by Kevin Klombies, Senior Analyst

Monday, March 17, 2008

Chart Presentation: WMT/SPX

The news wires over the weekend were full of reports that before trading opened in Asia there would be an announcement of a deal between JP MorganChase (JPM) and Bear Stearns (BSC). CNBC was suggesting the take over price would be close to $15- $20 per share. One way or another a deal has to be made and the sooner the better so that the markets can get back to fixating on what the Fed and U.S. Treasury will or will not do over the coming week to salvage the global financial system.

Some times simpler is better so we are going to start off today with a comparison that focuses on the broader concept of cyclical growth.

The chart below covers the time period between 1991 and the end of 2000 and shows the ratio between the stock price of Wal Mart (WMT) to the S&P 500 Index (SPX) and the CRB Index.

Below we show the WMT/SPX once again but instead of commodity prices we are showing the Nasdaq Composite Index from 2001 to the present time period.

Cyclical growth as evidenced by the trend for commodity prices bottomed in late 1992 following the collapse of Japanese asset prices in 1990. In other words there was a 2-year bear market in cyclical asset prices between 1990 and late 1992 followed by a recovery that extended through into roughly 1997.

The decline in the CRB Index during the second half of 1997 and through 1998 is in some ways similar to the pressures we have been seeing in the banks and brokers as well as the Nasdaq. Cyclical growth takes many forms- from commodity prices to tech to real estate as well as Asian and Latin equities- but when downward pressure is applied the weakest sectors will obviously decline first and farthest.

The point is that one way to rationalize the relative strength in stocks such as Wal Mart (WMT/SPX) starting in the second half of 2007 would be to suggest that it is a reflection of a weakening in cyclical growth. With that as a premise we note that much the same thing happened ten years ago as the CRB Index accelerated to the down side through 1998. While we are not prepared to argue that the Nasdaq will decline below the 2002 lows in the same manner as the CRB Index into early 1999 the conclusion would be that a reasonably defensive investment posture would be called for through the balance of the year.



Equity/Bond Markets

Our intention was to show the seasonal tendency for the stock price of Coca Cola (KO) to peak around the end of the second quarter but after watching the biotechs get hit on Friday we thought it best to focus on something else today. Seasonal tendencies and panicked markets do not go well together.

Below we show Citigroup (C), U.S. home builder DR Horton (DHI), and the U.S. 5-year T-Note futures.

All three of these markets have gone ‘round trip’ from the bear market bottom in late 2002. C and DHI pushed higher as bond prices declined and then corrected lower as bond prices rose so that, at least in a broad sense, all three are now back to levels associated with the end of the last major equity bear market.

Crude oil futures, on the other hand, were trading closer to 30 in late 2002 so if cyclical pressures had pushed oil prices back to those levels instead of elevating them through 110 we will argue that while we might very well be in a state of crisis it would involve a completely different collections of sectors.

In any event the generally held belief is that upward pressure on commodity prices comes from Asian instead of U.S. economic growth. Given that U.S. housing construction has collapsed and that, last seen, there was more than 400 pounds of copper used in the construction of a new home (and 50 pounds in an American-made auto) this remains a somewhat plausible conclusion.

Crude oil (and copper) futures prices hit bottom around the end of 1998 when the ratio between the Hong Kong stock market (Hang Seng Index) bottomed against the S&P 500 Index. The chart below right shows that over the past decade the Hang Seng Index has risen against the SPX while oil prices have trended higher.

Below we show a short-term view. The point is that if rising commodity prices come from Asian demand and Asian cyclical and economic strength is reflected in the trends for Asian equity markets then weakness in indices like the Hang Seng Index will ultimately lead commodity prices lower.