by Kevin Klombies, Senior Analyst

Wednesday, August 29, 2007

Chart Presentation: The AUD Couple

The chart compares the Australian dollar (AUD) futures with the S&P 500 Index (SPX).

The Australian dollar is one of the so-called commodity currencies so it tends to move higher or lower with the trend for commodity prices. We have argued on occasion in the past that it also trends with U.S. short-term interest rates so as long as it is strong and rising there is upward pressure on yields.

The AUD’s chart is virtually identical to that of the SPX so on days when currencies like the Australian, Canadian, and New Zealand dollars are weak- as was the case yesterday- the U.S. equity market also tends to move lower- as was most certainly the case yesterday.

The problem is that the SPX can and will trend with the AUD but it doesn’t ALWAYS trend with this currency. To the extent that the equity markets are being driven by the underlying trend for commodity prices then these two markets will tend to move in lock step.

Our point today is to show that the reason the equity markets are currently so choppy is that the commodity cyclical trend remains the dominant theme. Beyond that we wanted to show what is supposed to happen around the time that these two trend begin to diverge.

The chart at bottom compares the Australian dollar, the stock price of Wal Mart (WMT), and the SPX from the autumn of 1996 into the spring of 1998.

The chart shows that through 1997 and 1998 the equity markets trended nicely higher in the face of a declining AUD. In other words during these two years the U.S. stock market had moved away from the ‘all things commodity’ trend and had shifted back to a lower interest rate, large cap, consumer trend.

The key in our view lies with the stock price of Wal Mart. Notice that in early 1997 it stopped moving sideways to lower and began to push upwards. On many occasions and from a variety of different perspectives this year we have attempted to make the case that when WMT finally turns positive it should signify that the equity markets are changing themes. Until that time comes the SPX will remain hostage to daily fluctuations in the forex and commodities markets.



Equity/Bond Markets

Our view is that WMT is trading inversely to the Chinese equity markets. By this we mean that large cap stocks like WMT appear to represent the ‘source of capital’ for the push of liquidity into the Chinese equity markets that is causing prices to explode to the upside.

The chart at right compares WMT with the Shanghai SE Composite Index. We mentioned yesterday that the Shanghai Comp. is rising at a pace that would double its value every ten months and while admit that markets always rise longer and farther than one things possible… that is truly a heady pace.

When WMT jumped higher around the end of May you can see the reaction in the Shanghai Comp. From July through August WMT has been lower while China has been higher so the point would be that the SPX isn’t going to get away from the commodity trend until the Chinese equity markets stop pushing.

It is also our view that one of these days the energy trend will turn negative and that this will follow a break through the rising trend line shown on the chart of the Amex Oil Index/S&P 500 Index ratio at bottom right.

While oil prices held quite nicely on yet another volatile Tuesday the oil stocks were marginally weaker than the broad market which curled the XOI/SPX ratio just a bit to the down side.

Another argument is that the health care theme ‘takes turns’ with the commodity theme. The chart below shows JNJ along with copper futures. The idea here is that as long as base metals prices are declining from the July peak then the health care-oriented stocks have the potential to work higher. Of course it is difficult for any stock or sector to rise when the S&P 500 Index futures are hammering the entire market lower like they were yesterday.