by Kevin Klombies, Senior Analyst,

From time to time we have focused on a chart of the ratio between Canada’s S&P/TSX Composite Index and the S&P 500 Index. The argument has been that Canada’s resource-based economy does better along with its equity market when commodity prices are strong and rising while in a negative commodity trend the TSX will tend to underperform the SPX.

Today we will make a similar argument using a different perspective. We start with the chart at top right which compares the sum of copper and crude oil futures prices (copper in cents plus three times crude oil in dollars) with the share price of Abbott Labs (ABT).

We generally use Johnson and Johnson (JNJ) for these types of chart-based arguments but ABT work nicely as well. The idea is that from 1989 into early 1999 the trend for energy and metals price was essentially flat while the trend for ABT was consistently higher. In other words when commodity prices remain relatively dormant the markets tend to push money towards the consumer, financial, and health care sectors.

The trend for copper and crude oil prices turned higher in early 1999 following the series of crises that rocked Asian, Russia, and Brazil. This positive trend led to a long flat trend for ABT.

The argument would be that one of the ways that we will ‘know’ that the commodity trend has finally come to an end will be through new highs for stocks like ABT and JNJ. So far we have witnessed some intense weakness in energy and metals prices without much in the way of concurrent strength from the large cap consumer health care names.

The chart below right features the point spread or difference between the TSX (S&P/TSX Composite Index) and the DJII (Dow Jones Industrial Index). As of yesterday the TSX at 9795 was still more than 700 points higher than the DJII (9033).

From 1989 into 1999 the TSX declined from close to 1500 points above the DJII to close to 4000 points below for a net loss of 5500 points. From 1999 into 1998 the spread rose from -4000 to just over 3000 for a net gain of 7000 points. Another way that we will ‘know’ that the commodity trend has turned negative will be through relative weakness in the TSX. By this we mean that if the TSX minus DJII spread moves much below the ‘0’ line then the trend that began in 1999 will have come to an end.



Equity/Bond Markets

Second chart below comparison featuring the yield index for 10-year U.S. Treasuries (TNX) and the ratio between Johnson and Johnson (JNJ) and the S&P 500 Index (SPX).

We are showing this chart for two reasons. First because it makes the argument that long-term yields should be declining. If the JNJ/SPX ratio continues to rise through the highs of 2002 and 2003 then the argument would be that 10-year yields should decline below 3.3% and very likely below 3.0%.

The second reason is a bit less obvious. The argument is that the trend for yields turned lower in mid-2007 confirmed by the start of a rising trend for the JNJ/SPX ratio.

We are making this point because it is difficult to ‘see’ on a simple bond price chart where a rising trend may have begun. To explain we show below right a chart of the CRB Index and the U.S. 30-year T-Bond futures. The charts have been shifted or offset by two years.

The chart of the TBond futures shows two ‘bottoms’- one in 2006 and one in 2007. The JNJ/SPX ratio argues very nicely that the true bottom for bond prices was made in mid-2007. Fair enough.

The argument would then be that commodities lag bonds by two years so commodity prices should bottom and turn higher two years after the lows for the bond market. Once again… fair enough. If the TBond futures turned upwards in mid-2007 then we should see continued downward pressure on the commodity markets through into the end of the second quarter next year.

Our final point would be that the longer the rally for bond prices the longer the eventual rally for commodity prices. Ideally bonds make new highs between now and the middle of next year.

We have written on many occasions that we believe that the markets are shifting back to a more positive trend for the biotech sector. The problem is that it is difficult to see this when the equity markets are collapsing. However the chart below shows that at the end of last year the stock price of Genentech (DNA) was roughly 4.5% of the value of the S&P 500 Index while today it is close to 9%. In other words DNA has doubled- relative to the broad market- since the start of the year.