With the markets winding down in front of the holidays and year end we might as well go back over the same topic that we worked on in yesterday’s issue.
At right we show two comparative views of crude oil futures and the ratio between the share price of Coca Cola (KO) and the S&P 500 Index (SPX). The top chart is from the autumn of 1985 through 1986 while the lower chart starts in the spring of 2008.
The basic argument is that the ratio between KO and the SPX rises during periods of cyclical or commodity price weakness so when the ratio bottoms and begins to trend upwards the corresponding trend for commodity prices has turned negative.
The problem through 2007 and the first half of 2008 was that commodity prices in general and crude oil prices in particular kept rising even as the KO/SPX tracked higher. In other words in the face of a negative trend for commodity prices… commodity prices kept making new highs.
The point yesterday was that something similar has happened in the past- notably from 1984 into 1986- and it ended with a major collapse for crude oil prices. The idea was that the cycle bottom for crude oil prices will be reached- as it was in 1986- when the KO/SPX ratio finally pushes to a cycle top.
With this in mind we turn to the current situation’s chart. The KO/SPX ratio made its last high in late November so one could argue that crude oil prices could already be at the lows. In other words if the KO/SPX ratio fails to move upwards through the first half of 2009 then a very good case can be made that the lows for energy prices have already been reached.
Our point? Our view is that the KO/SPX ratio still has at least one more push to new highs ahead of it into next year. In fact, as long as it does little more than correct back to the rising 50-day e.m.a. line we are definitely not going to change our position that the commodity markets are going to be somewhat negative through the first half of 2009 with relative strength continuing to show up in the consumer defensive and health care themes.
Moving forward we will be watching the ratio of Coca Cola to the S&P 500 Index quite closely. As long as it continues to rise we will hold the view that the broad correction in the commodity cyclical sector has not yet run its course. If the ratio fails sharply to the down side, however, it will call into question our ‘strong dollar’ argument while suggesting that the commodity sector will be stronger than our current expectations.
At top right we show the U.S. 30-year T-Bond futures from 1985 into 1986 and the stock price of nickel producer Inco from 1987 into 1988. The 2-year lag argument suggests that commodity prices trail behind the bond market by close to two years. Following the 1987 stock market ‘crash’ the share price of Inco moved on to new highs because… two years earlier the bond market was in a strong rising trend.
Below right we have included a chart of Wal Mart (WMT) from the start of 2008 and the TBond futures from two years earlier. Our point is that from early 2006 into the middle of 2007 the bond market was essentially flat. In other words the difference between 1987 and 2008 is that the bond market in 1985 was strong while the bond market in 2006 wasn’t. Put another way… following the stock market’s decline in 1987 it made sense to return to the commodity cyclicals as evidenced by the push to new highs by Inco while in 2008- 2009 it appears to make sense to stick with those large cap names that do better in a weaker commodity trend. This is one of the reasons why we favor Wal Mart for the first half of 2009.
Below is a simple chart of Nippon Tel (NTT).
The argument is that the first stocks back to new highs following a stock market collapse represent the kind of relative strength that tends to last for at least a few quarters. There are very few stocks pushing to new highs these days but with the help of a stronger Japanese yen the U.S. dollar price of NTT has pushed back to the highs of 2007. For this reason we will likely show charts of NTT in the back pages of the IMRA on a fairly regular basis through the first quarter of 2009.