by Kevin Klombies, Senior Analyst

Thursday, May 1, 2008

Chart Presentation: Going Macro

The Federal Reserve cut the funds rate by 25 basis points yesterday -as expected- and while the markets were certainly jittery the action fell far short of anything close to real ‘chaos’. Too bad- it would have made for an interesting session.

To really kick things into gear we needed to see the dollar rise following the Fed’s announcement as Treasury prices weakened. This would have led to a healthy gain in the U.S. equity markets as commodity prices declined. Instead the dollar faded lower while bonds moved higher and in response a triple-digit rise in the Dow Jones Industrial Index turned into a minor decline as gold prices moved somewhat higher.

When the markets get too confusing in the short run we tend to revert to more ‘macro’ perspectives so that we exactly what we are going start with today. At right are two charts of the product of crude oil futures time natural gas futures (a broad measure of the trend for energy prices), the stock price of Boston Scientific (BSX), and the ratio between the share price of Coca Cola (KO) and the S&P 500 Index (SPX). The top chart starts in late 1999 and runs into 2002 while the lower chart starts in late 2006.

In a sense these charts show what we expect the markets to do- one of these days. The argument begins with the pivot upwards by the KO/SPX ratio in the spring of 2000. As Coke starts to outperform the broad market the idea is that this marks the beginning of broader cyclical weakness. Through the balance of 2000, however, energy prices continued to climb as the share price of BSX worked lower.

The lows for BSX were made as energy prices peaked at the end of 2000 so our point is that when the KO/SPX ratio turns higher energy prices can rise for some length of time but… eventually energy prices will turn lower which in turn will lead to a pivot upwards in those stocks and sectors that had previously been under pressure.

Moving on the present example we can see that the KO/SPX ratio turned higher some time in early to mid-2007 and quite certainly energy prices have been stronger. We continue to await the next phase of the cycle- an actual peak in energy prices- because this should mark an internal trend change within the equity markets. This is the reason that we fixate from time to time on the minor swings in the prices of companies such as Anheuser Busch and Boston Scientific even as we struggle with the trend for energy prices.



Equity/Bond Markets

Our conviction is that economic growth is powered alternately by consumer and capital spending. During any cycle there will always be some of both but typically one tends to dominate. When the Nasdaq turned lower in 2000 this marked the end of a capital spending-driven cycle which led into a consumer-driven cycle powered by rising real estate prices. A U.S. consumer cycle will tend to create an offset Asian capital spending cycle as commodities are demanded to build the factories to produce the goods for American buyers.

At top right we show the CRB Index and the ratio between the share prices of Apple (AAPL) and Micron (MU). Our argument is that Apple represent the consumer theme while MU represents capital spending so the bottom for the ratio at the end of 2000 marked the end of the capital spending theme and the top for the ratio will mark the true passing of the consumer theme. As well the end of one theme and the start of another appears to be marked by a peak in energy prices…

Below we show Research in Motion (RIMM) and FreePort McMoRan (FCX). Taking the argument one step further and substituting RIMM for AAPL we argue that at the trend will change at the peak for energy prices and it will be marked by weakness in commodity prices along with the share prices of commodity producers such as FCX and both AAPL and RIMM.

Pushing on we show at bottom right FCX, Wal Mart (WMT), and the share price of Matsushita (MC).

As we await a clear change in trend… notice how the markets began to move on months ago. As FCX moved into the start of a broad ‘flat’ trend ranging from around 70 up to just above 120 last August the trends for both WMT and MC turned positive. As long as FCX is not making new highs the argument would then be that these two stocks should continue to press higher over time.