by Kevin Klombies, Senior Analyst

Wednesday, February 27, 2008

Chart Presentation: Strange Days

With roughly 3 weeks to go until the March 18th FOMC meeting the markets continue to favor a 50 basis point rate cut to 2.5%. A week or two ago there was a small chance of 75 basis points but as conditions have firmed- somewhat- there is now roughly a 7% chance of only 25 basis points.

On a number of occasions during 2007 we showed charts of the stock price of Wal Mart (WMT) along with the Chinese equity market (Shanghai SE Composite Index) and pointed out that the two were trending in opposite directions. In other words as the Chinese market moved higher WMT’s stock price tended to decline. While the relationship continues to hold much has changed over the past few months.

At top right we have included a comparative view of WMT and the Shanghai Comp. If there is a nearby ‘line in the sand’ for WMT representing significant resistance it would cut through around 51.40. Oddly enough with crude oil prices ending in triple-digits we find WMT closing yesterday at… 51.40.

WMT back to the highs set last June as the Shanghai Comp. broke down towards the 3500 level is interesting, we suppose, but perhaps all the more so given the message that we take from this. Our argument has always been that WMT tends to do well when energy prices turn lower and quite obviously that has not been the case over the past few months.

The Shanghai Comp. is shown at bottom right along with ocean freight rates (Baltic Freight (Dry) Index) and the stock price of miner Rio Tinto (RTP).

The basic point is that strength in the Chinese equity market has gone with rising ocean shipping costs and definite strength in metals prices and the mining stocks. Yet since November of last year shipping costs have declined (by close to 50% at one point in January), the stock price of RTP has failed to make new highs, and the Chinese stock market has fallen by close to 30% even as WMT’s stock price has risen from around 43 up through 51.

Obviously WMT has risen into the low 50’s on a number of occasions only to slump back towards the low 40’s but we find it passing strange that WMT is once again threatening to ‘break out’ to the upside even as the CRB Index explodes to new highs. Strange days indeed.



Equity/Bond Markets

On the one hand rising commodity prices tend to be a positive for the equity markets in that they support the share prices of those companies involved in the production of commodities but on the other hand there are a wide variety of sectors that remain under pressure when commodity prices are stronger. Consider that the SPX has held below the 1550 level now for close to 8 years as commodity prices have recovered and that the mega-bull market that began in 1982 followed the commodity bull run of the 1970’s.

In any event the equity/commodity ratio (SPX/DJ AIG Commodity Index) remains under pressure as shown through the chart at right. On a more positive note the consumer and pharma stocks (JNJ, KO, and the PPH shown at right) have managed to dig in somewhat. With the DJ AIG Commodity Index at 211.74 as of yesterday a return to the 9:1 ratio top set during the first half of 2007 would require the SPX to rise to around 1900. In other words given current commodity prices the ratio would only have to rise to around 7.32:1 in order for the SPX to be back at the 1550 resistance level.

The commodity etfs remain rather ‘hot’ this month with the grains etf (JJG) spiking higher yesterday as crude oil price strength pushed the USO towards 80.

Below right we show Bear Stearns (BSC), Japan’s Mitsubishi UFJ (MTU) and an upside-down view of Japanese 10-year (JGB) bond futures. We are showing the JGBs upside down so that they trend with instead of against the share prices of the financials.

The peak for Japanese bond prices (bottom on our upside down chart) was reached in January at the lows for BSC and MTU. The JGBs then moved to 137 which went with BSC rising to almost 95 as MTU stalled out just below 10.

The point is that IF the JGBs break below 137 (they ended up .09 to 137.14 yesterday) it should indicate that the near-term sense of crisis in the banking sector has passed. For the time being. All things considered that would be a most welcome event.