by Kevin Klombies, Senior Analyst

Wednesday, July 18, 2007

Chart Presentation: Rolling

One of our favorite views on the markets revolves around the idea that major sectors or themes are rising to peaks in two-year intervals creating a series of rolling bubbles.

The chart at top consists of wheat futures and the Philadelphia Gold and Silver Index (XAU). We are using these two markets to represent the broad commodity theme that rose to peak into 1996.

In 1998- two years after the end of the commodity cycle- a number of large cap consumer and pharma stocks hit cycle highs. For this theme we show the stock price of Coca Cola (KO) at middle right.

In 2000 the tech and telecom sector topped and turned lower so to represent this we have included a chart of Intel (INTC).

From an intermarket perspective themes tend to end as a new theme begins. The counter or inverse of the commodity theme tends to be the U.S. dollar which bottomed in 1995 and rose to its own cycle top two years after the techs in early 2002.

The counter or inverse to the consumer theme would be commodity prices in general and the relative strength of crude oil prices in specific. The lows for crude oil on both an absolute and relative basis were made towards the end of 1998 and one of the most powerful and enduring trends since 1998 has been the steady rise in crude oil prices.

Our view is that as soon as the U.S. dollar starts to show any kind of strength it should mark the end of the commodity rally. From this perspective the consumers are already on the rise similar to wheat futures and the gold miners back in 2005 with the cycle top due in a couple of years.

The tech and telecom theme should now be largely through putting in a bottom with the next peak forecast for some time in 2010.

The point is that it may still be several years before the Nasdaq is ready to lead the equity markets but as the markets rotate through the various themes the most likely candidate for surprising near-term strength still appears to be the large cap consumer names. We suspect that this will become more obvious once the commodity markets start to show real weakness.




Equity/Bond Markets

The chart compares the stock price of Wal Mart (WMT) with the spread between crude oil prices and the U.S. Dollar Index. With crude oil prices near 74 and the DXY just under 81 the spread is now close to -7.

Our view is that WMT does well when the dollar is strong and it also does well when energy prices are weak. This would mean that WMT should rise in price when the spread line is falling and decline or at best hold flat when the spread line is rising.

At the end of 1996 the spread line turned lower and this marked the start of a major price rally for WMT. From early 2002 to the present day the spread has risen so this helps to explain why WMT’s share price seems invariably to be at or near 48. It will take a better dollar and ideally lower oil prices to turn the trend back to positive. The good news, we suppose, is that WMT has had a hostile or negative intermarket environment for the past 5 1/2 years.

There have been a number of equity markets ‘crashes’ but the two that we are interested in today are the broad collapse in October 1987 and Hong Kong’s stock price break in October 1997. The idea is that if one or more markets are showing a tendency to buckle in the autumn of years ending in ‘7’ then it is about time to start paying attention.

Below we have include charts of the U.S. 30-year T-Bond futures from 1987 and 1997.

What intrigues us about this comparison is the way bond prices began to ‘drive’ at the end of March in both of these years. In 1987 bond prices turned lower and after making a bottom in May were able to consolidate into late August. When bond prices broke to new lows the equity markets began to top before eventually breaking lower in early October.

The bond market did almost the exact opposite in 1997 with prices pivoting upwards in April. The stock market collapse in Hong Kong was marked not by a downward spiral in long-term Treasury prices but rather by a ‘flight to quality’ price surge.

The chart below of the TBond futures from the current time frame suggests that if the initial price trend coming out of March is any indication the biggest concern later this summer will falling bond prices and rising interest rates. The set up would be very similar to 1987 if the TBond futures break below 105 with 10-year yields rising through 5.25% a month of two from now.