The Fed begins a 2-day meeting today with the markets forecasting a 100% chance of a cut in the funds rate to .25%. Based on the Fed funds futures contracts this should bring the funds rate to the cycle bottom with the potential for a slow rise back towards .75% into the spring.
Equity markets-wise it still appears as if higher prices are likely into January with the next decision point due some time just after President-elect Obama’s celebrity-studded inauguration.
Belowwe show a comparative chart of the sum of the Canadian (CAD) and Australian (AUD) dollar futures against an overlaid chart of… Wal Mart (WMT) and the ratio between Johnson and Johnson (JNJ) and copper miner FreePort McMoRan (FCX).
The point? The peak for WMT and the JNJ/FCX ratio marked the end of a major trend back in 2000 that led in due course into a weak-dollar and strong-commodity trend that pushed on from 2001 into late 2007. The trend shifted back again as WMT began to strengthen in the final quarter of 2007 ahead of the peak for lows for the JNJ/FCX ratio and the cycle peak for the two commodity currencies (CAD plus AUD).
The real point? We might be- at best- five quarters into a new trend that should run for something close to five years. While it is tempting to hunt for bargains amidst the rubble of the recent small-cap commodity-driven trend we continue to believe that our oft-stated mantra of dollar, yen, large cap, and commodity-user offers the best potential over the next few years.
Belowwe show the comparison between Abbott Labs (ABT) and the sum of copper futures (in cents) and crude oil futures (in dollars multiplied by three times).
Our Big Picture view was that ABT was trading essentially flat as commodity prices (copper and crude oil) ramped higher. The peak for copper and crude oil was supposed to mark the end of the multi-year consolidation for large-cap growth/health care names such as ABT and JNJ. In other words… when metals and energy prices stopped pushing upwards ABT was supposed to swing on to new highs.
The point? In order for the equity markets to recover one or more major sectors are going to have to actually rise in price. Put another way the equity markets require leadership and our thesis was that ABT and JNJ would represent the kind of themes that would lead to the upside. We are still waiting…
Abovewe argued that the equity markets require leadership that involves actual price gains instead of mere relative price strength. The idea is that while the consumer defensives significantly outperformed through the final half of 2008 there is nothing particularly satisfying about being long a sector that simply falls by a smaller percentage.
The chartbelow compares the S&P 500 Index (SPX) with the ratio between the Morgan Stanley Consumer Index and M.S. Cyclical Index.
The chart makes an interesting point. While the ‘consumer’ theme has dramatically outperformed to get back to a stronger equity market it appears that ‘cyclical’ has to strengthen.
Most, we suspect, equate ‘cyclical’ with names such as Rio Tinto, Potash, or Caterpillar. While true we will argue that ‘cyclical’ can mean commodity ‘users’ and commodity ‘producers’ as well as ‘financially levered’.
The point that we are madly circling is shown below through the comparison between Wells Fargo (WFC) and the sum of General Motors (GM) and Citigroup (C). We have often argued that if all goes as expected WFC should lead the equity markets to the upside. Fair enough. A sustained recovery should include WFC pushing well above its moving average lines with the sum of GM and C trending higher. In this instance we are using GM and C to represent ‘cyclical’.
To quickly summarize before moving on the rather simple point is that a broad-based and sustained equity markets rally will not begin until names such as GM and C stop making new lows and start to recover but we still like the idea that WFC will lead to the upside.
Below we show the ratio between the Amex Oil Index (XOI) and Airline Index (XAL), the ratio between crude oil and the CRB Index, and the ratio between the Asia ex-Japan Index and Japan’s Nikkei 225 Index. From 1998 into 2008 the trend favored the oils relative to the airlines, crude oil relative to broad commodity prices, and Asia ex-Japan over Japan. Through the second half of 2008 we have seen relative weakness by the oil stocks, crude oil, and non-Japan Asia but perhaps not to the extent that would allow us to argue with full conviction that the trends have all reversed.
