We have argued on occasion that trend changes for the equity markets often show up between the 22nd and 25th day of the first month of a new quarter. Given our tendency to focus on macro issues it is rare that we get this specific.

The idea is that while trends tend to run quarter to quarter the actual change often takes place once the bulk of the previous quarter’s earnings have been announced and this usually happens around the final week of the month.

At right  is a chart comparison between the S&P 500 Index and the U.S. 10-year T-Note futures.

We are going to start off by examining the interplay between the equity and bond markets in January and April of this year.

The equity markets have been trending inversely to the bond market so a bottom for bonds should indicate a top for equities. And vice versa.

Notice that the U.S. 10-year T-Note futures hit a price bottom at the end of the final quarter of 2009 and again around the start of April. The equity market, on the other hand, held near the highs through the first few weeks of January and through into late April. In other words the bond market made the pivot higher at the start of the quarter while the equity markets pushed upwards for a few more weeks as quarterly earnings were released.

Our point is that the markets are in a much different position in July than they were at the start of the first and second quarters. The bond market, for example, is not pivoting higher from a low around the 115 level but is instead extending the rally that began back in April.

Our view has been that the markets worked through a one-quarter ‘crisis’ trend in response to weakness in the euro between April and June. The euro, of course, has bounced and within the various markets there are all kinds of ways to argue that bond prices really should have turned lower weeks ago. However... as long as the long end of the Treasury market keeps making new daily highs the equity markets are going to be prone to sharp downward corrections. If the trend is going to change in favor of stronger equities and weaker bonds then our expectation is that it should show up within the next week or so.

Equity/Bond Markets

When we introduce a topic that we believe may have some merit we like to beat it into the ground from a number of different perspectives. Since some of our views are somewhat complicated... repetition is not always a bad thing.

In yesterday’s issue we introduced the idea that the cross rate between the Aussie dollar and euro might have something to ‘say’ about the markets’ trend over the next year or two. In a sense we are arguing that the set up is similar to 1998 even though it is also almost exactly the opposite.

The argument begins with the idea of a trading range for the AUD/euro cross rate between roughly .50 and .70. If the cross rate holds within this trading range then we have something to work with.

Between 1997 and 1998 the cross rate tumbled for close to a year and a half until it reached the bottom end of the trading range. This marked capital moving away from Australia. The Aussie dollar trends with Asian growth and commodity prices so the weakness in this currency indicated a negative trend for Asian growth and a corresponding negative trend for commodity prices.

The chart at top right shows the AUD/euro cross rate, the S&P 500 Index, and the sum of copper futures and crude oil futures from June of 1998 through April of 1999.

The two points that were attempting to focus on were as follows. First, the low point for the AUD/euro occurred at the bottom for the S&P 500 Index. In other words the AUD/euro did not stop declining until the equity markets had reached a crisis bottom at the end of the third quarter in 1998.

Second, while the AUD/euro turned higher with the equity markets the price of copper and crude oil did not begin to recover for another four or five months. Coincidentally or not... the low point for copper and crude oil in February of 1999 was reached as the moving average lines for the AUD/euro crossed back to the upside.

Below right we show the current situation.

Our ‘logical leap’ was that we knew that the AUD/euro had reached the top of its trading range last quarter because the equity markets were back in crisis. The difference was that in 1998 money had been moving away from the AUD while the crisis occurred in Asia followed by Russia and Brazil and in 2010 money had been moving away from the euro ahead of the crisis that originated in Greece.

The next ‘leap’ was that if a peak for the AUD/euro marked yet another crisis bottom for the equity markets then it might also suggest that copper and crude oil futures are in the opposite position that they were in back in 1998- 99. In other words... the Asian crisis preceded a major cycle bottom for copper and crude oil so perhaps a European crisis marked either a major bottom for one or more sectors or... a cycle top for copper and crude oil futures.

In any event... the argument needs work but our thought was that if we were going to see weakness in energy and base metals prices it may not show up until late in the year. If, that is, the AUD/euro has fallen far enough by then to ‘cross’ the moving average lines.