Good economic news combined with continued low interest rates, along with mixed, but mostly encourag...
Thesis Test for the First Quarter of 2009
01/05/2009 11:50 am EST
The argument is and was that in a broad stock market collapse, virtually everything will decline in price, but once the correction has run its course, the stocks and sectors that recover the fastest have to have some kind of ‘tail wind’ behind them.
The second part of the argument is that the commodity markets lag behind the bond market by roughly two years.
The bond market peaked in mid-1986 and then turned lower in the spring of 1987. If the commodity markets lag the bond market by two years, then this would suggest that commodity prices would remain stronger into 1988 with actual weakness showing up in the spring of 1989.
The third part of the argument is that commodity stocks (such as Inco in 1987) trend with the commodity markets while consumer stocks (i.e. Coca Cola) tend to be weaker when commodity prices are rising and stronger when commodity prices are flat to lower.
When the stock market ‘crashed’ in 1987, the share prices of Inco and Coke fell sharply, but once the dust had settled, upward pressure from stronger commodity prices pushed Inco to new highs while Coke’s share price languished into 1989.
We have argued that the commodity trend turned negative back in the spring of 2006 and should continue negative into the end of the first half of 2009. In other words, while stock markets collapsed in both 1987 and 2008, the difference post crash would be that the consumer sectors—instead of the commodity sectors—should enjoy a positive ‘tail wind’.
Our thesis should receive a good test during the first quarter of this year. If we are correct, then stocks like WMT and JNJ should push back above their 200-day EMA lines and then move on to new highs. If we are wrong, then some other sector representing a very different theme will make new highs while the large cap consumer and health care themes languish in a manner similar to KO through 1988.
We have shown and argued recently that there is an ongoing relationship between the trend for the S&P 500 Index, the direction of ten-year Treasury yields, and relative strength between the consumer and cyclical sectors. In other words, as the SPX had moved lower, yields have also declined, and this has gone with strength in the consumer/cyclical ratio.
The idea has been that a broad recovery in the US stock market will begin once the consumer/cyclical ratio begins to decline and that this will take place once long-term Treasury yields have reached some sort of bottom. Fair enough.
Below we show two charts of the stock price of Citigroup (C) and the yield spread or difference between ten-year and 13-week (three month) Treasury yields. The chart below is from 2002, while the chart below right is from the current time period.
The idea has been that the ten-year minus three-month yield spread moved below ‘0’ in 2000, which helped slow the economy and tank the stock market. Once the cyclical correction had begun in earnest, the yield spread line rose sharply until it has pushed above ‘35’ (3.5%). From there it began to decline concurrent with the broad stock market. Once again fair enough.
We are using the share price of C to represent the financial sector, which generally turns higher with the broad equity market. C made an initial bottom when the yield spread moved below its 200-day EMA line, and then made a second and final bottom when the yield spread began to rise. Our thought is that the yield spread line through December may be similar to the yield spread line at the end of September in 2002.
By Kevin Klombies of TraderPlanet.com
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