by Kevin Klombies, Senior Analyst, TraderPlanet.com
We have argued from time to time over the past number of years that the markets have been running six month or two quarter trends. Through the first half of 2006, 2007, and 2008 the trend was dominated by rising energy prices while through the final half of both 2006 and 2007 the trend was generated from weaker energy prices. The argument coming into the end of the second quarter this year was that the next trend should favor non-energy cyclicals like the airlines along with the consumer defensive and health care sectors.
At top right we show the pharma etf (PPH) and airline AMR from 2006 while below right we show the same comparison for 2008.
There were very few stocks higher yesterday but AMR, Continental, and U.S. Airways were all up 6- 8% which, we imagine, makes sense given the weakness in crude oil prices. Similar to 2006 the airlines started to do better during the second half of the year.
The problem for us is that the pharma sector has yet to show any kind of life. The PPH made a low in October and has held nicely above that low through yesterday’s ‘test’ but on an absolute basis this can hardly be called a positive trend. On the other hand… the picture looks significantly different on a relative basis. Below we show the ratio of the PPH to the S&P 500 Index to point out that instead of being weaker than 2006 the pharma sector is actually significantly stronger relative to the broad market. While not going down as much as the market is much less profitable than actually going up… these days one takes what one can get.
We are going to take another run at an argument that we made on yesterday’s third page. We tend to throw quite a bit ‘against the wall’ so the more often we return to a topic the greater our conviction.
The second chart below shows the stock price of nickel producer Inco from 1987 through 1988.
The argument begins with the idea that commodity prices tend to lag the bond market by two years. The bond market turned lower in the spring of 1987 so the expected peak for commodity prices was some time in early 1989.
When the stock market ‘crashed’ in October of 1987 it hit virtually all stocks. Inco’s share price declined from 24 down to 13 during the concentrated blood bath. By December Inco had pushed back near the highs and in early 1988 it broke to new highs before pushing on to 35 by mid-year.
In the current cycle the bond market turned higher in mid-2007 so the commodity markets are expected to remain negative into the middle of next year. In other words while the stock markets have once again ‘crashed’ into October the underlying trend is somewhat different. Our view is that stocks like Johnson and Johnson and Wal Mart are in positive trends and could push on to new highs in the coming months.
Whether we are right or wrong in the details remains to be seen but the key is that the first stocks back to the recent highs will help confirm the nature of the underlying trend.
Below we show two charts of Citigroup (C) and the spread or difference between 10-year and 3-month U.S. Treasury yields. The chart below runs from 2000 through 2002 while the chart below right begins at the start of 2006.
The point is that the yield spread went negative at the end of July 2000 and again at the end of July 2006. The bottom for Citigroup was made in October of 2002 so if ‘time’ is actually important a bottom this month for C would represent the exact same lag to the yield curve inversion as occurred between 2000 and 2002. Make sense?
