by Kevin Klombies, Senior Analyst

Wednesday, October 31, 2007

Chart Presentation: Sequences Once Again

Crude oil futures prices fell rather sharply yesterday following the news that Goldman Sachs was suggesting that it was time to take profits on long oil futures positions after holding a 95 price target since July. The only problem was that lower oil prices on Tuesdays have been standard fare for months followed by even sharper price gains later in the week. From out point of view, the correction made for a nice change of pace.

We are going to return to a number of the charts that we showed yesterday as we tighten up the time frames somewhat. The challenge in doing ‘macro’ work is that one can be absolutely perfect give or take a month or quarter and with that sort of time slippage we can go from being dead right to dead on arrival.

The comparison is based on the sequence that the markets worked through during the 1990’s. It starts with the return to relative strength by the large cap U.S. consumer stocks in 1994 after a number of years of consolidation. We use the ratio of the stock price of Coca Cola to the S&P 500 Index (KO/SPX) as the starting point for this particular argument.

The KO/SPX ratio began to rise as the Fed attempted to cool cyclical growth through higher short-term interest rates. About six months after the ratio swung north short-term debt prices reached bottom.

The commodity markets continued to strengthen into the spring of 2006 with the CRB Index reaching its final peak in April of that year. Crude oil prices, by the way, continued to rise until the end of 2006 with the initial weakness in the CRB Index due to falling grains prices.

The current situation is very similar to the previous sequence with the KO/SPX ratio swinging upwards at the start of 2006 followed six months later by the peak for short-term interest rates and bottom for short-term debt prices.

If the markets repeat the previous pattern almost perfectly then the idea is that the CRB Index would be due to reach its final top this quarter. We aren’t going to snug this up from quarters to days but a literal comparison would suggest that we could well see a down turn in the commodity sector through November that would then hold negative for the next two to three years. With that in mind we move on to the second page.



Equity/Bond Markets

Oct. 30 (Bloomberg) — Former Federal Reserve Chairman Alan Greenspan said China’s stock market is a speculative bubble that he expects will burst.

Asked if China was in a state of “irrational exuberance,” a phrase Greenspan made famous in 1996, the former chairman said, “I think so,” speaking to a conference of insurance executives in Boston today. “When you don’t expect it, it breaks,” Greenspan said of the bubble. (emphasis ours)

We found the comments above interesting for two reasons. First, Greenspan’s ‘irrational exuberance’ comment in December of 1996 preceded the NASDAQ’s price top by more than three years so one would expect that he would be reluctant to have that phrase attributed to him once again. Second, he suggests he expects that the Chinese equity markets bubble will burst and then posits that it will break when one doesn’t expect it. Classic ‘Fed-speak’.

In any event we return to a shorter-term view of the comparison between the NASDAQ into 2000 and the stock price of Canada’s Bank of Montreal.

The idea is that the strength in the NASDAQ into 2000 went with both higher interest rates and a stronger U.S. dollar as capital flowed towards the U.S. markets in search of extraordinary gains.

The bottom for the Bank of Montreal (BMO) was reached on virtually the same day that the NASDAQ reached its March peak so we have included a ratio chart based on the BMO divided by the NASDAQ Comp. as a means of identifying the timing of the change in trend.

With the benefit of hind sight we can tell quite easily that the offset to the tech and telecom ‘bubble’ was a declining trend for stocks like BMO. We suspect that this relationship was not as evident in real time.

Our recent argument has been that the ‘speculative bubble’ forming in the Chinese equity markets has gone with an outflow of money from Japanese stock market. We have chosen the stock price of the world’s largest consumer electronics maker (Panasonic) Matsushita (MC) as our surrogate for the Bank of Montreal back in 2000.

In the fullness of time we will find out whether MC is a reasonable stock to use as a comparison; perhaps Japan’s Mitsubishi UFJ would serve as a better choice given that it is also a financial.

The chart pattern for MC is actually quite similar to that of BMO. BMO declined from November of 1999 into early March of 2000 and then rounded up towards and then through the 200-day e.m.a. line. MC turned back to the down side this past June and after working through a bottom from August into October is now making an attempt to swing back up through its moving average line.

What is missing- so far, at least- is weakness in the China and Hong Kong stock markets. The MC/Hang Seng ratio is still holding near the lows so it appears that before our argument will gain any traction this ratio will have to work back up through its 50-day e.m.a. line.

Our final thought is that the commodity trend has gone with the Hang Seng Index and both have moved inversely to the U.S. dollar. On page 1 we suggested that the commodity trend could turn back to negative this quarter.