There were two pieces of news for the markets to stew over yesterday. First, China raised interest rates by 1/4% on Christmas Day as it continues to try to offset rising asset price speculation and inflation. Second, bailed-out insurer AIG’s share price rose around 9% after it announced that the private capital markets had finally opened up for the company.

Quickly… rising interest rates in China are not a problem. Rising interest rates are an indication of positive cyclical strength and typically go with higher asset prices. It isn’t rising interest rates that one has to worry about but the end of rising interest rates. In particular the start of falling interest rates which marks the beginning of weaker cyclical growth.

We have been arguing in favor of the ‘laggard financials’ for some time so we view AIG’s news as a nice positive for this theme.

Below we return once again to the chart of the sum of the commodity currencies (Cdn and Aussie dollar futures) and the ratio between crude oil and the CRB Index.

The argument has been that after 9 months this divergence should start to resolve. Either we are going to see ongoing strength in the commodity currencies through the first quarter of 2011 with downward pressure on the U.S. dollar and crude oil prices driving into triple-digits or… the Asian/Latin/emerging markets trend will start to falter with crude oil continuing to weaken on a relative basis as the U.S. dollar swings higher.

Next is a chart of the CRB Index and two moving average lines for  Hong Kong’s Hang Seng Index. We haven’t run this chart for some time so we thought we would return to it today.

The argument is that the trend for commodity prices (CRB Index) is very similar to the trend for the Hang Seng Index. Asian economic strength leads to rising commodity prices.

We continue to watch out for enough weakness in the Hang Seng Index so that the moving average lines ‘cross’ to the down side. This has tended to mark the end of a rising trend for the commodities markets. At present the Hang Seng Index would have to decline back below roughly 21,000 to call into question the rising trend for commodities in general and base metals and energy prices in particular. The Hang Seng Index was last seen at 22,833.



Equity/Bond Markets

To put things into perspective somewhat we have included a chart of the Hang Seng Index, India’s Bombay Stock Exchange (BSE) 100 Index, and the ratio between Amazon (AMZN) and Wal Mart (WMT).

All three charts include the same basic trend. There may come a time when Wal Mart starts to show some kind of relative strength and this tends to occur when the Asian/Latin/emerging markets trend is beginning to tire.

So… the question is… should we worry about being a year early? Obviously the answer has to be a resounding ‘YES’ but, in terms of the bigger picture we wonder whether this is as important as it may seem.

Below are charts of the CRB Index from 1990 through 2004 and the Nikkei 225 Index from 2000 to the present day.

The argument has been that the cyclical trend tends to run from decade to decade. It focused on commodities during the 1970’s, consumer stocks and the Nikkei through the 1980’s, tech and large cap in the 1990’s, and then back to commodities in the 2000’s. If the pattern continues then the least loved market- Japan- stands to be a stand out for the next 8 or 9 years.

The problem is… 2011. Notice the chart similarities between the Nikkei over the past decade and commodity prices from 1990 to 2000. While the rising trend for the CRB Index began in earnest around the start of 1999 (a trend that was finally returned to at the peak in 2008) the year 2001 was definitely negative. Our near-term concern is that we will see some kind of cyclical sell off next year as China’s efforts to slow growth find traction. Our longer-term concern is that we might miss the rally by worrying about the near-term.