by Kevin Klombies, Senior Analyst

Monday, July 10, 2007

Chart Presentation: Rates

We show a comparison between Caterpillar (CAT) and the sum of two U.S. home builders (DR Horton plus Hovnanian). The argument has been that when CAT is rising there is upward pressure on interest rates which in turn puts downward pressure on real estate. The last time CAT broke below its 200-day e.m.a. line the share prices of the home builders began to recover.

We show U.S. home builder Beazer (BZH) along with the pharma etf (PPH) and Anheuser Busch (BUD). The idea was that stocks like BUD, KO, and the PPH are rising back to the levels of 2004 as the home builders decline to the prices prevalent at that time.

The chart below shows Intel (INTC) and 10-year Japanese (JGB) bond futures. 10-year Japanese yields were last seen at 1.95% and we have argued for years that yields will have to rise through 2.0% if Japan is going to successfully escape from deflation.

The very quick point that we are trying to make is that cyclical strength is pushing interest rates higher to the detriment of the real estate sector and with such powerful and opposing forces at work we find it difficult indeed to have a consistent view on the trend for the bond market.




Equity/Bond Markets

The chart at right compares the S&P 500 Index, copper futures, and the sum of the Canadian and Australian dollar futures from the spring of 2006.

The basic point that were are trying to make here is that the last time the equity markets (S&P 500 Index) were driven higher by strength in the commodity cyclicals when the trend finally came to an end… the equity markets tumbled. In other words one has to be careful what one wishes for.

The peak in the CAD plus AUD went exactly with the peak in copper prices in May of 2006 and one day after the SPX began to tumble. Notice that the SPX continued to decline right through the 200-day e.m.a. line until copper prices finally reached a bottom towards the middle of June.

So… the argument is that any market that is being pushed higher and higher by sectors like the oils and mines can decline very quickly when the commodity theme comes to an end. Another point might be that the equity markets could well ‘lead’ to the down side to tell us when the turn has come.

The last point is that while the SPX declined by close to 8% in the spring of 2006 not all stocks and sectors were negative. Below we show two charts of Genentech (DNA) with the chart below from late 2005 into the summer of 2006.

What intrigues us about these chart is not only that DNA bottomed in May of 2006 as the SPX, copper, and commodity currencies were topping but also that it had just completed a 6 month correction. From December 2005 into May 2006 the trend for DNA was lower as the trend for the commodity sector was higher.

Notice that DNA has now been negative for close to six months so, in a sense, history does seem to be repeating itself. DNA reports earnings tomorrow so at minimum the response has to be no worse than neutral for this to work but we do like the idea that the biotechs can show strength even if the commodity stocks pull the broad market lower.