by Kevin Klombies, Senior Analyst

Friday, September 28, 2007

Chart Presentation: Simple

We thought that we would do something rather simple today so we are going to show a few rather ‘macro’ charts.

At top right we feature a chart of the ratio between the stock price of Phelps Dodge (PD) and the S&P 500 Index (SPX) through 1981 while at middle right we show the same ratio through 1994. Below right is a ratio chart between the stock price of FreePort McMoRan (FCX) and the SPX.

Much of our work over the years that has been focused on the strength or weakness of the commodity cyclical sector was based on the price of Phelps Dodge. We developed all kinds of ratio and comparison charts using PD so we were understandably disappointed when it was bought out by FCX this past spring. Going forward we may end up working with FCX as a surrogate for all things ‘commodity cyclical’ or, over time, we might well find something else that works better.

The basic argument is that the peak for the commodity cyclical theme was reached during the third quarter of 1981 and then again 13 years later in the third quarter of 1994. Keep in mind that we are not referring to commodity prices but rather to the relative strength within the equity markets of the stock prices of the commodity producers.

If the commodity theme is working through a series of very long cycles that reach a peak every 13 years then if we count on our fingers and take off only one shoe we come up with the argument that the next top should be reached some around the third quarter of 2007. In other words, right about now.

With crude oil futures pushing higher yesterday and no end in sight for the recovery in metals prices it undoubtedly does not feel as if we should be at or over the top for the commodity theme. On the other hand (page 5) we suspect that the momentum will be broken by a sharp decline in the Chinese equity markets next month and to date, as the chart at right shows, the FCX/SPX ratio is still just below the peak set earlier this month.

The problem with ‘macro’ arguments is that they can be dead right even if they are months or quarters early. The charts do show that the PD/SPX ratio made a final peak in late September of 1994 so we remain somewhat encouraged.




Equity/Bond Markets

What we found especially intriguing about the 13-year cycle for the commodity theme is how the consumer and pharma theme is actually running more of a 12-year cycle which tends to create a sort of strange ‘over lap’ of themes.

At right we show three comparative charts of the stock prices of Coca Cola (KO) and Schering Plough (SGP). The top charts indicates that the commodity and pharma theme turned positive around half way through 1982 while the middle chart shows that this theme turned positive twelve years later in mid-1994. The lower chart makes the case that the theme once again turned to the upside in mid-2006.

Consider how this has played out. The commodity theme turned negative in the autumn of 1981 while the consumer and pharma theme did not turn positive until mid-1982. In between the autumn of 1981 and mid-1982 there was a rather significant bear market.

The end of the commodity theme in the autumn of 1994 trailed the start of the consumer and pharma theme by only a few months leading to a strong equity market. This time around the consumer and pharma stocks have been rising for the past 15 to 18 months concurrent with stronger commodity prices which, we suspect, is why each sharp decline in the SPX is followed by an equally sharp rally back to new recovery highs.

In any event when the consumer and pharma trend turned positive in both 1982 and 1994 it remained positive for four or five years. If history were to repeat this trend should be especially strong through 2009.

It has been some time since we have mentioned Micron (MU) so we wanted to show the comparison below. MU has been trending inversely to the long end of the Treasury market so it tends to rise when bond prices are falling and vice versa. What we noticed yesterday was that MU’s stock price jumped 5.6% even as Treasury prices moved higher. One day does obviously not a trend make but… we came away with the sense that the stronger MU’s stock price gets the more negative we should be on the TBonds.