We have argued- repeatedly, actually- that the broad U.S. stock market will recover once the oils begin to lose relative strength. While one might think that crude oil futures prices tumbling from around 147 to less than 40 would get the job done… the major oils continue to show rather impressive relative strength. We start off today with a chart-based look at this relationship.
Belowis a comparative chart showing the ratio between the Amex Oil Index (XOI) and the S&P 500 Index (SPX) and the ratio between crude oil futures and the CRB Index from early 1998 into 2003.
If we had shown a longer-term comparison a very strong case could be made that the trends for the XOI/SPX ratio and crude oil/CRB Index are virtually identical. In other words when oil prices are stronger than general commodity prices the oils are stronger than the broad equity market. Conversely when crude is weak relative to commodity prices then the oils are typically weak relative to the S&P 500 Index. We trust that this makes intuitive sense.
The relationships have diverged, however, with the most recent example occurring back during 1999 and 2000. The crude oil/CRB Index ratio pushed sharply higher through 1999 and into 2000 even while the XOI/SPX ratio held near the lows. Why? Because the techs and telecoms were attracting all the money.
The point is that the base trend for the XOI/SPX ratio is similar to that of crude oil/CRB Index although during periods of extreme emotion- either fear or greed- the trends can diverge. Such has likely been the case since mid-2008 as the ratio of crude oil to the CRB Index declined rather dramatically even as the XOI/SPX ratio held very close to record highs.
Our view is that the markets are behaving in a manner similar to 1999. At that time strength in tech and telecom limited the flow of capital into the oils while in the current time period weakness in the financials has kept money from leaving the oils. In other words even with sub-50 crude oil prices the markets are loathe to move away from the oils and, in fact, appear ready to pile back into them at every opportunity simply because they represent a sense of stability in a very unstable world. All of which brings us back to our original point- the broad U.S. stock market will begin to recover once the oils start to lose relative strength.
On today’s first page we suggested that relative strength in the oils through 2008 may, in some ways, be similar to the relative weakness exhibited by the major oils during 1999. To quickly expand on this idea we show the U.S. 30-year T-Bond futures from the current time period below along with the Nasdaq Composite Index from late 1997 into the autumn of 2001.
The quick argument would be that strength in the TBonds is similar to relative strength in the oils in that both reflect money moving towards some form of safety. If the oil sector began to show relative strength in 2000 once the Nasdaq reached a peak and turned lower then the oils could move towards relative weakness once the bond market begins to weaken.
Below arecharts of Cisco focusing on the final six months of 2006, Valero through the first half of 2007, natural gas producer Chesapeake through the first half of 2008, and AMR through the final half of 2008.
We have argued on occasion that the equity markets have been running ‘six month themes’ with the first half of the year dedicated to some form of energy price strength and the second half of the year focused on energy price weakness. The airlines and golds, for example, have tended to do through the final six months of the year while the oils, natural gas producers, or refiners have taken a run through the first half of the year.
The point that we are attempting to make here has less to do with ‘what’ and more to do with ‘when’. Aside from the fact that it is January and this is the time of the year when the markets tend to swing back to some form of energy theme the idea is that most of the pivots have not taken place until a few weeks into the first month of the quarter. In other words Cisco was weaker into its earnings report in August of 2006, Valero and gasoline prices started 2007 off to the down side, Chesapeake lost a quick 10% in January of 2008 before turning upwards, and AMR did not begin to strengthen until the middle of July. Put another way… we realize that the cyclicals are kicking back into gear but ideally it is still a bit too early for the next trend to emerge.