The consensus view appears to be that on the other side of the current correction/massacre there will be commodity-driven trend that favors non-U.S. equities. In other words while Russia has gone from first to worst and the CRB Index has declined to levels below the bottom set in 1982 at any moment the trend will swing back to being pro-BRIC.

We have a few problems with this view including the observation that the markets tend not to repeat dominant themes. We are not arguing that energy and base metals prices will decline forever or that the Hong Kong stock market will go to zero because, after all, cyclical is cyclical. The trend for the Nasdaq tends to be similar to that of Japan’s Nikkei, Hong Kong’s Hang Seng Index, Brazil’s currency, energy prices, and metals prices.

The point is that when commodity prices peaked in 1980 they eventually had periods of strength but did not return to being the dominant theme until at least early 1999. After the Nikkei collapsed in 1990 there were periods of strength but close to two decades later this market has not returned to relative strength leadership. The same is true for the Nasdaq which charged to a high back in 2000 and, some 9 years later, is still working through a consolidation.

Belowwe show a chart comparison between the ratio of the S&P 500 Index (large cap U.S. equities) and the NYSE Composite Index (small cap) along with the cross rate between the yen and the euro.

Below we feature the U.S. Dollar Index (DXY) futures and the ratio between the World ex-USA Index and the Dow Jones Industrial Index (DJII). The World ex-USA/DJII ratio represents everything ‘not U.S.’ versus ‘large cap U.S.’.

The idea is that the yen/euro, the U.S. dollar, large cap vs. small cap, and U.S. large cap vs. ‘not U.S.’ are part of the same general trend. It is possible that the consensus is correct and that the commodity, small cap, non-U.S., weak dollar, weak yen/strong euro themes will kick right back into gear but our conviction is that the current debacle is part of a major trend change that will ultimately lead to new relative strength leadership. Our view is that instead of swinging back to countries like Brazil money will begin to shift over to Japan. Instead of returning to the commodity producers it will flow towards the commodity users. Instead of favoring small cap we should see better action in large cap.



Equity/Bond Markets

We are going to continue with the page 1 topic.

On the one side are the commodity producers, commodity currencies, and commodity themes. These go with small cap and most everything outside of the U.S. and Japan. Kuwait will do better than General Electric ,the autos underperform the oil producers, and most cyclical themes will be based on rising raw materials prices.

On the other side are the U.S. dollar and Japanese yen as well as the Nikkei and S&P 500 Index. Cyclical themes favor companies that do well during periods of economic growth but are related more to the consumption rather than the production of raw materials. Large cap outperforms small cap.

Belowwe show the U.S. Dollar Index (DXY) futures and the ratio between the CRB Index and crude oil futures. In our scenario the CRB/crude oil ratio continues to rise- for years- as oil prices underperform general commodity prices and that this leads us back to a better trend for the autos and airlines through the second half of the year. The argument is that this view revolves around a stronger U.S. dollar.

Below we show the DXY futures once again along with the ratio between the i-shares for Brazil and Japan. In our scenario the dollar continues to rise making new highs above 89 and the Brazil/Japan ratio declines.

Below we show the Japanese 10-year (JGB) bond futures and the ratio between the Nikkei 225 Index and the S&P 500 Index (SPX).

Our view is that long-term bond prices peaked towards the end of 2008 and will trend lower through all of this year. Our argument has been that a falling trend for bond prices is an eventual positive for cyclical growth even though the markets won’t realize this until closer to the end of the second quarter. The argument below is that if weaker U.S. bond prices lead to weaker Japanese bond prices and weaker Japanese bond prices go with relative strength in the Nikkei then the Japanese stock market may end up swinging from worst to first.