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Chart Presentation: What If?
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Our initial thought today revolves around the topic of ‘what if’. What if Greece’s credit crisis shifts from a problem to a contagion similar to the subprime mortgage market in 2008? What if the euro’s decline turns out to be something more than yet another one-month sell off ? What if the erosion that the cyclical trend has shown this year really is a replay of 2008?
Our basic view is that 2008 was, by and large, the end result of 2007’s yield curve inversion. If memory serves all 7 U.S. recessions post-1968 have been preceded in the previous 12 months by an inverted yield curve. On the other hand... the ‘decade theme’ suggests that the ‘1’ year of a decade tends to include some kind of ‘slower growth’ issue.
Below is a chart comparison between, from top to bottom, the spread between platinum and gold futures prices, the share price of Goldman Sachs , and the price spread between Target and Wal Mart .
The argument is that the trend becomes cyclically negative when TGT starts to weaken relative to WMT. Conversely when TGT is stronger than WMT the markets tend to favor cyclically positive themes.
In late 2007 the spread between TGT and WMT started to decline along with the share price of Goldman Sachs. The commodity markets continued to push higher into the middle of 2008 but when the dust finally settled the weaker cyclical trend won out.
Our points are as follows. First, as long as the spread between TGT and WMT is falling the trend is still negative. This is especially true if GS is following along the same path. The commodity markets can- and have- diverged from this trend for a period of months but eventually the realities of markets-related ‘gravity’ will overwhelm the efforts of momentum-based traders.
The correction in 2008 concluded once platinum futures prices converged with gold futures prices. In what we hope would be the worst case scenario if the cyclical correction continues we might have a second opportunity to make a major bottom later this year once platinum and gold prices converge for a second time at the same price.
Equity/Bond Market
We very much wish that we had all of the answers but most times we aren’t even sure whether we know what the appropriate questions are. Perhaps ‘the question’ might be whether the sense of crisis surrounding Greece, Italy, Portugal, Ireland, and Spain is worse at present than it was during the second quarter of 2010.
The point is that if this is merely a replay of last year’s concerns then the correction has already largely run its course.
Just below is a chart of copper futures, 10-year Treasury yields, and the share price of Japanese bank Mitsubishi UFJ .
Around the end of March in 2010 copper futures prices peaked along with 10-year Treasury yields. A few weeks later MTU’s share price reached a top just north of 5.50.
Copper prices declined to and then below the moving average lines as yields moved lower. The eventual bottom for yields was reached at the end of September as copper prices pushed to new recovery highs. A few weeks later MTU started to rise.
The point is that in 2010 the markets corrected based on Eurozone concerns with copper prices first declining and then rising. The trend for yields remained lower until copper reached new highs and after yields swung upwards the ‘laggard banks’ began to recover.
If history were to repeat then we would expect to see copper prices declining for a few months with yields moving downward and the share price of MTU falling from around 5.50 to 4.50 . The leading edge of the recovery would include a return to a rising trend for copper prices with yield swinging higher as copper pushed to new highs. A few weeks later the banks would shift into recovery mode.
Below is a comparison between 3-month TBill yields, the ratio between the Bank Index and the S&P 500 Index , and the ratio between Brent crude futures and the CRB Index.
We can make a fairly good argument that the markets have been under pressure since the start of the year. This fits in nicely with the declining trend for the BKX/SPX ratio.
Concurrent with the banks weakening on a relative basis we have also seen short-term yields decline from around .15% down to almost 0% as Brent crude oil prices have moved higher relative to the broad commodities market.
Keeping with our inclination to view the glass as half full... any negative trend for the BKX/SPX ratio that is linked to declining TBill yields is necessarily bounded by the reality that rates really can’t fall any further than 0%.
On the other hand... if TBill yields continue to skyrocket then we could already be on the road to recovery. Obviously a hostile trend seems to include energy price strength and we may not see an end to this until some time later in the quarter but the point is that the negative trend went with falling TBill yields, TBill yields can’t fall much further, and the short-term trend is actually a bit higher.
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