We should start off by noting that we are REALLY big adherents to the notion or concept of above or below ‘trend’. Our conviction is that any time a market, sector, or security starts to push either higher or lower day after day after day… it is trying to come back ‘on trend’.
We will argue that the absolute collapse of the commodities markets of late was simply the result of a market that was rising that really should have been falling. Too many people bought- hook, line, and sinker- into the undeniable (apparently) logic of those who should have known better. Too many people read too many times and were told over too many cocktails that there would be Asian growth forever, that peak oil meant ever rising oil prices, that there was a shortage of food, that ‘growth’ was synonymous with ‘commodity’, that boom followed boom, and that the cyclical sectors were, we suppose, no longer cyclical.
In any event let’s start off with a rather bold statement. We believe that the trend for the equity markets turned positive around six months ago. We believe that the markets are moving rather rapidly ‘below trend’ and that in due course we are going to see a powerful stock market recovery that will swing the S&P 500 Index back to its recent highs (i.e. north of 1500). The problem is that we have no clear idea of exactly ‘when’ the equity markets will realize that they are declining through a rising trend in much the same way that we struggled with our argument that commodity prices should have been falling even as they moved higher from January of 2007 through June of 2008.
At right is a comparative view from 1981- 83. The chart compares the S&P 500 Index, the ratio between the ratio of Johnson and Johnson (JNJ) and the S&P 500 Index (SPX), and the U.S. 30-year T-Bond futures.
The simple point is that the trend for the equity markets turns higher with the bond market. The trend turned positive when bond prices started to strengthen in the autumn of 1981 even though- and this is the important point because this is exactly where we are at present- the SPX continued to decline through into August of 1982.
Let’s write this again. The trend for the equity market turned positive in August of 1981 even though stock prices fell for the next year. When the stock market began to rise in August of 1982 it did so very quickly. Why? Because it was a very long ways ‘under trend’.
Above we showed the TBond futures and the SPX. We also included the ratio between Johnson and Johnson (JNJ) and the SPX.
For months and months we have argued that we like the dollar and the yen. We have also argued that U.S. large caps should outperform virtually all other equity markets with the consumer and healthcare-related sectors showing the best relative strength. We have focused on stocks such as Wal Mart, JNJ, Coca Cola, and Anheuser Busch (recently bought out by InBev) although from time to time we have shown the pharma and biotech etfs.
The stock that we have shown the most of late would likely be JNJ just as we tended to use Phelps Dodge for much of our work back in the days when we were arguing in favor of the commodity cyclicals.
The chart at top right shows the ratio between JNJ and the S&P 500 Index from 1980 through 1984. We have marked the chart with three vertical lines.
The first line (1) represents the start of a declining trend for the S&P 500 Index. The JNJ/SPX ratio began to rise in late 1980 when the SPX turned lower.
The second (2) point represents the start of bond market price strength. This was the chart point that we were showing on the first page.
The third (3) point would be the bottom for the equity markets in the late summer of 1982.
From the start of weakness in the equity market in 1980 through the turn higher in the bond market in 1981 through to the bottom of the equity market in 1982 the ratio of JNJ to the SPX rose.
The chart at middle right shows the current situation. The JNJ/SPX ratio turned higher in mid-2007 at the start of the equity bear market. It pushed upwards a second time in the late spring (i.e. May) of 2008 when bond prices began to strengthen.
The point? Look at the JNJ/SPX ratio. We are close to a year and a half into a major equity bear market and roughly six months past the start of a rising trend for bond prices. In other words if we use the 1980- 82 cycle as our road map we are somewhere in between the start of bond price strength in 1981 and the realization by the equity markets in 1982 that prices have been falling in a rising trend.
Chart-wise if we were to make our best guess of where the equity markets’ trend is at present it would look something like the chart below right. The trend for the SPX is positive and rising even as the SPX collapses.
Does this mean that the SPX has to rise tomorrow, next week, or even next month? Absolutely not. If the markets follow the exact same path as 1982 we could be mired in a declining trend through into May of next year.
We are going to add an extra page today (page 2A) for three reasons. First, because today is Friday. Second, because this is an important topic. Third, because we are going to be away through the first half of December and we want to get as much ground covered before then as possible.
