by Kevin Klombies
We mention from time to time that cyclical is cyclical. By this we mean that the basic trend is similar for all cyclical sectors although the markets often do a very good job of confusing the issue by creating dominant themes.
For example... when energy prices represent the dominant theme the markets will, quite naturally, focus on
energy-related assets while putting downward pressure on those sectors that have significant exposure to
energy prices. Yet... over the fullness of time the markets do tend to let most groups take a turn through a positive cyclical trend.
There are probably any number of ways to explain what we mean but the share price of AMR is perhaps as good as any. At the cyclical bottom in 2003 the share price declined below 2.00. At the cyclical top in 2007 the share price eclipsed the 40 level. In the midst of a very strong energy price trend one could have made more money from bottom to top in AMR than in Exxon Mobil. Strange but true.
In any event... the chart at top right compares U.S. 3-month TBill yields and heating oil futures from 2000 into 2006.
We have argued that the break to new highs by crude oil and heating oil futures in 2004 was largely responsible for pushing short-term interest rates higher. In fact this was exactly the point that we made in late 2003 and early 2004 when we made the seemingly preposterous suggestion that crude oil prices would not only reach new highs but could rise to 75. In hindsight we might have been a bit timid with our projection.
Below is a comparison from the current time frame. The chart shows 3-month TBill yields once again along with the Nasdaq Composite Index.
The point is that the Nasdaq is flirting with the 2007 highs in a manner somewhat reminiscent to heating oil’s push above its 2000 highs back in 2004. Each time the Nasdaq snugs up towards 2900... the markets respond with some kind of crisis. Our thought is that one of these days the Nasdaq might resolve to new recovery highs even as investors crowd into gold and cash in the hopes of escaping financial Armageddon. If cyclical is cyclical and the Nasdaq breaks up through resistance... look for long-term yields and eventually short-term yields to follow.
Equity/Bond Markets
From time to time we return to the notion of... and now what?
Below is a chart of the S&P 500 Index divided by three different commodity prices. We show the SPX in terms of gold, crude oil, and copper.
This is an interesting perspective because it argues that the SPX ‘led’ to the upside during the 1990’s only to have basic materials prices ‘catch up’ during the 2000’s.
The end result 20 years later is a return to the same kind of relative prices that marked the start of the cycle back in 1990. The SPX is somewhat less than 1 times the price of gold (after rising to 5.5 times gold), well below 20 times the price of crude oil, and roughly 3 times the price of copper (in cents).
The argument is that we had a decade’s worth of rising financial asset prices from 1990 to 2000 and another ten year’s worth of rising real asset prices from 2000 into 2010. At the end of the cycle prices have come back into some form of balance suggesting that there is no particular reason why gold prices should return to 300, oil prices to 10, or copper prices back to under a buck. Unless, of course, the S&P 500 Index were actually set to fall back to the bear market lows of 1990 when it tested 300.
Our point is that a market that has returned to a kind of relative price ‘fairness’ is not exactly the kind of market that one would expect to be balanced on the precipice of collapse.
Beyond all of this the issue might be... and now what? After a decade of rising equity prices and a decade of rising commodity prices what happens next? What trend or theme will serve to dominate the current decade?
At bottom we have included a chart of the CRB Index from 1980 into 1982 and the Japanese 10-year (JGB) bond futures from 2010 to the current time period.
We obviously may not be right but this is our view of what we expect will happen next.
One or more major asset sectors has risen to a price peak early in a new decade. In the 1980’s it was commodity prices while in 1990 it was Japan. Ten years later it was the tech and telecom sectors and ten years after that... is an issue yet to be decided.
Our thought is that it could well be the bond market. In other words we are arguing that Japanese and U.S. long-term bond prices peaked in the autumn of 2010 in a manner similar to the CRB Index in the autumn of 1980. If we are correct then the U.S. will avoid the plunge into deflation while Japan responds with a swing towards a positive inflation rate over the next few quarters.
What we like best about this view is that it might rank as the least anticipated outcome even as it is supported by the might and determination of most the developed world’s central banks. With the Fed working so hard to stave off asset price deflation it seems to make some sense to conclude that we have reached a generational low for interest rates.
