Chart Presentation: Sequence

Thursday, October 28th, 2010

There are probably more logical places to start but whenever we see the Hang Seng Index from Hong Kong decline by more than 400 points in a single trading session we start thinking about one of the sequences that we have sketched out in previous issues.

So… we begin today with two comparative charts of the ratio between crude oil futures and the CRB Index, the Hang Seng Index, and the cross rate between the Aussie dollar and the euro. The top chart is from late 1996 through 1997 while the lower chart begins at the start of 2010.

We are comparing the relative strength of energy prices to the Asian growth theme to the commodity currencies .

The argument is that at the start of 1997 the crude oil/CRB Index ratio began to weaken somewhat. In other words energy prices started to decline relative to the broad commodities market.

For a number of months the equity and forex markets ignored the eroding energy price theme as the Hang Seng Index drove to new highs. At the same time the Aussie/euro cross rate kept hammering away at the top end of its trading range around .70.

By August of 1997 the Hang Seng Index began to fall confirmed by the negative trend of the AUD/euro. Money was starting to move away from Asia as the realization that the commodity cyclical trend led by energy prices was tailing off. During the final quarter of 1997 the Hang Seng Index ‘crashed’ as the AUD/euro declined. Fair enough. It took almost a full year but by the late summer of 1998 the outflow of capital from the Asian and commodity themes created a global stock market panic which, in turn, set the lows for crude oil and copper prices.

The chart below shows that the crude oil/CRB Index has been somewhat negative since the end of this year’s first quarter. Granted… quite a number of sectors have been negative since March including the semiconductors, airlines, and banks. However the point of our fixation has been that the Aussie/euro cross rate is back up at the top of its trading range suggesting that conditions today are somewhat similar to the summer of 1997. This is why sharp price corrections in the Hang Seng Index snap our attention back to this particular argument.

Equity/Bond Markets

Oct. 27 — Bill Gross, manager of the world’s largest bond fund at Pacific Investment Management Co., said a renewal of asset purchases by the Federal Reserve will likely signify the end of the 30-year bull market in bonds.

Strangely enough… Mr. Gross is probably right. In fact, he is probably ‘calling’ a trend change that actually began around the start of this month.

Below is a rather large chart comparison between the Japanese 10-year bond futures and the ratio between the Nikkei 225 Index and the S&P 500 Index.

Over the past 20 years the Nikkei has declined relative to the SPX. This relative strength erosion has gone with a rising trend for Japanese bond prices. The argument is and has been that IF the Japanese bond market has reached a final peak then the Nikkei/SPX ratio should also have made a major cycle bottom. In other words… the weaker the bond market the better the Japanese stock market should perform on a relative basis.

In terms of ‘time’ there is a certain sense of rightness about when this is happening. At top right we show a close-up view of the Japanese bond market in 1990. The low point for the JGBs was reached at the end of the third quarter of that year. Put another way… the last 20 years of the 30-year bond market alluded to by Mr. Gross was driven to a large extent by rising Japanese bond prices and falling Japanese asset prices.

If the end of September marked the 20th anniversary of the Japanese bond bull market then we may well have seen the trend change a few days into October this year as the share price of Panasonic punched up through its 200-day e.m.a. line. We argued on many occasions that this event could mark the highs for the JGBs… and, oddly enough, we may even be right for a change.