Chart Presentation: Sacred Cows

As of yesterday the markets were still pricing in a 50 basis point decline in the Fed funds rate following the March Fed meeting with some chance of 75 basis points. While the elevator ride down from 5.25% has been rapid we have yet to get to the bottom. In yesterday’s issue we made the argument that long-term Treasury yields should reach the lows some time towards the end of the current quarter and after yesterday’s equity markets drubbing that still seems reasonable.

Below we show a comparison between, from top to bottom, Google (GOOG), the gold etf (GLD), crude oil futures, and the euro futures.

Many economists believe that the U.S. economy is already in recession which explains the weakness in the equity markets. On the other hand commodity prices remain near record levels which, we submit, is at odds with the notion of true cyclical weakness. The net result has been declining U.S. interest rates in response to economic concerns and stable European interest rates due to inflationary concerns.

One stock and one sector at a time the markets have been hammering anything that dares to disappoint. Time and time again we have seen earnings come in above consensus followed by chasm-like stock price declines. This was certainly true for Google through the month of January as the stock price fell from north of 700 to roughly 500.

The chart comparison makes the rather simple but hopefully compelling case that there are a few markets that have yet to crack. As Google turned higher last August the euro, crude oil, and gold prices began to rise.

Our view is that momentum-based money has crowded into these sectors in search of positive relative returns but that in due course the markets are going to take a turn ravaging even these sacred cows. Of the three crude oil prices are the closest to support so if the 87 level fails to hold we could see the euro back at 1.35, gold prices down closer to 650, and crude oil prices back into the mid-60’s. This would go with the U.S. Dollar Index moving back towards roughly 82 while the Cdn dollar declines back into the .93- .95 range.

In yesterday’s issue we argued that based on recent cycles it appears that long-term U.S. interest rates will bottom towards the end of the current quarter before rising for the next 12 to 15 months.

We also showed that a number of sectors tend to trend with yields including Japan’s Nikkei, the biotechs, and the tech sector.

Today we wanted to show how this might work using the stock price of Micron (MU). Micron, by the way, gained 3 cents yesterday in what was almost an across-the-board rout.

The chart below compares MU with the yield index for 10-year U.S. Treasuries (TNX) from 1998 into 1999. Yields reached a bottom around the end of the third quarter of 1998 but the actual low for MU was made several months earlier in June.

Below right we show the same comparison from late 2002 through 2003. The bottom for yields was reached close to the end of the second quarter (i.e. June) while MU actually bottomed back in February.

Below is the same comparison for the current time frame.

The argument is that yields will tend to bottom close to the end of the quarter but ‘close to’ could range anywhere from early March through into early April. MU, on the other hand, has shown a tendency to bottom several months ahead of the lows for yields so, if history repeats, the January lows for MU will likely hold. Put another way as long as MU holds at or above the January price lows in the mid-5’s we can make a reasonable case for a bond price peak some time over the next two months. Perhaps the most bullish argument for MU that we could make would be based on the observation that the last two times 10-year yields hit bottom MU’s stock price was sitting on its 200-day e.m.a. line which at present is just moving below the 10 level.