Chart Presentation: Equities Lead
While there are always exceptions one of the better rules to follow is to never buy cyclical stocks that are ‘cheap' relative to earnings. A low PE multiple tends to reflect the markets' view that earnings are going to decline.
The point here is that equities ‘lead' and if one can grasp this fairly simple idea it helps to make the markets seem somewhat more rational.
First is a chart of copper futures and the ratio between FreePort McMoRan and copper from 2000 into 2006.
The ratio between FCX and copper drove skyward from late 2000 into the end of 2003. Relative to copper the share price of FCX became extraordinarily ‘high'. Did this mean that FCX should be avoided because it was ‘expensive'? No. It meant that the equity markets were funneling money into the mining sector ahead of a huge rise in metals prices.
Next is a chart of crude oil futures along with the spread or difference between 2 times the share price of Suncor and crude oil. The premise is that Suncor tends to trade at roughly one half the price of crude oil so when the spread is well above the ‘0' line it means that SU is ‘expensive' and when the spread is substantially below the ‘0' line it means that SU is ‘cheap'.
From the end of 2004 into 2007 the share price of SU rose relative to oil prices. To the extent that the equity markets ‘lead' the idea is that money was moving into the oil stocks ahead of an eventual catch-up rally by oil prices. First the oil stocks rose to a premium to oil prices and then oil prices swung to the upside into the 2008 peak.
We keep reading and hearing about how one should be buying the basic materials, energy, and agriculture sectors on weakness because they are ‘cheap' at current valuation levels but the message from the charts appears to be that instead of stock prices being ‘too low' it is more likely that the underlying commodity prices are still substantially ‘too high'.
Equity/Bond Markets
Being negative on commodity prices and positive on the Japanese stock market is a bit of a dicey view. Cyclical, after all, is cyclical. By this we mean that in general most economically sensitive sectors will rise and fall at the same time.
Below are charts of the CRB Index and the Nikkei 225 Index. The charts have been offset by one decade so we are comparing the trend for commodity prices starting in 1993 with the trend for the Japanese stock market beginning in 2003.
The arguments here are that the CRB Index bottomed in the final quarter of 2001 so we could see a similar low for the Nikkei later this year. As well the underlying trend for commodity prices turned higher in 1999 so the relentless push higher into 2005 was a reflection of a market working hard to come back ‘on trend'.
For this particular thesis to work we need help from two different directions. We need to get to a low point for long-term yields because a positive cyclical trend requires rising interest rates. We also require the dollar to not only turn higher but also to do so on a sustained basis.
Last is a chart comparison between the U.S. Dollar Index futures and the ratio between Panasonic and FreePort McMoRan .
The idea is that when the dollar is weaker cyclical strength is focused in on the commodity sectors with FCX rising relative to PC. A stronger dollar, on the other hand, leads to better price action for PC which, of course, represents the consumer cyclical and/or ‘Japan' theme.
The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.
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