by Kevin Klombies, Senior Analyst

Wednesday, November 21, 2007

Chart Presentation: Macro

The wilder and more emotional the markets get the more likely we are to start off the day with a ‘macro’ perspective. Today will be no exception.

At top right we show a comparison between the ratio of the stock price of Coca Cola (KO) to the S&P 500 Index (SPX) and Phelps Dodge (PD) to the SPX.

For many years we used PD as our surrogate for the trend for base metals prices so we were somewhat saddened when it was taken over this past spring by FCX. However, basic argument put forth by the chart at right still holds so we will continue to use it for the time being.

The relative value of the mining sector peaked in 1981 and then declined for roughly 5 years before swinging upwards at the start of 1987. As the PD/SPX reached its cycle high the KO/SPX ratio was beginning to rise.

Thirteen years later in 1994 the relative value of the mining sector reached another top and as it peaked the KO/SPX ratio turned upwards. After another five or so years of weakness the miners bottomed out in 2000.

The idea is that the markets go through periodic love and hate affairs with the metals and mining sector ending in dramatic relative strength peaks about every thirteen years followed by a good five years of underperformance. If the cycle were to repeat exactly then the next top would be expected some time this year.

At bottom right we show the KO/SPX ratio and the ratio between the share price of FreePort-McMoRan (FCX) and the SPX.

In the midst of rampaging crude oil prices and crumbling financial stock prices the markets are grinding through the cycle in a relatively normal fashion. At the peak for the FCX/SPX ratio last month we find the break out for the KO/SPX ratio following several years of basing. In other words for as much as the current time frame appears to be wholly unique and utterly random we find bits and pieces of rather reassuring constancy.

If history repeats over the next few years the KO/SPX ratio should approximately double. It rose from .01 to .02 between 1981 and 1986 and from the low .04’s to around .08 following 1994. Something closer to .06 would be about right so even if the SPX holds between 1400 and 1500 for a few years KO could still push on towards 90.



Equity/Bond Markets

Canadian Natural Resources (CNQ on both Toronto and New York) is one of Canada’s preeminent energy producers. At right we show the spread between Brent crude futures and CNQ’s stock price along with the S&P 500 Index.

Through much of 2007 the Brent minus CNQ spread was very close to zero which simply means that CNQ was tracking up and down with oil prices which, we suspect, makes sense.

Recently the spread has widened to more than 20 points as oil prices have risen while equity prices have declined. The chart at right makes the case that any time the spread has risen to close to +20 since 2003 the SPX has been at a bottom.

The SPX can rise with oil prices and it can rise with oil price weakness. If crude oil is actually ‘fair’ at current levels then the oil stocks are likely 20% to 25% too low. If the oil stocks are ‘fair’ then crude oil prices are a good $20 too high. Either way the divergence has become large enough to suggest that if history were to repeat the SPX would be at or near a bottom now that it has once again declined below its 200-day e.m.a. line.

Quickly… the chart at bottom right compares Intel (INTC) and the Fed funds target rate from 1998 into 1999. The Fed was forced to save the banking system in 1998 during the Asian/LTCM crisis. When the Fed is forced to support the weakest sectors the stronger sectors tend to do very well but our point is that in October of 1998 it wasn’t glaringly obvious that the tech and telecom stocks were going to explode into a ‘bubble’. Intel did not break out of its trading range until November, 1998. We were pondering how to identify the ‘next bubble’ that could form out of the current credit markets crisis. It may take weeks or even months before this becomes more clear but we did notice that the chart of JNJ (below) is quite similar to the pre-bubble chart of Intel. For what that is worth , of course.