March 13 (Bloomberg) – U.S. stocks rose, extending the biggest weekly gain for the Standard & Poor’s 500 Index since November, as a rally in health-care companies overshadowed a drop in energy shares on concern demand for oil is falling.
One of our recurring themes of late has been that rising long-term Treasury yields suggest a recovery in cyclical growth during the second half of this year. In other words over the longer run rising yields are a positive but in the shorter-term they serve as a negative.
The argument is that rising yields are a positive- eventually- but until such time as the improvement in economic growth begins to show up any increase in yields tends to be a negative.
To help explain we have included a comparative chart of the S&P 500 Index (SPX) and 30-year U.S. Treasury yields (TYX) from January through June of 2000. The idea is that the current situation is very close to the exact opposite of the cyclical peak that led to record highs for both the Nasdaq and SPX.
Long-term Treasury yields began to decline in January of 2000 which, we will argue, was both a positive and a negative. It was a negative over the long run because it clearly suggested that economic growth was slowing but it was a positive in that it helped to raise equity markets valuations even as stock prices raced upwards.
The cycle peak for the S&P 500 Index was reached at the low point for 30-year yields around the start of 2000’s second quarter. Even though the trend for interest rates was clearly lower there was a period of time during April and May when yields pushed higher and this went with rather abrupt equity markets weakness.
In terms of our view that today is similar but opposite to 2000 the idea would be that while 30-year yields should resolve upwards over time the low point for the equity markets should be reached at the first sustainable peak for yields. In other words- in the short run- the equity markets should respond favorably to falling long-term Treasury yields.
The problem from a chart perspective is that while 30-year Treasury yields have flattened out just below the 200-day e.m.a. line the trend has yet to show much in the way of weakness. To break the rising trend something under 3.5% for the TYX would be required.
Belowwe show a chart comparison between the CRB Index and the ratio between the share price of FreePort McMoRan (FCX) and JP MorganChase (JPM).
One of our big picture views is that the collapse in commodity prices was simply a return to ‘trend’. The base trend for commodity prices turned negative in the spring of 2006 and is not expected to swing back to positive until at least the second half of this year.
The chart makes the point that if the CRB Index is going to grind lower for another quarter or two then the FCX/JPM ratio has ‘left the station’ somewhat early. In other words to the extent that the ratio trends with commodity prices and commodity prices are still heavy… then the ratio needs to back and fill somewhat by elevating the price of the major financials while pulling back on the major commodity producers.
To put this into some form of perspective we show at bottom right the FCX/JPM ratio along with 10-year U.S. Treasury yields (TNX). The sharp rise in relative strength between the miners and the banks began towards the end of last year when long-term yields started to push upwards.
We are going to circle our point and come at it from a different angle by showing a comparison below between the Chinese stock market (Shanghai SE Composite Index) and the share price of Cisco from 1999 into 2003.
The improvement in cyclical growth that began to show up during the fourth quarter of last year has much to do with the perception that China is on the road to recovery. Strength in the Shanghai Comp. went with a bottom for copper prices, an improvement in ocean freight rates (Baltic Dry Index), higher long-term Treasury yields, and a sharp increase in the FCX/JPM ratio. Our problem with this is that China reminds us of the telecom equipment providers (i.e. Cisco) back in 2001. No matter how compelling your product or service it is difficult to show growth when your customers are either bankrupt or no longer financially capable of buying what you are selling.