by Kevin Klombies, Senior Analyst

Wednesday, June 20, 2007

Chart Presentation: Time Gentlemen Please

June 19 (Bloomberg) — Home starts in the U.S. fell for the first time in four months in May as interest rates rose, suggesting the worst housing recession in 16 years will persist.

With the Bloomberg comments above as our cheery lead-in we show a chart of the Nasdaq Composite Index from late 1993 into 2003, the sum of the share prices of two U.S. home builders- DR Horton (DHI) and Hovnanian (HOV) from 1999 forward, and the CRB Index (commodity prices) starting from the beginning of 2001.

What we are looking at today is ‘time’. The idea is that the equity markets rally began in early 1995 after interest rates finally reached a peak. It lasted for just over five years before peaking out in 2000 and then corrected lower into the end of 2002.

The bull market for the home building sector began in mid-2000 as the sum of short and long-term interest rates finally began to decline. The home builders rose for roughly five years with a peak in mid-2005 and a down trend beginning in earnest at the start of 2006. In terms of ‘time’ the positive trend for the home builders lasted almost exactly as long as the 1995- 2000 bull market for the major U.S. equity indices.

The positive trend for commodity prices began in early 2002 in response to a downward trend in the U.S. dollar. The CRB Index peaked in mid-2006 but from any number of perspectives we could argue that rising commodity prices remain the dominant theme to the present day.

The first point would be if the bull market trend for the CRB Index runs as long as the trends for the Nasdaq and the home builders then it should now be ready to turn negative with some conviction.

The second point is that the home builders were leading the commodity markets by roughly a year and a half and to date the home builders are still mired in a bear market which suggests that once the CRB Index breaks lower it will be some time before the eventual bottom is reached.

The third point is that it took somewhere between 30 and 36 months for the Nasdaq and S&P 500 Index to find a meaningful bottom. This suggests that the real estate sector is going to get much worse before it finally bottoms out next year. If the CRB Index declines for a similar length of time then we could be looking at a low well into 2009 that, we expect, would go with the next significant top in the U.S. dollar.




Equity/Bond Markets

The chart compares the stock price of Genentech (DNA), crude oil futures, refiner Valero (VLO), and the ratio between the Amex Oil Index (XOI) and the Airline Index (XAL).

The dominant trend through the first half of 2007 has been strong commodity prices with an emphasis on energy. In particular the rising trend for gasoline futures prices has helped lift the share price of VLO and pushed the oils higher and the airlines lower.

The flip side to this theme would have to be ‘biotech’ as DNA has declined in virtual lock-step with the ascent of stocks like VLO.

Recently we have seen energy price weakness on Tuesdays and yesterday was no exception as crude oil futures lost a few cents in the face of general strike news out of Nigeria. The XOI/XAL ratio bent a bit lower and VLO was actually down on the session. No sign of life as of yet, however, in the biotechs.

As a trend ages it tends to get more and more speculative. In the early stages of a metals cycle the focus is on the major producers but eventually the attention shifts to the penny stocks. The same was basically true with the 1995- 2000 equity bull market with the Nasdaq accelerating upwards during the late stages. The chart below shows the ratio of the Nasdaq 100 Index to the S&P 500 Index from 1998 through 2000 and compares it to the late-cycle action in China’s Shenzhen SE Composite Index. The basic point is that parabolic price action is typical of an aging trend.

As for the gold miners… when there is downward pressure on interest rates gold does better than copper and vice versa. The recent strength in yields goes with strength in copper but now that yields are starting to move lower the focus shifts over to gold. The chart at bottom right shows that when short-term U.S. interest rates began to decline the oils (XOI) tend to weaken relative to the gold miners (XAU). The very simple point, however, is that without weakness in energy prices there is little chance of lower interest rates.