by Kevin Klombies, Senior Analyst

Wednesday, January 30, 2008

Chart Presentation: Intermarkets in Action

We are going to start off today by showing our intermarket ‘take’’ on two comparative charts.

The chart below features the stock prices of U.S. airline AMR, refiner Valero (VLO), and gold miner Barrick (ABX).

Crude oil prices peaked in August of 2006 and then turned lower into January 2007. The first group to respond to declining energy costs was the airlines with AMR’s stock price rising from around 20 in early September to 40 by the following January.

The peak for the airlines went with the bottom for energy prices. In particular it went with the start of a widening spread between refined products prices (i.e. gasoline) and crude oil which helped increase the profitability of the refiners. Up went Valero from January into the summer of last year.

Once Valero reached a peak the markets began to push into the gold mining sector in response to the subprime crisis and the associated decline in interest rates. When AMR was rising VLO and ABX remained flat and once VLO turned higher AMR was done while ABX continued to chop along its moving average lines. When the golds lose momentum the markets will move on to another sector. The points are that all of these trends lasted 5 to 7 months so once started they tended to continue for some time and simply catching part of only one of these trends (much less all three) could literally ‘make your year’. The question now is what group, sector, or theme is set to swing higher as the golds begin to tire?

Anheuser Busch (BUD) reports earnings later this week so we thought we would show an intermarket perspective. The basic idea is that BUD has three significant market- related ‘costs’- energy (transportation), aluminum, and grain (barley, hops, etc.). We have cobbled together a chart of crude oil times rice futures (energy times grains) to show the impact on BUD’s share price.

In early 2006 the energy times grains combination turned flat and BUD’s share price trended steadily higher. By mid-2007 strength in the grains along with recovering energy prices drove the combination to new highs which effectively halted the advance of BUD and turned the trend back to ‘flat’. Once the commodity trend calms the argument would be that BUD should return to the top edge of its trading range and then move on to higher levels.




Equity/Bond Markets

At right is a chart of the biotech etf (BBH) divided by the S&P 500 Index (SPX). Below it is a chart of Japan’s Mitsubishi UFJ (MTU). The two charts have been offset by about 5 months.

The premise is that there are a number of sectors including the Japanese banks and the biotechs that have been left for dead over the past two years as the markets focus on either the commodity theme or, periodically, the anti-commodity themes. In other words we have seen nice rallies in the oils and the refiners as well as the airlines and the autos even as the Japan theme and the biotechs have steadily declined.

The point here is that MTU has tended to trend with the biotechs but with a lag of about 5 months. Obviously ‘5 months’ is an overly precise number but if we line up the peak in the BBH/SPX in late 2005 with the subsequent peak in MTU in the spring of 2006 the chart comparison works rather well.

Another spin on this is shown below without the lag. We have included a chart of the BBH along with the ratio of the Nikkei 225 Index to the Japanese 10-year (JGB) bond futures. A more stable bond market and some strength in the biotechs would do wonders for the general Japanese theme. As a quick aside- we understand that Mitsubishi UFJ and Matsushita- MC- (which will formally change its corporate name to Panasonic later this year) are due to report earnings later this week.

U.S short-term interest rates typically turn lower with cyclical weakness and cyclical weakness usually includes weaker energy prices. The recent cycle has been challenging because interest rates have declined in the face of rising commodity prices and that has served to ‘mess up’ several of our views and arguments.

The chart below right shows Boston Scientific (BSX) and the ratio between Exxon Mobil (XOM) and BSX. The idea was that the ratio should peak and then move back to 4:1 over the next few months as money shifts away from the energy sector and on to the health care names. So far we have yet to see a compelling break in the rising XOM/BSX ratio.