by Kevin Klombies, Senior Analyst

Friday, June 25, 2007

Chart Presentation: Dominant Theme

We start out today with a comparison between U.S. 3-month TBill yields and the stock price of steel maker Nucor (NUE) from late 1999 into 2001.

There are cyclical markets and then there are cyclical markets. By this rather trite statement we mean that not all cyclical markets will trend together. The steels are an excellent example of a cyclical sector but the chart shows that as the Nasdaq pushed to a high into 2000 steels like NUE were trending lower.

The bottom and subsequent pivot into a rising trend for NUE occurred at the start of the fourth quarter in 2000. This was also the start of the bear market trend for tech and telecom that led a few months later to the first interest rate cut the Fed.

The point is that weakness in the dominant theme- tech and telecom- led to strength in a sector that had previously been negative- steel. We commented recently that one wants to be long those sectors that are pushing interest rates higher and never long those sectors that are causing interest rates to decline. This does not mean, however, that a decline in interest rates due to cyclical weakness will be negative for all cyclical sectors but merely that if something like real estate is pulling interest rates lower then one is best served by not being long the home builders.

We do not recall hearing a bell ring at the start of October in 2000 to announce the end of the rising trend for tech and telecom. In fact a full three months passed before the Greenspan Fed decided that perhaps it was time to stop fighting inflationary pressures and get back to the business of trying to offset a major collapse in capital spending. If there was a bell, however, it might be the concurrent pivots or trend changes for tech and stocks like NUE.

The argument would be that when the dominant theme- in the current case quite clearly all things related to commodities- turns negative those cyclical sectors that react positively should represent the leading edge of the next dominant theme. Since the markets tend to shift gears and changes trends around the start of a new quarter it may be that whatever will happen has yet to start in earnest. Our thought was the Japanese banks might be turning higher in a Nucor-like manner but Friday’s weakness did little to support our conviction. Still… there are some similarities between MTU at present and NUE through the last peak in short-term yields in 2000.



Equity/Bond Markets

The chart features the S&P 500 Index (SPX) from the spring of 1994. We are going to use this ‘mini-crash’ instead of the more dramatic 1987 example for a change of pace.

At middle we show the sum of copper and crude oil futures. This ‘sum’ represents the trend for cyclical asset prices that is impacting the trend for interest rates.

The argument is that the sort of dramatic decline that is often referred to as a ‘crash’ comes from a market that has set a negative trend and then pushed up and out from that trend. Typically the price or momentum peak is made around 6 to 7 weeks before the market snaps lower to catch up with the falling trend.

The 1994 SPX topped in early February and then pushed ‘up and out’ at the start of March before snapping back to the falling trend during the final week of the quarter. Our thought was that copper plus crude oil had made a similar peak in early May and had the look of a market that was trying to decide which way to break- up or down.

The equity markets began to lift at the start of the third quarter last year and for six months the trend was driven by falling commodity prices and yields and then for the next six months the trend features rising commodity prices and yields. Our thought was that the closer we get to the end of this quarter the more likely the prospect for lower commodity prices.

Wal Mart has slipped back to the moving average lines even as tentative signs of weakness emerged in the Chinese equity markets last week. WMT tends to do better with a strong dollar and weaker energy prices so Friday’s oil price strength was a negative.