by Kevin Klombies, Senior Analyst,

We probably shouldn’t do this but… for what it is worth… our guess is that the equitymarkets will bottom and pivot higher around the end of this week. Just an observation gleaned from looking at too many charts of market and sectors bottoms into the month of October.

At time of writing (Sunday evening) both the U.S. Dollar Index and 30-year T-Bond futures are somewhat higher with the S&P 500 Index futures and crude oil futures lower.

Below we show two charts of the stock price of airline AMR and the sum of the U.S. 30-year T-Bond futures and U.S. Dollar Index (DXY) futures. The chart below is from 1994- 1995 while the chart below right begins at the start of 2008.

We have argued from time to time that there are four basic equity markets trend
that arise out of concurrent trends in the dollar and bond market. When the dollar and the bond market rise in tandem then the consumer, financial, and health care sectors tend to outperform. We are not arguing that the mines and oils have to decline but rather that relative strength will show up in the defensive non-commodity sectors.

Our point today is that the major U.S. airlines also tend to do quite well when the dollar and bond market are trending upwards as exemplified by the rising trend for AMR’s share price out of the fourth quarter of 1994.

The last major peak in ocean freight rates took place during the first half of 1995 so we are relatively comfortable with the suggestion that there are at least a few similarities between that time frame and the current period. The argument is that a significant trend change that leads into sustained strength in the ‘sum’ of the dollar and TBond futures tends to create an upward bias in the share price of AMR.

For all intents and purposes the world changed at the end of this year’s second quarter when commodity prices peaked and turned lower. The chart below shows that both AMR and the sum of the TBonds and DXY turned higher in July. Obviously any time the equity markets fall in large chunks on a daily basis it is difficult for a positive trend to gain much in the way of traction but that doesn’t alter the fact that AMR is net ‘up’ by a fairly wide margin through what has been a very challenging quarter.



Equity/Bond Markets

On quite a number of occasions in the past we have shown a chart anchored by AMR and the biotechs. The argument was that AMR and the biotechs pushed higher through the second half of 2006 followed by the refiners, the golds, and then the natural gas and coal stocks. The idea was that if the cycle is repeating then the second half of 2008 should feature better strength in the airlines and biotechs as crude oil prices weaken with some hope of better action by the refiners through the first half of 2009.

We mention this because the refiners are generally driven by the spread between crude oil and refined products prices. At right we show Valero (VLO), gasoline futures, and crude oil futures.

The point is that gasoline and heating oil futures are still leading crude oil lower. Notice that gasoline futures broke the September lows last week while crude oil held about 91. As long as crude oil prices remain stubbornly strong on a relative basis one simply has to avoid the refiners.

One of our BIG arguments has to do with offsets. Weakness in one sector tends to create offsetting strength in another or, we suppose, strength in one sector tends to lead to weakness in another. Dollar strength, for example, has gone with commodity price weakness but aside from the dollar and bond market there are very few sectors that have shown much in the way of strength- yet- as commodity prices tumble.

Below we show Amgen (AMGN) from today and home builder DR Horton (DHI) from 1998 into early 2003. The collapse of the Nasdaq in 2000 led to lower interest rates
and a rising trend for the home builders. The offset to weak commodity prices and falling interest rates this year? The most obvious candidate continues to be the biotechs.