Monday, August 27, 2007
Chart Presentation: Resistance
The lesson learned this month is that derivatives
are useful for hedging market risk, sector risk, and security risk
but they fail when it comes to liquidity risk. Fortunately the major
central banks stepped forward to provide additional liquidity so
once again the computer models appear free to fire away at even the
riskiest asset classes.
The problem, we suppose, is that the reason for
the crisis- weakness in the U.S. housing market coupled with almost
criminally lax credit standards over the past few years- hasn’t gone
away. There remains the potential for a couple of million home
foreclosures and a couple of hundred billion dollars worth of
subprime mortgage losses so, for all intents and purposes, this go
around may be the first of many.
Our basic view is that the U.S. economy shifts
from consumer driven to capital spending driven on occasion. When
the tech cycle ended in 2000 easier credit conditions helped fuel a
new consumer spending cycle and in the days, months, and years to
come the Fed’s attempts to staunch the bleeding in the housing
market will lead to an offset through increased capital spending.
In the face of impending doom one wonders how the
equity markets manage to screw up enough conviction to push higher.
Today we wanted to show two chart comparisons that help- we hope- to
add some form of perspective.
We show the S&P 500 Index (SPX), Cisco (CSCO),
and IBM through early 2007. We have argued on occasion that those
stocks that were forced lower in early 2004 are now working back to
those levels. For IBM the target was 100 while for CSCO it was
roughly 29. Notice that when the stock prices finally reached these
levels and stopped rising the SPX slowly began to lose momentum.
After the February sell off both IBM and Cisco steadied and then
moved on to new highs.
The chart shows the SPX, Anheuser Busch (BUD),
and the pharma etf (PPH). BUD and the PPH (along with Coca Cola)
reached the critical 2004 resistance line in May and June and
similar to IBM and Cisco earlier in the year this led to a loss of
momentum for the SPX and an eventual correction. Now that these
stocks have washed out if history is any guide the rising trend
should reassert itself leading to new highs later in the year.
Equity/Bond Markets
When the U.S. equity markets began to tumble
back in late 2000 the catalyst was a sharp decline in capital
spending in the tech and telecom sectors that was offset by
lower interest rates. As interest rates declined consumers were
able to refinance mortgages to increase spending. In due course
the cycle was dominated by rising real estate prices and ‘flip
this house’ home renovation projects.
The point is that years ago if one had known
that the cycle was going to include consumer spending, strong
real estate prices, and home renovations the obvious stock
market ‘winners’ should have been stocks like Home Depot (HD).
Instead the chart shows that HD has been mired in a declining
trend since early 2000.
The chart at middle shows copper futures and
an overlaid view of the ratio between the Morgan Stanley
Consumer and Cyclical Indices along with (in green) the U.S.
Dollar Index.
The idea is that the real dominant trend has
been ‘cyclical’ and that this goes with both a weak dollar and
rising metals prices.
The chart below shows the Canadian equity
market (S&P/TSX Composite Index) and the ratio between large and
small cap U.S. stocks (S&P 500 Index/NYSE Composite Index).
Similar to ‘cyclical’ versus ‘consumer’ the
trend has featured prolonged relative strength in small cap
versus large cap and non-U.S. compared to U.S.
The strange thing about the recent trend is
that it has been driven by U.S. consumer spending but within the
equity markets the best sectors have been non-U.S. and cyclical.
The prevailing view seems to be that weakness in housing prices
will slow consumer spending and lead to weakness in retailers
like Wal Mart and Home Depot but perhaps it actually makes more
sense to conclude that the real damage will done to the non-U.S.
cyclical and small cap sectors.
The chart below shows HD scaled in semi-log. The argument
here is that everything post-2000 actually represented a long
correction within the rising trend that moved HD’s stock price
from the upper channel line back to support. The weakness in the
U.S. dollar, the shift to small cap and foreign, and the
persistent strength in metals prices would then be mere
by-products of a major theme in need of a consolidation.
Read Other Recent Articles by
Kevin Klombies
