by Kevin Klombies, Senior Analyst, TraderPlanet.com
It is difficult to have much of a short-term view these days given the steady stream of bank-bail out news crossing the wires over the weekend. We commented last week that cyclical down turns into the month of October tend to hit bottom around October 10th so our view was that the equity markets would likely hit bottom by the end of the week. Time will tell.
Below we have included a chart comparison from 1987. The chart compares the S&P 500 Index (SPX) with the U.S. 30-year T-Bond futures.
The argument has been that the bond market literally dragged the equity markets lower in 1987 culminating in the October ‘crash’. Once the SPX had lost all of its gains by declining down to around 230 (the level that marked the start of the ‘bubble’ in the autumn of 1986) the bond market snapped upwards. The first target for the TBond futures on the rally was the 200-day e.m.a. line.
Our view has been that something similar has been taking place between the equity and commodity markets today. At bottom right we show the CRB Index and the S&P 500 Index for the current time period.
At the end of last week the CRB Index finally broke below the lows of August of 2007. In other words the entire ‘bubble’ top has been removed.
The argument would be that commodity prices have been pulled lower by a tumbling equity market in much the same way that equities were pressured lower by bond prices back in 1987.
The good news, we suppose, would be that this places the S&P 500 Index in a position similar to the TBonds in October of 1987. If history were to repeat then the SPX should rally smartly back towards 1250- 1300 into November.
It will be interesting to see how this plays out because by our rough count the first bout of strength off of a major low usually runs for about 22 trading sessions. We mention this because human nature, being what it is, will likely leave most investors glued to the sidelines for weeks if not months as they await either new lows or the retest of the lows. If the 1987 bond market is any sort of guide that may not happen.
A few weeks ago we introduced a fairly new topic. We argued that the equity markets have four basic ‘themes’ that work off of the trend for the U.S. dollar and the long end of the U.S. Treasury market.
Quickly… if the dollar and the bond market are falling emphasize basic commodity sectors. If the dollar is falling but bonds are rising in price then focus on gold. If the dollar is rising and bond prices are also rising then stay with large cap U.S. consumer, financial, and health care names. If the dollar is rising and bond prices are falling then the tech and telecom sectors tend to do well.
At top right we show a chart of the sum of the U.S. 30-year T-Bond futures and U.S. Dollar Index from 1986 into late 1989 along with the ratio between Johnson and Johnson (JNJ) and Caterpillar (CAT).
Through the 1987 stock market ‘crash’ the trend was driven by weakness in bonds AND the dollar. This went with weakness in JNJ (consumer) relative to CAT (cyclical).
Below right we show JNJ and nickel producer Inco (N) from the end of 1986 into 1988. In a ‘weak dollar and weak bond market’ trend it should not be surprising that a base metals stock (Inco) was back to new highs well before JNJ. In other words… the ‘crash’ knocked the speculation out of the equity markets but it did not alter the underlying trend which favored the commodity cyclicals before AND after the crash.
Today is not, by the way, similar to 1987 but we will leave the explanation for the next page. Below we show the U.S. 30-year T-Bond futures and the CRB Index from 1984 into 1989.
The key is that- in our view- that commodity markets follow or lag behind the bond market by roughly 2 years. Strength in bonds in 1984 led to rising commodity prices in 1986. Weakness in bond prices in 1987 may have helped break the equity market but the underlying trend for commodities remained positive into early 1989. That is why Inco moved to new highs while JNJ languished.
