by Kevin Klombies, Senior Analyst

Monday, December 24, 2007

Chart Presentation: Macro Perspectives

We were pondering what to show today given the rather thin nature of the end-of-year trading. As usual when we are at something of a loss with regard to the short-term trend we revert to more macro perspectives so today will be no exception.

The chart at right compares, from bottom to top, the ratio between Intel (INTC) and the CRB Index, the S&P 500 Index (SPX), and 3-month eurodollar futures.

In many respects the equity bull market is long in the tooth after a five-year run with some kind of cleansing bear market somewhat over due. On the other hand we can make the case that a new trend began roughly 18 months ago and likely has a good 4 years of life left in it.

On the chart there are three bottoms for eurodollar prices that mark the three peaks for U.S. short-term interest rates. The first bottom occurred around the end of 1994 at the starting point for a prolonged rise in the relative value of ‘tech’ compared to commodity prices.

The second bottom for eurodollar prices occurred at the end of the third quarter of 2000 (five years and 9 months later) at the peak for both the SPX and the INTC/CRB Index ratio.

The third bottom for eurodollar prices was made in mid-2006 at the bottom for the INTC/CRB Index ratio. In other words following a bull market for tech vs. commodity that extended for 5 years and 9 months the markets then spent the next 5 years and 9 months pushing commodity higher versus tech with each major trend shift marked by a concurrent low in eurodollar prices.

The point is that if the pattern continues we should see relative strength in the share price of Intel compared to the CRB Index for at least the next 4 years with the cycle coming to an end the next time the Fed completes a long tightening trend. Given the Fed’s recent experience with monetary tightening we suspect it will be some time before it musters up enough conviction to start pushing interest rates higher.


Equity/Bond Markets

In early 1999 the Bank of Japan pulled short-term interest rates down to close to 0%. The chart at right shows that euroyen futures traded close to 99.9 into early 2000 and for most of 2001 through into early 2006.

The Bank of Japan has attempted to move its policy rate up from 0% on two occasions- 2000 and 2006. Concurrent with a rising trend for Japanese short-term interest rates the U.S. 2-year T-Note futures have begun to trend upwards. In other words each time the Bank of Japan attempts to tighten the U.S. Treasury market starts to ease in anticipation of a cyclical slow down and/or markets crisis.

The premise is that bad things seem to happen each time the BOJ raises interest rates.

Euroyen futures prices began to decline in early 2006 so we will use that as our reference point as we consider the comparative chart of Mitsubishi UFJ (MTU) and Bear Stearns (BSC) below right.

The negative trend for MTU began in early 2006 while BSC ballooned upwards into early 2007 before collapsing back to the same falling trend line that has governed the share price of MTU. Put another way the collapse of the U.S. banks and brokers this year pulled them back to the negative trend line that was initiated in early 2006 when the cost of Japanese credit began to increase.

The reason North American financials crumbled had much to do with weakness in the U.S. housing market which makes the comparison below of euroyen futures and U.S. home builder DR Horton (DHI) rather intriguing. The argument is that the driver behind the weakening U.S. housing market that worked into the U.S. financial system was an increase in Japanese (and likely European) short-term interest rates so to the extent that the never-ending series of crises causes lower policy rates and higher euroyen and euribor prices… there is a reasonable chance that 2008 will be a much better year.