by Kevin Klombies, Senior Analyst, TradingEducation.com, LLC


Monday, June 23, 2008

Chart Presentation: Correction

June 23 (Bloomberg) — Crude oil fell in New York trading after Saudi Arabia pledged to increase production next month and militants in Nigeria called a cease-fire in their attacks on oil pipelines and vessels.

We have included three comparative charts on this page that show the S&P 500 Index (SPX), the Amex Oil Index (XOI), the ratio between the share prices of Caterpillar (CAT) and Pepsi (PEP), and CAT.

In both 2006 and 2007 the low point for the SPX was reached right around the time that the XOI, CAT, and the CAT/PEP ratio declined to their 200-day e.m.a. lines. The argument is that the U.S. equity markets are more than a month into a correction that has been fighting to pull these three markets back to first support but through the end of last week the process was not quite complete. Whether history repeats exactly or, perhaps more importantly, whether the underlying trend and all of its relationships are set to change is open to debate but as we approach the end of the quarter a bit more weakness in the oils and CAT and some additional strength in consumer stocks such as Pepsi would go a long way towards improving the equity market’s tone.

We suggested recently that at the low point for the S&P 500 Index on two previous occasions the bond market had turned higher around 12 to 13 trading days previously. In fact, the bond market had bottomed and started to rise late in one quarter with the equity markets turning higher mid-way through the first month of the following quarter.

Given that the U.S. 30-year T-Bond futures have managed to not make a new closing low for a whopping 5 trading sessions... we can make some kind of case that a pivot higher is rapidly approaching.

On this page we feature three comparative charts that show the SPX along with the ratio between crude oil futures and the U.S. 30-year T-Bond futures. The chart at right is from 1990 while the chart below right is from 2006. Below we show the current situation.

The idea is that the low point for the SPX should be made very close to the day when the crude oil/TBond ratio reaches a peak. In other words weaker oil prices and rising bond prices have the potential to do wonders for the trend of the U.S. equity market.

Given that the crude oil/TBonds ratio will chop higher and lower- even within a rising trend- it might make sense to wait for a large enough decline to break below the 50-day e.m.a. line. This is certainly not a perfect or risk-free strategy because we can see that in 1990 the ratio took a few runs at the moving average line between late October and mid-November while in 2006 it almost ‘sat’ on the moving average line into mid-August but... it makes some sense for those not inclined to get whipped on a daily basis by energy futures traders. Another way of viewing this would be to argue that the crude oil/TBonds ratio close to or below 1:1 would be encouraging so with the TBonds in the 113’s it would take- at minimum- crude oil prices below about 118 to generate a positive signal.

Kevin Klombies is a prolific writer and market analyst specializing in the commodity stock market and bond commodity market trading in the energy sector. He  graduated in 1980 from the University of Saskatchewan with a Bachelor of Commerce degree (Honours) in Finance/Economics.  Click here for full bio >>