Dec. 17 (Bloomberg) — Oil fell below $40 a barrel for the first time in more than four years as OPEC failed to convince traders that the glut in crude will diminish and the U.S. government said supplies climbed for the 11th time in 12 weeks.
One of our recent chart fixations has focused on the ratio between heating oil and the stock price of Ford (F). The argument is that when the ratio finally reaches a peak and turns lower (the autos begin to rise relative to energy prices) the base trend for the U.S. equity markets turns positive.
The chart below shows the heating oil/F ratio along with the S&P 500 Index (SPX) from 1981 into early 1984. The ratio peaked in late 1981 creating a rising trend for the SPX even though the equity markets sagged down to a final bottom into August of 1982.
In a sense the markets are working through a ‘teeter-totter’ trend at present. Economic weakness- predominantly in the commodity cyclicals- is creating offsetting strength in the Treasury market. From the November lows through trading yesterday the U.S. 30-year T-Bond futures have risen by close to 25%.
In any event our point is that we believe that the equity market’s ‘base trend’ is now positive even though we expect that there will continue to be downward pressure for the next five or six months. To help explain we show an upside down chart of the sum of 3-month and 10-year Treasury yields and the CRB Index below right. The charts have been shifted or offset by two years so that yields (scaled upside down) in, say, 2006 line up with commodity prices in 2008.
We have argued that the trend for commodity prices tends to lag the trend for the bond market by two years. Since we are using yields instead of prices we have scaled the chart upside down.
The idea is that the trend for bond prices turned sharply positive in mid-2007 so, all things being equal, we would expect to see the trend for commodity prices turning positive around the end of next year’s second quarter. This suggests that through the first half of next year a rising trend for financial asset prices (as money works slowly out from Treasuries to corporates and into the interest rate-sensitive and defensive sectors of the equity market) should be offset by a declining trend for real asset prices.
The scenario that we view as most likely for the first half of 2009 will be somewhat reminiscent of 1982. It may or may not include an actual decline for the SPX but we suspect that at minimum there will be some sort of ongoing battle between rising financial asset prices and declining real asset prices.
At right we show two comparative chart of Intel (INTC), Coca Cola (KO), and Canada’s Bank of Montreal (BMO on both Toronto and New York). The top chart is from 1981- 82 while the lower chart is from the current time period.
The Canadian banks weathered the early stages of the banking system rout somewhat better than their American counterparts because they had limited exposure to U.S. real estate. On the other hand they have rather large exposure to the commodity cyclicals and, we understand, significant exposure to the auto sector.
In the spring of 1982 the stock price of BMO broke below support. This marked the start of a rising trend for Intel and Coke even as the S&P 500 Index moved towards its eventual bear market bottom.
We argued a few times recently that BMO had once again broken to new lows (chart below right) and that if history were to be kind enough to repeat this should mark the start of a rising trend for both KO and INTC. So far, so good.
So… why did the S&P 500 Index move to new lows during 1982 even as KO and INTC began to rise? The basic answer is shown below using a comparative view of copper producer Phelps Dodge (PD) and oil service company Schlumberger (SLB).
The commodity cyclicals- in this case PD and SLB- continued to make new lows well after KO and INTC began to rise and it was this ‘weight’ that served to pull the broad market lower. If we are correct in our views this is essentially what we expect to see through the first quarter or so of 2009- downward pressure from the commodity sector leading to upward pressure on financial asset prices.