by Kevin Klombies, Senior Analyst

Friday, February 29, 2008

Chart Presentation: To the Wall

The U.S. 30-year T-Bond futures rose sharply yesterday and our best explanation for the sheer violence of the move would be that the markets had reached a cross roads of sorts earlier in the week. To explain we have included two bond markets-related charts.

The chart below compares an upside down view of the Japanese 10-year bond (JGB) futures with the stock prices of Japan’s Mitsubishi UFJ (MTU) and Bear Stearns (BSC).

The argument has been that if, as, or when the JGBs move below 137 it should signal at least a short-term ‘all clear’ for the stock prices of the banks and brokers. When the JGBs declined in price to 137 in late January it went with price rallies for MTU to just below 10 and almost 95 for BSC.

The point is that bond price strength reflects cyclical weakness which, in turn, is part of the negative trend for the financial sector. As long as money is inclined to flee towards the safety of the Japanese and U.S. bond markets we have not yet reached the point in time where it makes sense to lean on the financials from the long side.

The chart below compares the U.S. 30-year T-Bond futures with the stock price of Micron (MU).

We argued a few weeks ago that based on past cycles we would expect to see the next bottom in long-term Treasury yields around the start of the second quarter of this year. We also suggested that our conviction with this forecast would increase substantially if MU were able to hold above the January lows through the end of the quarter.

The chart makes the point that the TBond futures were resting on the rising support line going into the end of this week. Further price losses would suggest that the downward pressures that began to form during the third quarter of 2007 were clearing which, in turn, argued for a recovery in the cyclical techs perhaps at the expense of energy and metals prices. With the dollar breaking below support at 75, crude oil prices hammering away at triple-digits, the euro moving through the 1.50 level, and gold not yet up to the psychologically important 1000 mark… the existing trend gained new life as the TBonds rose by almost 2 points in trading yesterday. Bottom line all this means is that we have yet to reach a true change in the trend.



Equity/Bond Markets

Today’s theme has to do with markets going to ‘the wall’. In other words we are looking at a number of trends that were in danger of breaking or changing this week.

The chart below compares the ratio between Wal Mart (WMT) and the S&P 500 Index (SPX) with the product of crude oil futures times the Australian dollar (AUD) futures.

The idea here is that on only occasion in relatively recent history has the WMT/SPX ratio turned higher (1997) and this trend change occurred around the time that the commodity theme reached a peak. We use oil price and the commodity-sensitive AUD as our proxies for the broader ‘commodity theme’. The recovery in WMT and the rise in the WMT/SPX ratio suggested that 11 years later the trend was once again changing in favor of WMT. In response… crude oil prices and the AUD pushed to new highs to muddy the waters somewhat.

The chart below compares 10-year Treasury yields (TNX) with the ratio between Johnson and Johnson (JNJ) and the SPX. The point is that when yields are falling the JNJ/SPX ratio tends to rise which simply means that when the economy is soft enough to warrant declining long-term yields the health care sector tends to outperform.

Below is a chart that we have shown on a number of occasions of late. The chart compares gold futures prices with the spread or difference between the U.S. Dollar Index (DXY) and the price of the TBond futures. When the spread is falling it means the dollar is weaker than bond prices and this goes with rising gold prices. Notice that only a few days ago the decline in bond prices combined with the flat trend for the dollar had put the positive trend for gold at risk. Once ‘the wall’ had been reached the markets responded by cratering the dollar and snapping the TBond futures higher in price. No trend changes as of yet.