by Kevin Klombies, Senior Analyst

Tuesday, June 12, 2007

Chart Presentation: Relationships

The chart compares the S&P 500 Index (SPX), the U.S. 30-year T-Bond futures, and crude oil futures.

When crude oil prices are either strong or weak the bond market tends to move in the opposite direction. In other words a rising trend for energy prices goes with a falling trend for bond prices and vice versa.

Over the past number of months crude oil prices have been chopping back and forth between roughly 61 and 66.50. In early May oil prices began to rise from the bottom of this range back to the top with the TBond futures working down from around 112.

The chart argues that the equity market is able to rise in the face of falling bond prices as long as crude oil holds within the channel. Fair enough. Last Thursday, however, crude oil futures pushed through the top of the range and in response bond and equity prices fell sharply. On Friday oil prices moved back into the range, bonds rallied up from the early price weakness, and the equity markets strengthened.

Below we show the U.S. Dollar Index (DXY) futures and the stock price of chip maker Intel (INTC).

To get a sense of what happened last week consider that on Thursday the cyclical trend pushed oil prices through resistance creating a sharp decline in financial asset prices. The next day the dollar broke through resistance putting downward pressure on commodity prices which in turn pulled crude oil back into the established trading range. The tech and telecom stocks tend to trade with the dollar so following Thursday’s rout the equity markets staged a recovery based on a better dollar and strength in stocks like Intel while bond prices began to flatten out.

In a strong cyclical trend interest rates will rise but the charts argue that if crude oil futures prices hold within the trading range then the recent negative pressure on bond prices should abate. The dollar’s strength suggests that cyclical trend is shifting away from the weak dollar/commodity theme and back to some of the non-commodity sectors.

Our views are that the equity markets should be positive as long as crude oil futures hold below 67 with the bond market now in the process of groping for a price bottom. A more dramatic sector shift that would be positive for the consumer, pharma, and airlines sectors would occur if crude oil futures prices break below 61.



Equity/Bond Markets

We show a chart comparison of, from bottom to top, the ratio between corn futures prices and general commodity prices (CRB Index), IBM, Anheuser Busch (BUD), Fannie Mae (FNM), Boston Scientific (BSX), and an upside down view of the Canadian dollar futures.

The argument was that when energy and metals prices began to rise in early 2004 it pushed interest rates higher. As interest rates moved upwards many non-commodity stocks began to decline including IBM, BUD, FNM, and BSX. Through the upside down view of the Cdn dollar we can see that the forex markets shifted strength towards the currencies of commodity producing countries.

We have been arguing that those sectors that were forced down from the levels of 2004 are in the process of recovering. Note, for example, how the rally in corn prices last year snapped the corn/CRB ratio back to the same level as early 2004 in the same way that IBM’s share price worked back to the 100 level earlier this year.

The clear laggard in this group is BSX which remains well below 2004’s peak. We have included a comparison between BSX and steel producer Nucor (NUE) to show that these two stocks tend to trend in opposite directions.

We have been looking for ‘gaps’ in the equity markets so we were intrigued by the action in NUE yesterday. Below we show how NUE gapped lower while semiconductor company NSM gapped higher at the end of last week.

We credit Fannie Mae’s recent strength to the widening of the yield spread that has come from rising long-term interest rates. On the other hand BSX tends to do better when short-term interest rates are declining which makes NUE’s reaction all the more interesting. If the steels turn lower now then we actually may see lower short-term interest rates some time later this year.