by Kevin Klombies, Senior Analyst

Wednesday, June 18, 2008

Chart Presentation: Looking Ahead

One of our arguments of late has been that the markets have shown a tendency to change trends at the start of the year and at the midway point so as we approach the end of this month it is time to start thinking about what might happen next.

At top right we have included a comparison between the sum of copper and crude oil futures along with the sum of the U.S. 30-year T-Bond futures and the U.S. Dollar Index (DXY).

The idea is that at roughly six month intervals the combination of long-term Treasury prices and the dollar has moved higher and lower. In fact the trend was positive through the second half of both 2006 and 2007.

A rising trend for bonds and the dollar tends to create a shift within the equity markets away from the oils and the base metals. Through the second half of 2006 the equity markets favored most of the non-commodity cyclicals while through the second half of last year the focus was pointed at the golds as the financials weakened.

Below right we show the Japanese 10-year bond (JGB) futures and the ratio between equities (S&P 500 Index) and commodities (DJ AIG Commodity Index).

At the end of June in both 2006 and 2007 the Japanese bond market turned higher with markedly different results. In 2006 with equities ‘low’ relative to commodities the trend change favored the S&P 500 Index while in 2007 the shift created exactly the opposite outcome.

At present the equity/commodity ratio is once again ‘low’ at just below 6 times. In 2000 the ratio exceeded 17:1 after turning higher back in 1995 from roughly 4.5:1.

The point is that if the markets are going to change gears then it is likely that the next trend will go with a better dollar, stronger bonds, or some combination of the two. If this is the case then we will make the argument that the relative strength leaders through the next six months will not be the oils and the mines. On the other hand… why bond prices show strength will also be important. Bonds tend to rally for one of two reasons- cyclical weakness which tends to show up through falling copper prices- and financial markets crisis. The former would be better for the consumer, health care, and financial sectors while the latter would obviously be better for the golds.



Equity/Bond Markets

On this page we have included three comparisons based on the sum of copper and crude oil futures and the U.S. 30-year TBond futures. The chart at top right is from 1990 into 1991, the chart below right is from the end of 2005 into 2007, while the chart directly below is from the current time period.

The lows for the equity market (SPX) were made in early October of 1990- a few weeks into the start of a new quarter. Concurrent with the start of a rising trend for stocks two things happened- bond prices turned higher while oil prices broke lower.

We have argued in the past that copper prices tend to rise with crude oil but then turn lower a few months before energy prices so for today’s view we have combined copper and crude oil prices.

In 1990 the bond market bottomed in late September just ahead of the equity market (around 13 trading days) and at the peak for energy and metals prices.

In 1996 the bond market bottomed in late June just ahead of the equity market (around 12 trading days) and very close to the peak for energy and metals prices.

At present the bond market has managed NOT to make new lows for two entire trading sessions while the sum of copper and crude oil prices holds near the highs. The argument would then be that roughly 2 to 3 weeks after the bond market makes its final low we could well be at the starting point for a sustainable equity markets recovery that would go with a decline in crude oil and copper prices back to at least this past January’s levels.