by Kevin Klombies, Senior Analyst

Friday, April 18, 2008

Chart Presentation: Horns and Bells

It would be nice if a horn would go off or a bell would chime to mark the end of one trend and the start of another. We have mentioned in the past that those who make the most money through any given trend are those with the greatest conviction and it is this conviction that tends to take them all the way to the top and then back down the other side.

We have argued that the mark of any true bubble is the ‘absurd comparison’. At the peak for Japanese real estate prices the Imperial Garden’s value eclipsed that of the state of Florida and near the peak for the Nasdaq in 2000 the market cap of Cisco moved above that of General Electric. We mention this because we noticed this week that the market cap for Potash Corp. (POT) was now larger than Canada’s Royal Bank (RY). POT may make more money than RY this year but… if you have ever driven by a potash mine you will have a hard time believing that as a long-term business it has more value than Canada’s largest bank.

From what we have been told it may prove to be as hard to convince POT share holders to sell as it was to pry the Nortel shares from people’s fingers eight years ago. Of course since POT continues to make new highs those with real conviction have been richly rewarded.

At top right we show the ratio between the Bank of Montreal (BMO) and the Nasdaq Composite Index from 1998 into 2001. Below right we show the ratio of Japan’s Mitsubishi UFJ (MTU) to the gold etf (GLD) from 2006 to the present day.

The true tech and telecom die-hards likely didn’t realize that the trend had changed until the fourth quarter of 2000 although for most it may have taken another year or so before the reality that it ain’t coming back any time soon really sunk in. With the benefit of hind sight we can see that the pivot occurred in March of 2000 as the markets stopped selling financials to buy cyclical tech. In other words once the BMO/Nasdaq ratio stopped grinding lower and pushed back above the 200-day e.m.a. line the old trend had ended and something new had begun.

We have used a number of ratios based on MTU including MTU/crude oil, MTU/CRB Index, and MTU/GLD in our efforts to find the end of the weak dollar and strong commodity trend. The MTU/GLD chart makes the point that similar to 2000 the trend may well have started to change in the month of March but, even so, it is still too early in the game to call this one ‘done’ even if, in fact, that is exactly what is happening.



Equity/Bond Markets

Below we show a chart of the ratio between the S&P 500 Index (SPX) and the NYSE Composite Index. The argument is that this ratio represents the ongoing war between large cap and small cap relative strength.

In early 1995 the equity markets began to lift as interest rates declined and eventually the dollar started to firm. This served to lift the ratio as money moved into the large cap names.

As a trend gets older it tends to become more speculative and it does that by moving into smaller sectors and creating parabolic price rises. In a sense the Nasdaq’s strength from 1998 into 2000 was the tail end of a cycle that began with the large cap consumer and financials and ended with crazed action in the internet sector.

When the trend came to an end in early 2000 the SPX/NYSE ratio snapped right back to the original starting point as prices rapidly readjusted. From there the U.S. dollar began decline which heralded in a new trend that focused on small cap in almost exactly the same manner that the last trend had been driven by large cap.

Our point is that the large cap names are becoming as ‘low’ relative to small cap as they were ‘high’ into 2000. We would also note that much of this has been driven by capital flows away from the dollar.

In the current time frame we can’t help but notice how the trend has rotated into ever smaller markets in search of some thing that can be driven. The problem with a commodity trend is that unlike an internet or solar power company stock price when the thundering herd drives something like rice futures prices through the roof it impacts people’s ability to eat and, as Martha Stewart might have said, that really isn’t a good thing.

The chart at bottom shows that each time the CRB Index pushes higher the Canadian stock market rises relative to the S&P 500 Index. Narrowing the focus down to the very short-term we feature the same chart below. Similar to our page 1 point it may be that the trend began to change in March but through trading yesterday the markets were certainly acting as if it was still onward and upward.