Chart Presentation: Thesis ExpansionWednesday, October 31st, 2012
A more intelligent person would probably suspend publishing a daily markets report until the markets get back to actually trading. We realize that the futures markets are open but until the U.S. equity market returns to some semblance of normality… there are only so many way we can think of to spin the same arguments.
We have a variety of theses that hopefully dovetail into one major view. We have argued that cyclical bottoms tend to be made in the autumn with a particular emphasis on the autumn of the second year of each decade. For months and months we have been focusing on this particular point in time to mark some kind of cyclical low.
Another view has been that the markets seem to be trading in a similar manner to 1996-97. This was the time frame following the peak for the commodities trend with money rolling away from the commodity currencies and BRIC-related themes. This was a particularly positive time for the energy ‘using’ cyclicals.
A third view- explained in yesterday’s issue- relates to the way the bond market has been driven to the top of its very long-term trading channel in response to cyclical weakness. We suggested that this was similar to 1986- 87 in some ways although the ‘driver’ for bond prices at that time was the collapse in crude oil prices. This time around the pressures have tended to emanate from the relentless series of crises emanating from the Eurozone with periodic help from tech and Asian weakness.
Below is a chart of crude oil futures and the U.S. 30-year T-Bond futures from 1986. The basic point is that the bond market did not reach a final peak until oil prices reached bottom through the second and third quarters of 1986.
Below is the current situation. If there is a shoe left to drop that would extend the duration of the TBond’s visit to the channel top it might come from additional pressure on oil prices. If, on the other hand, crude oil futures prices have already bottomed out then we are that much closer to the start of a cyclical pivot.
The point? The current or recent trend has been based on a flat bond market and a steady rise in valuations for stable and non-cylical stocks. Eventually the trend will shift back to the cyclicals with the transition taking place significantly quicker if crude oil prices have already made some kind of lasting price bottom.
Below is a chart of the TBond futures and the ratio between the share prices of Caterpillar and Coca Cola from 1986- 87.
The argument yesterday was that in 1986 the CAT/KO ratio declined from around 3.5:1 down to 2.0:1 in response to the rise in bond prices. The ratio swung back to the upside once the bond market started to weaken at the end of the first quarter in 1987.
The point is that as long as there is upward pressure on bond prices the defensive or consumer growth themes will tend to outperform. The shift from defensive back to cyclical rests with the bond market. While there is a significant risk of missing the first chunk of the transition one detail to pay attention to is the position of the TBonds relative to the 200-day exponential moving average line. Notice how the TBonds bounced off of this line in 1986 and then broke down through it in the spring of 1987.
Below is the same comparison for the present time frame.
The CAT/KO ratio declined from close to 3.4:1 down to just above 2.0:1 this year. The period from July through October looks somewhat similar to the fourth quarter of 1986 through the first quarter of 1987. At the same time the TBond futures are still finding support at the moving average line so there is no indication as of yet that a change in trend has taken place.
The one intermarket detail that still bothers us relates to the chart below. The chart shows the sum of the Canadian and Australian dollar futures.
As we will mention once again on page 5… cyclical is cyclical. This means that in a bullish cyclical trend almost all cyclical markets will rise in tandem and at the top of the list of ‘cyclical’ are commodity prices and the commodity currencies. The point is that a significant cyclical pivot should push the commodity currencies higher but with both the Cdn and Aussie dollars still over parity against the U.S. currency this looks more like a top than a bottom. For this reason we keep wondering whether the bond market’s topping process will or should extend for another few months in response to weakness in the commodity-related themes.