BREAKOUT IN BOND YIELDS HURTS REITS WHICH HAVE BEEN FALLING SINCE THE START OF 2005 -- JAPANESE MARKETS ARE RISING
TEN-YEAR T-NOTE YIELD HITS SEVEN-MONTH HIGH ... It may have been the recent rise in commodity prices to 24-year highs and weakness in the dollar. Or it may have been economists' raising their 2005 forecast for economic growth. It may even be the fact that the Japanese yen is rising which implies less Asian buying of U.S. Treasuries. All that really matters is the fact that the yield on the 10-year T-note has broken out today to the highest level since last August. That greatly increases the odds that long-term rates are finally starting to rise in reaction to rising inflation pressures. That's of course bad for bonds since it pushes bond prices lower. It should also raise concerns about the stock market. It was the spike in rates last March that contributed to the downturn in stocks through the first half of 2004. One of the areas that we're seeing an immediate impact is in rate-sensitive stocks -- and real estate in particular. Homebuilding stocks are correcting today. But most of the selling is coming in REITS.
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REITS VS. RATES ... Chart 2 compares Cohen & Steers Realty iShares (ICF) over the last year to the 10-year T-note yield. They show a generally negative correlation. The spike in rates last spring pushed REITs down much more than the rest of the market (see falling relative strength line). REITs started doing better after rates peaked in May. Chart 2 shows, however, that the REIT ETF peaked in December and has been dropping since then. Its relative strength line has also been dropping since the start of the year. I recently suggested that loss of leadership by REITs was one of the market's way of telling us that it expected long-term rates to start moving higher. That's why it's no coincidence to see REITs falling sharply today as long-term rates reach a seven-month high.
JAPANESE YEN CLEARS 50-DAY LINE ... I mentioned the rising yen in the opening paragraph because it's climbing over its 50-day moving average today and is trading at the highest level in a month. That weakens the dollar which is potentially inflationary. But the extent to which the Japanese allow their currency to rise diminishes their appetite for U.S. Treasuries. The Japanese are the biggest foreign holders of U.S. debt. They buy that debt with dollars bought trying to keep the yen from rising. If they let the yen rise, they have less need to buy dollars and fewer dollars to buy Treasuries. Speaking of Japan, Chart 4 shows Japanese iShares (EWJ) trading at new 52-week high. Asian markets are especially strong today. Part of the Asian buying is tied to rising commodity prices which helps emerging markets in that region of the world. Some of that money may be coming out of the U.S. markets and Treasuries in particular.
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