by Kevin Klombies, Senior Analyst

Friday, February 01, 2008

Chart Presentation: Extended Trends

The news just keeps on coming this week. Today we get the monthly U.S. employment data even as OPEC meets to decide on a potential increase in crude oil production quotas. The equity markets have to slog through what appears to be a briskly lower trading level for Google (GOOG) even as record profits for Japan’s Matsushita (MC) help support the Nikkei.

The chart blow compares the U.S. Dollar Index (DXY) futures with the World ex-USA Index divided by the Dow Jones Industrial Index (DJII).

The argument is that money began to find better places to invest around the start of 2002 following- perhaps coincidentally- the terrorist attacks in the autumn of 2001. From 2002 through 2007 the declining trend for the dollar suggested that capital was moving away from the dollar while relative strength by non-U.S. equity markets showed, in a sense, where it was heading.

As the dollar weakened capital flows into foreign markets helped support and bolster growth in Asia, Africa, the Middle East, Latin America, etc. so while work tends to expand to fill available time capital expenditures tend to expand to use up available capital. In other words one can just as easily argue that growth in countries such as China, India, and Russia was the result of massive capital inflows instead of the other way around.

In any event for the past six years the dollar has been weaker while foreign equity markets have outperformed. The trend has lasted almost as long as the 1995- 2001 rising trend for the dollar that helped finance the internet’s productivity miracle. When it ends the dollar will strengthen while the U.S. equity markets will return to some semblance of relative strength.

Below we show the ratio between the S&P 500 Index (large cap U.S. equities) and the NYSE Composite Index (small cap U.S. equities).

The chart makes the argument that the U.S. large caps were the focus of true excess into 2000 but if the pendulum had swung too far in one direction into that time frame it has likely swung just as far in the other direction into early 2008. Our point? The base trend favors foreign over U.S. and small cap over large cap but given that the trend is old and rather extended we prefer to take the other side of the trade and focus on the large cap U.S. names.




Equity/Bond Markets

The chart compares Intel (INTC) with the ratio between the S&P/BARRA Growth Index and Value Index.

In general ‘value’ tends to outperform in negative or defensive market cycles while ‘growth’ does better during strong price trends. What we find interesting is the way the ratio favored ‘value’ from 2000 into 2007.

Around the time that growth stock Intel finally bottomed and turned higher in 2006 and again in 2007 money began to shift back to the ‘growth’ side only to be pummeled for showing such temerity during the first few weeks of January.

From our perspective we still like Intel and we favor the growth over value as a ‘style’.

Below is a chart showing the ratio between crude oil futures and the CRB Index as well as the Asia ex-Japan Index and the Nikkei 225 Index.

The chart show the relative strength of crude oil compared to a broad measure of commodity prices and the relative strength of Asia compared to Japan. Being somewhat contrary we tend to prefer the wrong side of any trend that has become as extended as the ones shown by the ratios so we like the Japanese equity market particularly on crude oil price weakness.

Quickly… below we show the combination of crude oil futures times the Australian dollar and the ratio between Wal Mart (WMT) and the S&P 500 Index. WMT’s push back above 50 yesterday was most welcome but if this is truly ‘the turn’ it is only the beginning of a trend that should run for a number of years.