Chart Presentation: Stirring

The recent tendency for crude oil prices to decline the day before the weekly energy inventory report was broken yesterday as traders apparently couldn’t wait to get long in front of what is assumed to be a bullish inventory draw down of crude oil supplies. The link between oil prices and the Canadian dollar helped push this currency up more than cent against the U.S. dollar.

From our perspective whenever a market or security literally screams higher it typically means that it coming back ‘on trend’. At right we show crude oil futures, the stock price of Alcan (AL), and U.S. biotech company Genentech (DNA).

If we mark the start of the rising trend around mid-2002 (somewhat debatable given that on page 3 we show that it likely started post-September 11, 2001) and run trend lines up through the tops for these markets we get a sense of what has been happening.

The incredible run upwards for Alcan culminating in a take over earlier this year becomes somewhat understandable if we accept that the stock price had been languishing well below the rising trend. The same would be true for crude oil futures prices which have followed each decline or consolidation with a relentless push back to the upper resistance line.

The first point is that- as drawn- crude oil futures hit the resistance line yesterday so the ‘easy’ price gains have now been made. Given that there is more than a bit of artistic license involved in drawing the trend line it is certainly possible that oil prices still have further to go but, all things being equal, we should be reasonably close to the end of this run.

The stock price of DNA represents another market that has periodically pushed dramatically higher creating a rather steeply sloped trend line. Notice that in 2003 the stock price was at a low as oil prices touched the trend line and then with oil prices well below trend into 2004 DNA swung upwards.

Our second point is that once energy prices stop pushing the markets should be ready to find something new to send into orbit. Whether this will drive DNA towards 140 remains to be seen but the sharp rise in Nortel’s stock price yesterday (chart on page 6) suggests that some of the more dormant sectors could be stirring back to life.

Equity/Bond Markets

In yesterday’s issue we mentioned that we were intrigued by the U.S. home builder stocks but thought that perhaps this might be something that we should sit on until next year. For good or for bad we wanted to explain our thought (or lack thereof) process.

The chart at right compares Anheuser Busch (BUD) with home builder Hovnanian (HOV) from late 1988 into 1992. The last major real estate peak and subsequent recession occurred during 1990 and 1991.

HOV was trending with BUD through much of 1989 but late in the year the two stock began to diverge as the home builders turned lower well in advance of the actual weakness in real estate prices.

As HOV broke down through its 200-day e.m.a. line to signal the start of a negative trend the offset was a positive and rising trend for consumer stocks like BUD. In other words you can trace the rising trend for BUD that began in late 1989 to the break down in the home builders.

HOV made a bottom along with BUD in October of 1990 concurrent with the peak in oil prices and the bottom in bond prices. We showed the other day that the current trend is somewhat ‘muddy’ in that bond prices have been rising even as oil prices push towards triple digits.

The equity market and BUD began to strengthen in the autumn of 1990 but HOV held flat until January of 1991. This ‘lag’ may represent the hesitancy by investors to take a position in such an out of favor sector so close to the end of the year. Portfolio managers tend to prefer to show that they were long the strongest sectors into year end and then with the start of the new year are much more likely to take more aggressive or contrary positions. This tendency was one of the reasons we focused on General Motors in January of 2006.

While the current trend is certainly different in many respects from 1990 we suspect that there are enough similarities (rampant Asian equity market growth, speculative but deteriorating real estate market, tensions in the Middle East, sky-high oil prices) to make the comparison worth the effort.

The idea was that when HOV broke down through its 200-day e.m.a. line it marked the start of a rising trend for BUD. The chart at right shows that this is exactly what happened towards the end of 2005.

The argument then went on to suggest that the lows for HOV should be set around the time that BUD has sold off in the face of rising oil prices or falling bond prices. While crude oil prices are making new highs this week bond prices bottomed in June and BUD made its low in August.

The next point was that after BUD turns higher it marks the start of a similar rising trend for HOV but, if 1990 proves to be an accurate guide, there will be a lag of a few months potentially through the end of the year.

The thesis gains considerable veracity if BUD continues to recover and moves up through the multi-year sticking point around 54- 55. If one were inclined to take a ‘shot’ at the home builders based on the idea that between late 1990 and early 1992 the stock price of HOV rose by just over 600% through the heart of a real estate bear market and the potential demise of Citicorp then we would look for strength in BUD while keeping in mind that any positive action may not begin until early in 2008.