We use the IMRA as a forum for our intermarket work and views and do our best to stay far away from such contentious topics and religion, politics, and global warming. Every now and then we will take a swipe at a central banker or two but aside from that we do try to stay on topic. However… with the very best of intentions… Merry Christmas, happy holidays, best wishes, and seasons greetings!
We are going to show today how the best laid plans of mice, men, and chart-crazed fools sometimes don’t come together exactly as planned. To start with we show at top right a comparative view of copper futures and the stock price of Johnson and Johnson (JNJ) from late 1991 through 1999.
The intermarket argument is that a strong and rising copper price is a negative for consumer growth-type stocks. In other words if you look at a chart of a stock that has been rising for decades- like JNJ- you will notice that the rising trend tend to ‘go flat’ when copper prices are overly strong.
Such was the case into early 1995 as JNJ held below 15 while copper prices pushed to a peak. When copper prices (which tend to trend with long-term Treasury yields) finally reached a top in 1995 the stock price of JNJ kicked back into a rising trend that lasted through into 1999.
In terms of ‘best laid plans’ our view was that the basic commodity trend had turned negative in 2006 following the first push to 4.00 for copper. Right on cue the stock price of JNJ began to rise but as commodity prices remained stronger into mid-2008 JNJ held below resistance at the 70 level.
When commodity prices finally began to weaken at the start of this year’s third quarter the stock price of JNJ began to strengthen as it moved up from 63, through resistance at 70, and on to around 72. Then… the entire stock market fell apart as the financial was ripped by one banking crisis after another.
The point? In general when copper is stronger JNJ is weaker and when copper is weaker JNJ is stronger. The current reality is that while JNJ has rather sharply outperformed the broad U.S. equity market it has yet to show the kind of break out strength that we were expecting. The plan was that JNJ would rise as copper prices declined but the reality has been that both have been weaker.
Our view for quite some time has been that we favor U.S. dollar (and Japanese yen), large cap, consumer and health care names. In point of fact we were close to perfect on this forecast with one very important caveat- we would have been better off in cash.
At top right we show a chart comparison that keeps us ever hopeful. The chart compares the U.S. 30-year T-Bond futures, the ratio between gold and copper futures, and the ratio between the share price of Johnson and Johnson (JNJ) and the S&P 500 Index (SPX).
As mentioned previously the share price of JNJ has rather dramatically outperformed the broad U.S. stock market. In other words the JNJ/SPX ratio has risen a considerable distance since the middle of 2007.
The problem- once again- is that outperforming the worst stock market in memory isn’t quite the same as making positive and real gains. It certainly could be worse but, then again, it also could have been better.
The point shown through the chart is that the TBonds have exploded to new highs and, as one might expect, the gold/copper ratio has followed. The markets are, at present, leaning harder towards deflationary non-cyclical growth than at any time in the last few decades.
The twist is that the JNJ/SPX ratio tends to trend with both the TBonds and the gold/copper ratio and if both are ‘real’ then it would not be too much of a surprise to see the JNJ/SPX ratio rise rather abruptly through the 2002 highs. The problem is… if the JNJ/SPX ratio rises will it be because JNJ has moved higher or because the SPX has broken lower? Our oft repeated view has been that as long as the autos remain above the November lows our conviction is that the base trend for the S&P 500 Index turned upwards last month. The SPX may still decline to new lows but it will do so within the context of a rising ‘base trend. This simply means that the longer the SPX declines while the base trend rises the more dramatic the upswing later on. One only has to think of what happened to the commodity markets (rising when the base trend turned negative in 2006) to understand how powerful this can be.
Below we show, from top to bottom, 3-month euroyen futures, 10-year Japanese (JGB) bond futures, and the stock price of Japanese bank Mitsubishi UFJ (MTU).
Japanese asset prices moved to a bubble peak in 1990 and by 1998 Japan was mired in a state of deflation as short-term Japanese interest rates moved down close to 0%. The Bank of Japan attempted to raise short-term yields in 1999 but had to pull them lower once again after the Nasdaq collapsed. In 2006 Japanese short-term yields once again began to rise (i.e. euroyen futures prices started to decline away from 100) and many believe that Japan had finally escaped the deflationary squeeze. Not so.
The point is that if, as, or when Japan moves away from deflation Japanese LONG-TERM interest rates will rise. Notice that when short-term Japanese yields moved upwards the markets began to pull long-term yields lower as the JGB futures pushed upwards. The end result of rising short-term yields and falling long-term yields is… a squeeze on banking system profits… which explains why MTU’s share price turned lower in early 2006. Quickly… notice as well that unlike the U.S. 30-year T-Bond futures the JGBs have not spiked to new highs. This suggests, strangely enough, that Japan’s economy may actually be stronger than that of the U.S. Ideally… we return to rising euroyen futures and falling JGB futures and the stock price of MTU swings upwards.