by Kevin Klombies, Senior Analyst

Friday, July 20, 2007

Chart Presentation: Selling the Banks

We adhere to the view that the hardest trade often turns out to be the best trade. With that in mind we did a quick survey a few weeks back of a few Canadian retail brokers asking them what, in their view, the hardest trade would be. Specifically we wanted to know what one idea their clients would be the least receptive to. To our surprise the answer was ‘selling bank stocks’.

We can understand why, we suppose, given that the Bank of Nova Scotia (BNS) has risen at a constant and compounding rate of about 18% since Japan’s asset markets began to crumble in 1990 and was a stellar performer during the tech and telecom melt down in 2000. It also provides a dividend yield of close to 3.5% so there is a lot to like here. Another reason why share holders are reluctant to sell is the prospect of a huge tax on the capital gain so from a growth, income, and taxation perspective it makes sense that selling the banks is truly the ‘hard trade’.

We have shown and argued in the past that the positive trend for the Canadian banks along with stocks like Bear Stearns (BSC) has been created by the long decline in Japanese interest rates (chart on page 4). We have also argued that the dividing line between disinflation/deflation and positive inflation appears to be 2% for Japanese 10-year yields (last seen at 1.90% today).

Today we wanted to show one more reason why we believe that the Canadian banks may be very close to the top of a major cycle and not likely to see these prices again for years to come.

The chart above compares the Bank of Nova Scotia (BNS on both Toronto and New York) with Intel (INTC) back in 2000. Notice that the BNS was just beginning to swing up through its 200-day e.m.a. line in March as the Nasdaq approached its peak. The offset to the early deterioration in capital spending in 2000 was lower interest rates even though the Fed remained concerned about inflation until January 2001.

Below we show Intel and BNS from 2007. Notice that this time around INTC pushed up through its 200-day e.m.a. line in March at the top for BNS. It is like the markets in 2000 but only in reverse. Instead of weakness in tech leading to strength in the banks we find potential weakness in the banks going with strength in tech. Given that 7 years later stocks like Intel, Cisco, Microsoft, Nortel, etc. have come no where close to their trading levels of 2000 perhaps selling the banks this summer is not only the hardest trade but the smartest trade.



Equity/Bond Markets

The chart compares the stock price of Google (GOOG) with 3-month U.S. T-Bill yields.

This is an odd comparison for two reasons. First it makes no sense and second… it has worked. We have been showing this for the last couple of years to make the point that GOOG’s stock price has been tracking higher with short-term yields rising from 200 when yields were 2% to 500 when yields finally reached 5%.

We are showing this today because GOOG’s share price ended the regular session around 548 yesterday suggesting that the next rate change by the Fed will be higher and is now trading around 508 after reporting earnings. Since our view is that next rate change by the Fed will be lower instead of higher GOOG at or below 500 fits in quite nicely.

Microsoft reported earnings as well after the close yesterday. Our chart (below right) suggested that the 31.50 price would act as resistance until we reached the end of the rising trend for energy prices. MSFT ended the session at 31.51 and is showing 30.90 in late trading.

We featured a ‘crash top’ scenario for gasoline futures prices yesterday on page 5 and will show the charts once again today. Obviously gasoline futures prices did not ‘crash’ yesterday.

What we did find interesting was the weakness in the share prices of stocks like Nucor (NUE- down 1.19) and Valero (VLO- down 1.41) and the small decline in the Amex Oil Index (XOI) on what appeared to be a positive day for the energy sector.

VLO has corrected back to its 50-day e.m.a. line and through the rise this line has acted as support. Our thought is that the price support line on the ‘crash top’ chart for gasoline futures at or just below 2.10 should go with VLO’s success at holding the moving average line. The weaker VLO the greater our conviction that gasoline futures prices can lead the rest of the energy sector lower. More on page 3.