by Kevin Klombies, Senior Analyst

Monday, November 26, 2007

Chart Presentation: Primary trends

We often comment that the current market or cycle is similar to a previous market or cycle. We might note that this or that detail is reminiscent of something that we have seen before although in truth history tends to repeat more in generalities than specifics. Our thought is that the financial markets resemble primary colors in that there are only so many base ‘drivers’ that can influence a trend. Mixing red and green light, for example, yields shades of yellow, orange, and brown while combining red and blue yields shades of purple and magenta.

A market cycle can include falling or rising interest rates, positive or negative currency trends, strong or weak raw materials prices, and relatives strength or weakness in various equity markets. While money is constantly moving from sector to sector and region to region in search of the highest returns the fact that higher current prices limit future potential gains and lower current prices increase the future potential for profit turns ‘trends’ into ‘cycles’.

In any event the recent trend has been dominated by a weak U.S. dollar which, in turn, reflects private sector capital flows towards higher returns in foreign markets and results in an offsetting increase in central bank holdings of dollars. Those regions that have received the largest flow of speculative capital will tend to have central banks bursting at the seams with dollars so while it is common to read that when central banks decide to sell or diversify away from the dollar the dollar will collapse it is just as likely that similar to 1998 and 1999 speculative capital will flow back towards the dollar creating a drain on central bank reserves.

To start things off today we show the ratio between the Amex Oil Index (XOI) andcrude oil futuesprices. The chart above right runs from 1995 into 1999 while the chart below right starts in early 2006.

At present the ratio ofoil stocks(XOI) to crude oil prices is actually quite ‘low’. The ratio tends to rise up from the ‘base range’ of 14:1 to 18:1 whenoil pricesdecline which was most certainly the case between the start of 1997 through 1998. The only point that we are trying to make here is that reports of massive dollar holdings by China, Russia, and various OPEC countries reflect two component ‘drivers’- the previous flow of speculative capital towards these regions in search of higher returns and the massive shift in capital away from the users of energy towards the producers of energy. While history may not repeat exactly we only have to look back to 1997 and 1998 to see just how quickly these trends can reverse once oil prices peak and turn lower.



Equity/Bond Markets

We have written on so many occasions that this or that trend will reverse once crude oil prices turn lower but as of the end of last week crude oil prices had quite obviously NOT turned lower. However- ever hopeful as usual- we thought we would return to a relatively pedestrian chart comparison that we have shown on a number of occasions in the past.

Below is a chart that includes thestock priceof Boston Scientific (BSX) and the ratio between Exxon Mobil (XOM) and BSX.

The idea was that over time the XOM/BSX ratio travels through wide swings that reflect the flow of money towards and away from the energy and health care themes. When the ratio is strong and rising it tends to mean that energy as a theme is dominating while when it is declining it means that money is making a multi-year shift towards health care and consumer products.

We began running this comparison because a year or so ago we pointed out that there were two stocks- BSX and Lear Corp. (LEA) that tended to do very well once the Fed began to cut the funds rate. LEA ended up becoming embroiled in a take over battle so we decided to focus more on BSX.

The XOM/BSX ratio peaked in 1993 and then again seven years later in 2000. Our thought was that this had the appearance of a 7-year cycle that might lead to a third top in 2007.

The charts at right shows shorter-term views of this relationship with the top chart focusing on 1993- 94, the middle chart on 2000- 2001, and the lower chart detailing the current time period.

While the XOM/BSX ratio peaked in October of 1993 and December of 2000 the one detail that was consistent was that after rising to roughly 7:1 it then declined to 4:1 by March of the following year. Another thought was that key trends often reverse at the start of a new quarter which explain in part why BSX turned upwards in October of 1993 and January of 2001. Barring something dramatic in the trend for the dollar or crude oil prices it may be January before the markets get around to making any kind of substantive trend change.