997, back towards WMT into 2002, and then right back to SLB into 2007. If history were to repeat the trend would favor WMT all the way through into 2012.
The equity markets in the U.S. broke to new lows yesterday which, of course, is never a good thing. We are going to have to stretch somewhat today to make lemonade out of this pile of financial lemons.
To do so we have to move all the way back to the equity bear market bottom in 1982. Below we show the SPX, 3-month eurodollar futures, and the U.S. 30-year T-Bond futures from 1982 while below right we have included the same comparison from 2008.
The stock market bottomed in August of 1982 AFTER 3-month eurodollar futures pivoted higher and right about the time that the TBond futures broke to new recovery highs. Our oft-mentioned point has been that the TBonds above 123 would be a positive so yesterday’s close at 122 3/32 was a leap in the right direction.