by Kevin Klombies, Senior Analyst

Thursday, February 07, 2008

Chart Presentation: Should Have Known

The market is now close to evenly split between a further 50 basis points and as much as 75 basis points of reduction in the Fed funds rate following the March 18th Fed meeting. On the other hand the ECB is widely expected to hold interest rates flat at 4% following its bi-weekly meeting today. At best the ECB may cool down some of its inflation rhetoric.

With the benefit of hind sight all trends are not only understandable but also obvious. Today’s topic deals with some of things that ‘one should have known’.

The idea formed after we read an article detailing how some of the truly smart money- at least based on past performance- had been accumulating positions in forestry stocks. At bottom right we show the stock price of Canada’s Canfor (CFP), U.S. home builder Beazer (BZR), Bear Stearns (BSC), and FreePort McMoRan (FCX).

Lumber prices peaked in early 2004 and then turned lower while the stock price of Canfor continued to rise for another twelve months. One should have known that the forest products stocks were going to decline given the weakness in lumber prices.

After Canfor turned lower the stock prices of the U.S. home builders continued to rise for another twelve months before peaking in late 2005. Once again one should have known that the weakness in the forest products sector was a harbinger of impending weakness in home building.

As the home builders declined to reflect weakness in the U.S. real estate market the banks and brokers continued to rise in price for another twelve months but, once again, one should have known that a declining housing market would eventually impact those companies that were trading in or holding sub-prime related paper.

When the banks finally turned lower in early 2007 the mining stocks continued to rise as the focus- apparently- turned to China’s economic growth. By the end of 2007 ocean shipping rates had begun to plummet as crude oil prices began to weaken and, we suspect, that one should have known that the commodity sector would finally turn lower given the sequential weakness in forest products, housing, and the major financials.


Equity/Bond Markets

Below we show the stock price of JDS Uniphase (JDSU), the Australian dollar futures, and the combination of the Mexican peso times the Brazilian real.

JDSU had a very good day yesterday following a surprisingly strong earnings report. However, the response to Cisco’s earnings after the bell may serve to cool the market’s near-term enthusiasm for the telecom sector.

The idea was that JDSU turned lower in early 2006 along with the biotechs and Japanese banks as money continued to push into the commodity and emerging markets sectors. The strength in the Aussie dollar, peso, and real shows the direction that money was moving while the decline in JDSU shows, at least in part, where this money came from.

The upside ‘gap’ in JDSU yesterday shows that the markets were surprised by the extent of the good news and this is the sort of action that tends to mark a major trend change.

At bottom right we show General Motors (GM) and the ratio between the CRB Index and crude oil futures. We show a shorter-term view of this relationship below right.

From the bottom of the Asian crisis in 1998 through into late 2007 one of the most dominant and persistent trends included relative strength by energy prices as the CRB/crude oil ratio moved lower. From the peak in GM in 1998 to the bottom between 2006 and 2007 the trend was based on rising energy prices. In the midst of a U.S. recession and with the prospect of a global economic slow down it is very hard- almost impossible, actually- to entertain the thought of going positive on GM but intermarket-wise that is what the charts are suggesting.