by Kevin Klombies, Senior Analyst TraderPlanet.com
Friday, June 29, 2007
Chart Presentation: Outcomes
We show a comparative chart of the sum of the stock prices of Cisco (CSCO) and Nortel (NT) along with 10-year U.S. Treasury yields from 1999 into 2001. Below we show the stock price of U.S. steel maker Nucor (NUE) and 10-year Treasury yields from the current time period.
Trends tend to change when it makes the least amount of sense. In January of 2000 the U.S. economy had just completed a roaring quarter to end off 1999 and with the world’s computer systems still intact following Y2K and the Nasdaq powering higher almost daily it certainly made little in the way of sense for long-term interest rates to start to decline. But they did. The consensus was that it was a technical reaction to the Treasury’s decision to stop auctioning 30-year bonds.
The chart shows that 10-year yields peaked in January close to 6.8% and then declined to a low of 5.7% in April before holding that level into late October. What the bond market was ‘saying’ months before the Nasdaq reached a top was that cyclical growth was slowing.
Almost one year after 10-year yields began to decline the Fed decided that perhaps it was time to stop worrying about inflationary pressures and get down to the task of offsetting the weakness in capital spending by cutting the funds rate.
The recent cycle was very similar to 2000- up to a point. 10-year Treasury yields peaked at the end of June in 2006 and then worked down to just below 4.5% into November. If basic materials stocks like Nucor were following the script perfectly then prices should have peaked out this past February to be followed by new lows in Treasury yields and a Fed funds rate cut this month. We hate it when the markets decide to abandon the script and simply ad lib.
Going forward there are two outcomes that we have to watch out for. The first would be lower bond yields and higher bond prices with 10-year yields moving to new lows. This would indicate that the ‘top’ for the cycle is similar- albeit longer in duration- to 2000. Our expectation is that this outcome becomes much more likely if stocks like Nucor, U.S. Steel, Caterpillar, FreePort-McMoRan, and perhaps even Exxon starting breaking below their respective 200-day e.m.a. lines. Notice that combination of CSCO and NT led 10-year yields lower during the autumn of 2000 to be followed, as usual, by the Federal Reserve. We will show the alternate outcome on the next page.
In 1987 bond prices began to decline in March and after reaching a bottom in May the bond market went ‘flat’ into late August. As bond prices began to decline once again the equity markets stopped rising and moved into a ‘top’ that extended through into early October to be followed by a very sharp decline.
The 2007 bond market also turned lower in price at the start of March and has just recently made a bottom around 105 that goes with 10-year Treasury yields reaching 5.25%. Our argument is that as long as the TBonds hold above the June lows the equity markets should remain positive but if bonds continue to decline later this summer then it opens up the very real potential for a problem in the equity markets. In other words… as long as Treasury yields remain between roughly 4.4% and 5.25% we like the equity markets.
It is strange indeed to see stocks like Ford (F) push to new recovery highs with JetBlue (JBLU) moving upwards even as crude oil futures nip above 70. Strange indeed. The most dominant negative for the autos and airlines has been strength for crude oil relative to commodity prices in general so this type of price action tends to suggest that there is either a very negative surprise due for crude oil prices or the rest of the commodity market is getting ready to stage a big recovery.