Jan. 19 (Bloomberg) — U.S. stocks rose, boosted by a rally in health companies on speculation Republicans will block an industry overhaul, while Treasuries fell for the first time in three days and the dollar strengthened… An index of health-care companies in the S&P 500 led the advance with a 2 percent rally as Merck & Co. and Pfizer Inc. gained more than 2.6 percent. U.S. Democrats face the possibility of losing a Senate seat held by the late Edward Kennedy as voters in Massachusetts went to the polls. A loss could cost the party a 60-vote supermajority needed to help pass a health-care overhaul.
The story yesterday was essentially strength in the health care sector. At the very least it gives the markets something new to focus on.
One of our views is that virtually everything that one needs to know about the markets can be discovered using a chart of Coca Cola (KO). Not Coke per se but the theme that it rather broadly represents.
According to ValueLine when Coke’s share price peaked in 1998 it had sales per share of 7.63, earned 1.42, and paid a .60 dividend. If their numbers for 2010 prove to be correct sales per share will be 13.85 with earnings of 3.20 and a dividend of 1.76. In other words between 1998 and 2010 as the share price declined from almost 90 down into the 50’s earnings, sales, and dividends have roughly doubled.
The point- in our view- is that between the end of the 1990’s and the current time period the markets have been consolidating the ridiculous valuations afforded to most of the large cap U.S. names. Through this time frame capital that had previously been poring into large cap names such as Coke, Intel, Microsoft, Johnson and Johnson, and even Wal Mart has been rotating from asset class to asset class to bring relative prices back into line.
To make the case that commodity prices will dominate trading through the next decade one has to believe that the process of valuation consolidation is at best only half way completed. In other words if 50 times earnings is one extreme and something like 6 times earnings represents the ending point then the bullish commodity argument makes sense.
There will be a point in time- perhaps years from now and perhaps a year behind us- when rising earnings and dividends will be sufficient to halt the valuation consolidation and once large cap U.S. stocks start to gain traction and attract a renewed flow of capital… the ‘commodity and foreign’ themes that are so much in favor will shift away from the center stage.
Below is a comparison that we show from time to time between Johnson and Johnson (JNJ) and the ratio of JNJ to the price of the U.S. 30-year T-Bond futures.
Above we argued that much of the migration of capital away from the U.S. large cap sector (and dollar) has been a reflection of the egregious valuation levels that many stocks climbed to at the end of the 1990’s. The idea was that once the valuation levels had been ‘snugged up’ sufficiently money would stop pushing away from the dollar and into the BRIC-type themes.
We are mentioning this once again because it is relevant to the chart at top right. The idea is that within the period of valuation contraction that began a decade or so ago… the share price of JNJ has drifted modestly higher with periodic peaks associated with those times when the ratio between JNJ and the TBonds climbed above .60.
Let’s back it up and try again. 5-year U.S. Treasuries yield close to 2.45% at present with 10-year yields closer to 3.7%. JNJ yields 3% but, unlike a standard Treasury bond, the dividend can and does rise over time. In other words… JNJ is, more or less, supported at current levels by its yield.
As long as the consumer and health care sectors remain out of favor as valuations contract… the chart at top right makes sense. JNJ becomes a ‘sell’ once the ratio of its share price to the TBond futures rises above .60. If the TBonds are trading at 100 then JNJ is a sell at or above 60 but if the TBonds are, say, 120 then the exit point rises to around 72.
In any event… what will be interesting if, as, or when the ratio rises above .60 this year is whether this is yet another rally in what is essentially a flat market or the start of a major trend change. If JNJ stalls out closer to 70 then it is most likely the former while a big push through 75 could easily indicate the latter.
At bottom is a comparative view between gold futures, the share price of Newmont (NEM), and the Swiss franc futures.
Over the longer run gold prices trend fairly closely with the Swiss franc. Whether this will hold true over the very short term is another question but… it does make for an interesting chart exploration.
The idea here is that gold is rising up from the lows set in December below 1100. The two markets that trend with gold- the franc as well as the share price of Newmont- have also held their December lows. Fair enough.
The detail that we have been fixating on has to do with the very minor divergences that have shown up in these charts over the past week or so. The franc was weaker yesterday while gold and NEM was stronger.
Our thought is that this is worth paying attention to if the Swiss franc or the share price of NEM fails back below the December lows over the next week or so. That would suggest that even as gold prices show every intention of pushing on to new highs that… the internal trend is actually lower. These kinds of divergences can lead to rather sharp price corrections- a point that we will continue with on today’s fifth page.
