by Kevin Klombies, Senior Analyst

Friday, August 10, 2007

Chart Presentation: Leading and Lagging

The markets returned to a state of near chaos yesterday as the ECB added liquidity to the banking system in response to the rather sharp increase in the London interbank offered rate (LIBOR). 1-month LIBOR futures prices (chart below) declined in response to the drying up of credit. Strangely enough… the markets usually are quite boring during the summer months.

The chart shows the sum of the stock prices of two U.S. home builders- DR Horton plus Hovnanian. Below right we have included a chart of the CRB Index. The charts have been shifted or offset in time by roughly six months.

The idea is that the leading edge of the cyclical slow down showed up in the U.S. housing market during 2005 with the commodity markets lagging behind by approximately two quarters. The home builders stock prices bounced upwards in the summer of 2006 followed by a recovery in the commodity markets in early 2007.

The charts suggest that we have reached the tipping point for the CRB Index with lower prices expected through the balance of the year. If the home builders continue to strengthen- and these shares were broadly higher during yesterday’s rout- then similar to this year we could see the next pivot higher for the CRB Index early in the first quarter of 2008.



Equity/Bond Markets

The chart compares the CBOE Volatility Index (VIX) with the sum of copper and crude oil futures.

Our view is that a rising VIX is not necessarily negative for equities but it does mean that the trend that has been pushing metals prices higher and moving money away from the dollar into smaller currencies has come to an end. Our view is that similar to last year the upwards spike in volatility marks the peak in the trend for copper and crude oil. If the argument is valid then the next bottom should be reached during the first quarter of next year with the commodity cyclicals showing significant weakness over the next two to three months.

Below we show the September 3-month eurodollar futures contract. We have argued that before the Fed cuts the funds rate we will likely need to see eurodollar futures trading strongly up through 94.75. The problem is that the front month contract- August- is still trading at 94.60 with a last trade date of August 13th. The September contract (in a significant divergence to LIBOR shown on page 1) was briskly higher yesterday closing at 94.76. The point is that ever so slowly the markets are starting to get serious about pushing U.S. short-term interest rates lower.

The chart below compares the ratio of corn futures to the CRB Index with the ratio of the share price of Coca Cola (KO) to the S&P 500 Index.

We have argued on many occasions that the markets ‘split’ in early 2004 when energy and metals prices began to surge higher. Now we are seeing markets that were stronger after early 2004 turning lower and markets and sectors that we weaker turning higher.

The sharp rally in corn futures last year following the peak in crude oil and copper brought the ratio back to the 2004 trading range in a most dramatic fashion. Our sense is that the KO/SPX ratio is working in much the same way as relative prices adjust in a manner that will bring the ratio up to around .045. This is generally bullish for KO as long as the SPX doesn’t break any lower than around 1220 (i.e. if KO held flat and the SPX fell to 1220 the ratio would rise to .0457:1).