Chart Presentation: Tick, Tock, Tick

As the days, weeks, and months roll by we get closer and closer to the final quarter of 2011. While perhaps not important in any number of ways we have argued over the past few years that this may prove to be a key turning point for the markets. So... once again we return to the Decade Theme.

The Decade Theme argues that the markets keep repeating the same basic trends but with different leadership from decade to decade. Cyclical peaks tend to be made in the ‘0' year, corrections occur through the ‘4' year, crashes and crises litter the ‘7' and ‘8' years, with intense cyclical strength through the ‘9' year.

Below is a chart of the CRB Index from 1995 into 2003 along with a chart of Japan's Nikkei 225 Index from 2005 to the present day.

The 1970's were dominated by rising commodity prices following the large cap excesses of the Nifty Fifty into the 1960's. Once the commodity trend peaked the markets shifted to consumer-related themes during the 1980's, corporate spending and large cap themes in the 1990's, and then back to commodities for the 2000's. Large cap, commodity, consumer cyclical, large cap, commodity... and now what?

The poster child of the 1980's may well be Japan and given its status as ‘the hard trade' our contrary natures find it appealing. Often the hardest trade- the one that makes the least amount of sense- turns out to be the best trade over time.

The idea is that the Nikkei is following the same path as the CRB Index ten years ago so as we grind into the final quarter of this year and into the early stages of 2012 the comparison suggests that the Nikkei may finally be ready to swing back to the upside.

Equity/Bond Markets

To get any kind of sense of why the Nikkei may rise from the dead perhaps it would be best to go back over exactly why the commodity markets turned higher almost exactly ten years ago.

Next is a comparative view of the U.S. Dollar Index futures and the CRB Index futures from 2001 into early 2005.

After twenty or so years of relative weakness why did the commodity markets return to favor at the end of 2001? We will argue that there were two very good reasons.

First, commodity prices had not yet had their turn. Bond prices had risen and equity prices had risen but raw materials prices were still trading in the same old ranges. Over time the markets push one sector higher after another and it was commodity prices ‘turn'.

Second, the U.S. dollar had been driving higher through the ‘capital spending' trend of the 1990's as money flowed into large cap stocks in large cap markets. To get a sense of this recall that the Asian/Russian/Brazilian crises of 1998 and early 1999 were essentially the result of capital flowing away from these markets towards the dollar.  By the end of 2001 the pressure on commodity prices began to abate as the dollar gradually began to decline.

So... the case ten years ago for a bullish trend for commodity prices was based on the fact that commodities had yet to catch up with the general rise in asset prices while the flow of capital into the dollar was starting to reverse. The trend that followed was commodity-based with an emphasis on smaller or emerging markets as money flowed away from the dollar. Fair enough.

Are there any indications that the recent trend is starting to ‘crack'? We believe so.

Below is a comparison between the U.S. Dollar Index futures and the ratio between the World ex-USA Index and the Dow Jones Industrial Index .

The World ex-USA Index is essentially everything other than U.S. stocks. We divide this by the DJII to come up with a measure of the trend for ‘everything but U.S.' compared to U.S. large cap companies.

From the end of 2001 into the middle of 2008 the trend was firmly ‘weaker dollar' and ‘stronger everything but U.S.'. Notice that the trend since 2008 has been somewhat different as the dollar has essentially traded flat even as the ratio of the World ex-USA Index has weakened in comparison to the DJII.

Now it is conceivable that the dollar will simply collapse to new lows with the markets swinging back to the emerging markets and smaller cap foreign themes but our sense is that the money that flowed so hard away from the dollar from 2002 into 2008 is gradually starting to find reasons to work back towards this currency and... as it does... the risks of being invested in the Asian, Latin, and emerging markets themes are building. With a stronger dollar our views are that there are two key markets to focus on- U.S. large cap names and... the one market that desperately requires dollar strength to actually begin to outperform. That market is, of course, Japan.

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