by Kevin Klombies, Senior Analyst,

We started off the week by suggesting that we expected that the equity markets would bottom out around the end of the week. We mentioned in yesterday’s issue that previous October crises had reached a selling climax around October 9th- give or take a day. We also noticed while digging back through the charts of cyclical sectors showing extreme weakness into October that the lows were often made around October 10th. Of course this does not include the October 1987 stock market crash or factor in the tendency for equity markets that begin the quarter under pressure to pivot back to the upside around the final week of the month. Perhaps we should just write that the markets will rally from these or lower levels and be done with it…

At right are two charts that we showed on numerous occasions through the first half of the year. The charts compare the U.S. 30-year T-Bond futures with crude oil futures times natural gas futures. We use oil times gas as a surrogate for the general energy price trend.

The top chart runs from the end of the first quarter in 2000 through into mid-2002 while the lower chart begins at the end of the third quarter in 2006 and runs to the present time period.

The argument was that while the rise in crude oil prices through June this year may have felt extraordinary it was, in fact, quite similar to 2000. The sequence begins with bond prices making a bottom- as they did in January of 2000 and again in July of 2006- and then moves on to the peak for crude oil times natural gas one year later. From there bond prices tend to rise (although not in a straight line) until the product of crude oil times natural gas returns all the way back to its original starting point.

The parabolic rise in energy prices from mid-2007 through mid-2008 becomes little more than a replay of the end of the Nasdaq’s cycle. We argued as well that the peak and subsequent break in the Nasdaq in 2000 forecast the cyclical decline in energy prices just as the peak and rather obvious decline in the Chinese equity market indicated trouble ahead this time around.

Our point? The TBond futures (which were sharply lower yesterday) still look generally higher to us. Energy prices, of course, still look lower. If history continues to repeat the next top for the TBonds will not be reached until the product of crude oil times natural gas declines to something closer to ‘400’.



Equity/Bond Markets

We are usually lucky if we can time a major trend change to the nearest calendar year but… for a change of pace… we thought that we would show something equity markets bullish.

We tend to believe that any time the markets create either intense levels of greed or fear the correct trade is do the exact opposite. When the herd is stampeding in it is best to get out and when it is fleeing through every available exit it is usually time to get in. Not the deepest of thoughts we suspect that they shall serve as something of a segue to comments below.

Below we have included a charts of the CRB Index and the S&P 500 Index (SPX). The charts have been offset or shifted by a bit more than a year and a quarter.

The argument is that the CRB Index bottomed in late 2001 while the SPX did not turn higher until early 2003. In other words the commodity markets have been leading the equity markets for the past seven or so years.

The 2006 peak in the commodity markets lines up with the 2007 top for the equity markets with the sharp sell off into January of 2007 for the CRB Index creating downward pressure on the SPX into 2008. If the relationships were to be kind enough to continue then the SPX would not only recover but do so in a manner that could well lead to new all-time highs into 2009.

The problem is that the pivot was supposed to begin back in July as energy prices turned lower. The chart below right shows that both Wells Fargo and Carnival Cruise Lines started to recover before being pressured to the down side by the financial markets crisis.

The final point is that the U.S. equity markets were supposed to act as an anchor. By this we mean that our expectation was that the SPX would outperform foreign equity markets but the problem is that the SPX continues to slide. It is still outperforming but not in a very profitable manner.