Chart Presentation: Views

Our view is that the U.S. equity markets will remain under pressure through into the fourth quarter and then explode to the upside through 2009 making new all time highs and possibly moving above 2000 within the next 18 to 24 months.

Our view is that the U.S. dollar is making a bottom and will resolve up through 80 (U.S. Dollar Index) on the way back above 100.

Our view is that crude oil futures prices will break below 120, 110, and then 100 before rallying back towards the 110 level before eventually resolving back towards 70- 80.

We have suggested in the past that one should never be positive on those sectors that are causing interest rates to decline and should instead be positive on those sectors that are putting upward pressure on yields.

The problem at the moment is that real estate and the financials are putting downward pressure on yields while commodity prices are exerting upward pressure. In a sense our views run contrary to our own logic. Fair enough.

We started off by noting that we expect the U.S. equity markets to remain under pressure through the autumn. While this makes sense to us we are less sure of exactly what, why, and where the pressures will come from. Our sense is that the trend is at a decision point. If copper and crude oil prices continue to decline then long-term yields should follow and this will go a long way (through lower mortgage costs) to providing a floor underneath home prices.

At top right we show the S&P 500 Index and the ratio between crude oil futures and the U.S. 30-year T-Bond futures from 1990 into 1991. The low for the SPX was made at the peak for the crude oil/TBonds ratio. Once again… fair enough.

Below right is a chart comparison between Pepsi (PEP) and the crude oil/TBonds ratio. Our expectation is that stocks such as PEP, Coca Cola, Proctor and Gamble, Unilever (which was very weak yesterday), etc. have turned higher after bottoming through the first half of July. Our view is that the crude oil/TBonds ratio made a peak almost a month ago and that those sectors pressured lower by rising energy prices are now on the mend. As the commodity-oriented equity sectors decline into the fourth quarter we look for offsetting strength in the consumer sector creating a modestly positive slope to the chart of the S&P 500 Index.

At right we show a rather messy chart comparison that we have been using in one form or another since 2007. The chart begins with AMR on the bottom and then works through oil refiner Valero (VLO), gold miner Barrick (ABX), Canadian natural gas producer Duvernay (DDV on Toronto), and then to the biotech etf (BBH).

As an aside we tend to believe that Royal Dutch Shell’s take over bid for Duvernay ranks right up there with the British government’s decision to sell gold below 300 as historical examples of poor timing. In terms of this chart comparison we have at times substituted Chesapeake (CHK) or the Amex Natural Gas Index (XNG) for DDV so at the bottom right we have included a comparison between CHK and natural gas prices.

The chart-based argument works something like this. Over the past number of years the markets have worked through what we tend to call ‘dominant trends’ that have extended for two consecutive calendar quarters. The first six months of the year has featured a strong energy theme while the final six months has tended to focus on ‘something else’.

At the end of the second quarter of 2006 the theme shifted towards the consumer and financial sectors and by September weakness in crude oil was sufficient to drive AMR’s share price higher. AMR peaked in early 2007 as the markets shifted back to an energy theme dominated by the refiners. As Valero reached a peak in mid-2007 the theme shifted over to the golds as the banks and brokers went into a tail spin. Barrick topped out in early 2008 as the markets pivoted back to the natural gas and coal stocks. Our argument over the past few months has been that the dominant theme through the balance of 2008 appears to have something to do with biotech.

Quickly… on Wednesday crude oil prices surged higher along with the shares of the energy producers. The chart below shows that each time the Amex Oil Index has declined below 1300 since May of last year it has marked a bottom for crude oil prices. The markets will continue to do what has worked in the past until it becomes crystal clear that the trend has finally changed and for that to happen we will need to see crude oil futures prices well below 120.