Market Anthropology: Picture this

Thursday, January 16, 2014

Picture this

Picking up where we left off – with respect to form and symmetry, here’s another pattern we have watched for years with the curious expectation that it will eventually complete its relative symmetry on the downside. 

It’s a ratio chart that depicts the SPX relative to oil (West Texas Intermediate). 

As shown in the chart below that breaks out the ratio, the first shoulder of the pattern was formed when a glut of oil appeared in the market in early 86′ and collapsed prices. With the exception of the pronounced divergence in the SPX relative to oil during the banking crisis in 1990; over the next ten years – oil largely traded in a narrow band while the SPX more than tripled. The exhaustive pinnacle of the pattern was formed when oil prices collapsed between 1997 into December of 1998 – while the SPX returned almost 70%. 

On the mirrored recoil of the pattern, oil prices more than tripled coming out of the late 98′ lows – while the SPX tacked on a little more than 20% heading into the March 2000 equity highs. Broadly speaking, the ratio moved lower for over six years from the retracement high that ended subsequent to the September 11th attacks, until the pronounced divergence between the SPX and oil in the first half of the most recent financial crisis. From the October 2001 lows until its exhaustive high in July 2008 – oil prices went up more than eight fold while the SPX traded in a wide range and went basically no where. 

Since the summer of 2008, the ratio has crisscrossed the range carved during the financial crisis and has been moving steadily higher since the commodity markets peaked in Q2 2011.  

By balancing out the marginal asymmetry of the actual mirrored decline and normalizing the broader cycle to each financial crisis, the ratio is currently sitting within the protracted window for a pivot lower. At this point we would stress that we would be simply looking for a pivot – and would not make any assumptions as to the velocity of a prospective move lower. 

By itself we would never hang our hats on just form alone and try and always rigorously evaluate an idea from several different perspectives. The long and short of things is we believe the numerator (SPX) of the ratio should back off its exceptional performance trend and expect another pulse of inflation to start moving through the system – helped in part by a weaker dollar. While the dollar has held up over the past few weeks, we anticipate the roll that began last year will build momentum if and when the 50% retracement level ~ 79 is broken. Below that and there’s relatively little support back to the 2011 Q2 low right below 73. All things considered, a weaker dollar should provide a strong tailwind for the oil market. 

Of course it shouldn’t hurt that as mentioned in this Reuters article out today (see Here) that OPEC has also decided to lower its output even further – below the demand forecast for 2014 (thanks Gary). A fitting coda to the patterns mirror of what the Saudi’s did with ramping production in late 1985 that led to the glut of oil in the market in early 86′.