Below is a chart comparison between the Nasdaq Composite Index and the share price of energy pipeline company TransCanada Corp. . The chart shows the time period between 1997 and 2002.

The argument is that the Nasdaq’s ‘bubble’ into 2000 was the tail end of a trend that began years earlier. The larger trend focused on strength in financial assets relative to real assets which helped push stock prices higher versus commodity prices. This trend began to gather momentum at the end of 1994 when interest rates reached a peak and turned lower.

Nasdaq strength become even more evident in 1997 as commodity prices and Asian growth started to turn negative. By 1998 became so strong that it started to pull capital away from other sectors. In other words the offset to the parabolic rise in the Nasdaq and concurrent rise in interest rates through 1999 can be seen through the decline in yield and commodity sensitive stocks such as TransCanada Corp.

A similar albeit almost completely opposite trend formed during the last decade. At right we show a comparison between the product of the Japanese 10-year bond futures times the Japanese yen futures and the Nikkei 225 Index.

The Nasdaq’s trend began in earnest when interest rates started to decline at the end of 1994. The negative trend for the Nikkei, banks, forestry stocks, and home builders dates back to 2004 when interest rates started to decline in response to rising energy prices.

The Nasdaq did not reach a peak until after long-term interest finally turned lower in 2000. This was the markets’ way of ‘saying’ that growth was slowing. As yields worked back to the down side the Nasdaq declined and TransCanada began to rise. Fair enough.

An argument can be made that the bond market and Japanese yen are this cycle’s ‘bubbles’. Goldman Sachs noted yesterday that the yen is the most overvalued that it has been since the mid-1990’s and by now anyone following the financial markets will have realized that bond prices have recently been accelerating to the upside. Our thought was that the Nikkei 225 Index may well be one of the offsets to this trend in a manner similar to TransCanada back in 2000.

Equity/Bond Markets

Below is a rather large chart comparison between the S&P 500 Index and the ratio between Japanese and U.S. 10-year bond futures.

We have shown this comparison from time to time in these pages over the last few years. Even though it is the kind of ‘macro’ argument that seems to have little relevance to the current situation we thought that it was important enough to show repeatedly. We still believe that this is the case.

The argument is that in 1990 the ratio between Japanese and U.S. bonds began to rise. In other words Japanese growth and inflation weakened relative to the U.S. This helped put downward pressure on U.S. interest rates which in turn led to a decade-long rally for the S&P 500 Index.

Ten years later- in 2000- the ratio finally reached a peak and began to turn lower. A falling ratio suggested that U.S. growth and inflation were being pulled down towards Japanese levels and that the markets were arbitraging long-term U.S. yields down towards Japanese yields. Given that it has been  a decade or so since Japanese 10-year bond yields last saw the sunny side of 2% this helps to explain the fact that U.S. 10-year yields are currently close to 2.6%.

In any event... over the past two decades the SPX has tended to rise when the JGB/T-Note ratio is also moving higher. Conversely the SPX has tended to decline when the ratio starts to fall.

The chart below shows the recent situation. The ratio turned lower in late 2007 before bottoming at the end of 2008. It turned back to the down side this spring. The bearish argument for the equity markets would be that the ratio has to decline back to or below 1.10 to set the next bottom. With the JGBs currently around 143 that would mean that the U.S. 10-year T-Notes might have to push from their current level of 125 21/32 up to at least 130 to set the next pivot point. The bullish argument? The ratio is actually a bit higher over the past five trading sessions...