by Kevin Klombies, Senior Analyst

Friday, December 14, 2007

Chart Presentation: JNJ/SPX

The chart at right compares the stock price of Canada’s Bank of Montreal (BMO) to the ratio between Johnson and Johnson (JNJ) to the S&P 500 Index (SPX) through the last half of 1999 and into the spring of 2001. Given the rather extreme levels of volatility exhibited by the markets this week we thought we would start off with something relatively ‘macro’.

JNJ tends to outperform the broad market during periods of cyclical weakness so it made perfect sense that the ratio would begin to rise in the spring of 2000 as the Nasdaq Comp. peaked and turned back to the down side. As we have shown on a number of occasions recently the offset to the end of the tech and telecom trend was a decline in interest rates and a rising trend in the Canadian bank shares.

The current cycle is shown below using the same comparison. The obvious difference is that the banks are not rising along with the JNJ/SPX ratio because the banks represent the problem.

The point is that in 2000 we could ‘see’ the start of a negative trend that would eventually last until late in 2002 through the rise in the JNJ/SPX ratio. Those stocks and sectors that moved higher even as the broad market declined turned upwards with the ratio- including the Canadian banks.

Since last cycle’s leaders are now this cycle’s problems it makes sense to avoid the financial sector although we have obviously been focusing on the major Japanese banks of late. We expect that our thesis will get a good and thorough test over the next few trading sessions.

Below we show Japan’s Matsushita (MC). MC represents the kind of stock that turned upwards after a prolonged decline along with the JNJ/SPX ratio. We will argue- tentatively, of course- that this helps support our ‘Japan’ thesis.




Equity/Bond Markets

When the markets get as erratic as they have been this week we tend to get more and more ‘macro’ in our work and in particular with our views. In general we are trying to see beyond the day to day fluctuations so that we can maintain some semblance of calm and/or sanity.

The chart at right shows commodity prices (DJ AIG Commodity Index) along with the stock prices of Coca Cola (KO), Anheuser Busch (BUD), and Johnson and Johnson (JNJ).

When commodity prices peaked in mid-1994 the large cap U.S. consumer defensives (KO, BUD, JNJ) began to trend higher. We could make this more complicated but in reality that is about as simple as it gets. When commodity prices peak the markets rotate out to the consumer names.

One might wonder given the recent strength in crude oil and grains futures prices when a similar trend will begin but the answer is that it started some time around the spring of 2006. In other words we are already more than 18 months into a trend change that we suspect few have even noticed.

If there is a problem it might be that BUD continues to struggle with the 54- 55 range while JNJ has been stuck between 68 and 70 since early 2005. However, we can see that between 1994 and 1998 each of these three stocks went through periods of consolidation only to resolve nicely to the upside. Our point is that unless the major commodity indices make new highs- which would certainly surprise us- this is the theme that we expect will do well for the next year or two (or three).

The Japanese banks were whumped yesterday (whumped may not be the correct technical term but that is certainly how it felt to us). Since we are linking the recovery in MTU and MFG with the peak and decline in crude oil prices the sharp rally in crude on Wednesday was enough to put the entire thesis into some doubt. The basic point is that this stands a good chance of working unless crude oil prices go on to new highs or the global banking system does a complete melt down. If the latter turns out to be true then one should focus more on being long canned goods and ammunition.