by Kevin Klombies, Senior Analyst

Monday, November 19, 2007

Chart Presentation: Money

Many will lay the blame for recent asset price bubbles on the door step of the Greenspan Fed- and to some extent that is likely a good place for it to rest- but even with a 1% funds rate the U.S. was never the low cost source of credit. That particular honor belonged to, and remains with, Japan.

The chart at top right compares the NASDAQ Composite Index with Euro yen futures. At a price of 100 Euro yen futures would reflect a yield of 0% while at or near 99.90 the yield would be roughly .1% which, more or less, is effectively 0%.

Following the Asian crisis in 1998 the Bank of Japan pushed short-term interest rates down close to 0% in an attempt to reinflate Japan’s real estate and equity markets. In response the credit created shifted into the tech and telecom sectors as the NASDAQ rose from 1500 to 5000.

Through the first half of 2000 Japanese yields began to rise as Euro yen prices moved lower and the chart shows that in virtual lockstep the NASDAQ began to weaken.

By late 2000 central banks were forced to stop fighting inflation and return- with vigor- to inflating asset prices. The chart below compares Euro yen futures with the stock price of U.S. home builder DR Horton (DHI).

One could identify any number of recent asset price bubbles ranging from gold and crude oil to Asian and emerging markets stocks. The chart, however, suggests that the first and perhaps primary bubble occurred in the U.S. housing market as free money from Japan translated into free money in the U.S. for the speculative purchase of built and yet to be built houses and condos.

We are currently slogging through the post-binge hang over associated with the cessation of free money from Japan in the spring of 2006. Notice on the chart at right how the start of declining Euro yen futures prices went almost directly with a negative trend for the home builders. In a sense the charts are arguing two things. First, that the markets and, perhaps, global growth remain inextricably linked to near-free credit (which, we would argue, still suggests that the deflationary trend remains intact) and second, the birth of the next great asset price bubble is only one ‘crisis’ away from taking place. If, that is, it hasn’t already begun to form.



Equity/Bond Markets

The charts at top right compare the sum of two U.S. home building stocks- DR Horton and Hovnanian (DHI plus HOV) with commodity prices (CRB Index). The charts have been shifted or offset by just under a year.

IF the positive trend for the home builders began at the end of 2000 in response to the return to 0% interest rates in Japan AND the positive trend for commodity prices did not begin for a full year THEN we could argue that the home builders are leading and the CRB Index is lagging.

With the charts offset we can ‘see’ that the peak for the CRB Index in 2006 lines up with the 2005 highs for the home builders. We can also make the case that the rally for the home builders through the second half of 2006 has helped create the positive trend for commodity prices for much of this year.

We could obviously shift the chart comparison a few months in either direction but the broad idea is that the home builders turned upwards first with commodity prices following and the builders peaked and turned lower well in advance of the CRB Index in 2006. To the extent that the home builders have not yet bottomed we will argue that whatever low the CRB Index is going to reach likely won’t be made until at least the final quarter of 2008.

At bottom right we show the pharma etf (PPH) and the ratio between equity prices (S&P 500 Index) and commodity prices (DJ AIG Commodity Index).

We are specifically focusing on the red dashed declining trend lines that start in March 2006 and June 2007. These lines show the negative or corrective trend for equities relative to commodities. The point is that the ratio bottomed in July of 2006 some 16 trading days before the final peak in crude oil futures prices. 5 trading days have elapsed this month since the ratio bottomed. We show two charts of crude oil futures below with the top chart marked with the July bottom for the ratio and the number ‘16’ just above the final August high for oil prices. The bottom chart shows the current time frame. The idea is that- in theory- we are very close to the highs for crude oil but… this could still drag on for another two weeks. As long as the equity/commodity ratio holds the lows and the pharma etf pushes higher then the actual peak for oil prices is simply a matter of patience and time.