We tend to believe a market is in a ‘bubble’ when one starts to read about absurd comparisons. When the market cap of a company or the price of an asset class is so high that it no longer makes sense… then it is in a bubble. A simple example would be Japanese real estate back in 1989. At the peak for Japanese asset prices the real estate value of Japan’s Imperial Gardens exceeded that the states of Florida or California. That was the absurd comparison.
People love to sell short markets that make no rational sense and, invariably, they get driven out at higher prices for big losses. In a battle between momentum and common sense one is best off siding with momentum. It has been our experience, however, that the best time to sell a bubble is well after prices finally break to the down side because… invariably it takes close to two years before a bubble market becomes thoroughly washed out.
Our point is that when a market or sector reaches a true bubble peak it is unlikely to turn sustainably higher for at least two years.
Belowwe compare the stock price of Amazon (AMZN) from 1999- 2002 with crude oil futures. When AMZN finally broke to the down side at the end of 1999 the ensuing bear market managed to run right through into late 2001.
We will argue that crude oil prices into 2008 represented a bubble. We will argue that prices were driven by momentum trading, fed by ever-increasing analyst price targets, and made little in the way of rational sense. Others will likely take issue with this view but if we are correct then our point is that crude oil prices may rally- often- but they are not going to turn positive until some time in 2010.
Our conviction is that the CRB Index/crude oil ratio will resolve to the upside. In other words regardless of what oil prices do on an absolute basis one of the defining trends for years to come will be relative price weakness for crude oil prices. It is our conviction that the ratio between the Airline Index (XAL) and the S&P 500 Index (SPX) will resolve to the upside as the airlines benefit later this year from improved economic growth without the negative impact of sharply increased fuel costs.
March 10 (Bloomberg) – Stocks around the world staged the biggest rally of the year after Citigroup Inc. said it was having its best quarter since 2007, spurring speculation the worst of the banking crisis is over. Treasuries and gold fell.
The equity markets were definitely better yesterday so we thought we would return to two chart comparisons that we have argued would help to define or show the eventual ‘turn’.
Below we feature the yield index for 10-year U.S. Treasuries (TNX) and the ratio between Japanese bank Mitsubishi UFJ (MTU) and the gold etf (GLD).
The ongoing argument is that rising yields (TNX) represents improving cyclical strength. When the stock market begins to strengthen we would expect to see the financials (MTU) rise relative to gold prices (GLD). The chart shows that 10-year yields rising above 3.05% would be helpful while an eventual push above the 200-day e.m.a. line (currently close to 3.25%) would help confirm the trend change towards higher yields. Our view is that 10-year yields will approach or surpass 4.0% towards the end of this year.
Belowwe show the ratio between the Amex Oil Index (XOI) and the S&P 500 Index (SPX), the share price of Carnival Cruise Lines (CCL), and Wells Fargo (WFC). When the equity markets are ready to push sustainably higher we should see improvement in both WFC and CCL as the XOI/SPX ratio breaks below recent support on the way down through its 200-day e.m.a. line. So far, so good… although it is still far too early to mark this one as paid.
Quickly… below we show heating oil futures and the share price of Nucor (NUE). If the equity markets have reached some kind of bottom then the question is… what to buy? As mentioned on page 1 we still believe that 2008’s price peak for crude oil marked the end of a decade-long trend dominated by energy price strength. Since the basic trend for something commodity sensitive like steel maker Nucor is similar to that of heating oil and we are not looking for strength in energy prices… it still makes sense to us to focus on energy ‘user’ sectors like the airlines instead of the commodity ‘producer’ sectors like Nucor.
