Chart Presentation: Up the Chimney

We are going to do a quick run through the Qualcomm argument once again while we still have time. With the bulk of this year’s third quarter earnings due next week we want to get this one done now.

In 1999 a number of stocks were rising at a nice pace as the fourth quarter began. Through the final two or three months of the year, however, names such as Qualcomm, Amazon, and even Yahoo! went absolutely ballistic. Between the start of the fourth quarter and the last day of trading the stock price of QCOM rose by just a bit over 400% only to turn back to the down side as the new quarter and year began.

Our thought at the time was that the combination of equity markets momentum, excess liquidity sloshing around pre-Y2K, and the urge by speculative longs to maximize profits into the end of the year helped create a once-in-a-lifetime event. After watching the Asian markets do almost the same thing last quarter, however, we wondered whether lightening could indeed strike twice in the U.S. markets.

With this in mind we started looking for charts that had a similar look to QCOM between March and early October in 1999. In particular we were trying to find stocks that were holding during corrections at the rising 50-day exponential moving average lines (blue line on the charts at right).

In yesterday’s issue we showed Coca Cola, Intel, and Cisco and mentioned that IBM also had the same ‘look’. Another name that we could have used here would be Hewlett Packard (HPQ).

In order for this idea to have any chance of working we likely require at least three factors to come together. First we need a strong and rising equity market. Second we need to identify stocks that are so intrinsically strong that they were barely impacted by the recent equity markets correction.

The third factor is the most difficult because it depends upon something that hasn’t happened yet. To squeeze a stock price right ‘up the chimney’ into the end of the year we need to see a blow out earnings report and an upside ‘gap’ in the share price in response. We suspect that any potential candidate will have to rise by at least 10% to new recovery highs almost immediately following the release of earnings and then continue to push higher for at least the next few trading sessions.

Equity/Bond Markets

The chart at right compares the ratio of equities to commodities (S&P 500 Index divided by the DJ AIG Commodity Index) to the sum of copper and crude oil futures (copper in cents added to 3 times the price of crude oil in dollars) from 1993 into early 1999. Below right we feature the same comparison for the current time period.

The argument goes something like this. Through a broad cycle there are at least three different trends. The first trend includes sharply rising commodity prices (i.e. the sum of copper and crude oil pushes higher) and a declining trend for the equity/commodity ratio.

The second trend begins at the peak for copper and crude oil prices and features flat to lower interest rates and a rising equity/commodity ratio. This also tends to be the strongest time period for the Asian equity markets.

The third trend begins once the Asian equity markets turn lower and features actual weakness in metals and energy prices. The equity/commodity ratio accelerates to the upside due in part to falling commodity prices. This is often the best period of time for the autos and airlines.

On page 1 we used the stock price of Coca Cola (KO) in our Qualcomm-based argument. This is obviously a bit of a stretch because KO doesn’t have the same cyclical nature as an internet or telecom company but the thought was that the large cap consumer and pharma names (we use the PPH below) trend very closely with the equity/commodity ratio.

In any event the idea is that as we start a new quarter the sum of copper and crude oil appears to be rolling over and we have already experienced huge runs in the Asian equity markets. If the SPX/DJCI ratio were to break to new highs this month (and the chart below shows that it wouldn’t take much for that to now happen) then some of the U.S. large cap consumer, pharma, and tech names that turned upwards in the first half of 2006 might be good choices into the end of the year.