From the November equity markets lows through trading last week the trend had swung back towards relative strength in the cyclicals, a stronger stock market, and downward pressure on the bond market. The question at present might be… was that it?

Instead of stumbling around and reacting to hourly or daily price swings we tend to build a thesis and then stick with it as best we can. There are times when we wish that we were centered a bit more in the ‘here and now’ and other times when a momentum-based approach would serve us better but for good or for bad… we use a macro-based thesis approach.

Belowwe show a comparison between the U.S. Dollar Index (DXY) futures and the CRB Index (commodity prices). Our thesis has been that commodity prices ‘actually’ peaked in early 2006 and have been in a downward trend for close to three years. The problem was that in mid-2007 as the U.S. Dollar Index broke below roughly 82 the commodity markets exploded to the upside. After 18 months of pushing higher within the context of a negative trend… commodity prices finally collapsed lower as the dollar pushed up through the 82 level.

Below we feature a comparison from 2002- 2003. The lows for 10-year Treasury yields in 2002 occurred when the Nasdaq Composite Index hit bottom in early October.

Our points? First, our macro view was the commodity prices had to come back ‘on trend’ and this has now been accomplished. Our thesis, however, was that commodity prices would not turn positive until the second half of 2009. It is also our view that a bottom- although similar to 2002 perhaps not THE bottom- for 10-year Treasury yields will occur when the cyclical markets find some form of support.

Our thought is that the commodity-related equity markets sectors could work through a transition through the first half of 2009 that would look something like the Nasdaq between October of 2002 and March of 2003. In other words… a quick bounce followed by a correction into mid-year. Our next thought is that this would go with a similar trend for 10-year Treasury yields. Our final thought is that the best way to keep the commodity markets rally under control would be through renewed strength in the U.S. Dollar Index. The higher the DXY gets relative to the 82 level the greater the rally-stifling pressure on the CRB Index.

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Equity/Bond Markets

Belowwe show the yield index for 10-year Treasuries (TNX) and the ratio between the Morgan Stanley Consumer Index and M.S. Cyclical Index. The Consumer Index includes names such as Coca Cola, Wal Mart, Abbott Labs, McDonald’s, and Merck while the Cyclical Index includes Alcoa, Dow Chemical Citigroup, Ford, Deere, etc.

We have argued that one never wants to be long those sectors that are pushing interest rates lower and always long those sectors that are driving rates higher. To the extent that yields have been declining the sectors to avoid have been virtually anything ‘cyclical’. At least until late last month.

Below we show the Japanese 10-year (JGB) bond futures and the ratio between the Nikkei 225 Index and the S&P 500 Index (SPX). The quick point is that when Japanese bond prices are declining (which tends to go with rising U.S. long-term yields) the Nikkei tends to strengthen versus the SPX. In other words… the Nikkei is most definitely ‘cyclical’.

Below we show a comparison between, from top to bottom, the stock price of U.S. home builder Hovnanian (HOV), the Baltic Freight (Dry) Index (ocean shipping rates for dry bulk cargo), the price spread or difference between platinum and gold futures, and… the ratio between gold futures prices and the Nikkei 225 Index.

This is either a very intriguing chart comparison or a rather pointed case of ‘talking one’s book (thesis)’. The idea is that over time the markets have been building and then destroying one bubble after another with the home builders, ocean shipping rates, and the platinum-gold spread first rising and then collapsing. One of the very last potential bubbles would be the gold/Nikkei ratio as gold has risen with bond prices while the cyclically driven Nikkei has declined as bond prices have moved higher. The point? Every now and then we wonder how this ratio could ever decline back to the levels of 1995- 99. We imagine that it would have to include some amount of gold and bond price weakness but, then again, it would also have to go with strength in the Japanese stock market.

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