RISING RATES ARE ALREADY HURTING FINANCIALS WHICH ARE USUALLY THE FIRST STOCKS TO PEAK -- THE SCALE HAS TIPPED IN FAVOR OF INFLATION
THEY'RE USUALLY THE FIRST TO PEAK ... From an intermarket perspective, there are three things that have historically led to market tops. The first two are a falling dollar and rising commodities. We've had those two for some time. The third thing is an upturn in long-term interest rates. That's been a long time coming, but may finally be happening. Since rising rates have historically led to stock market peaks, one of the ways to tell if that process has started is to look at how financial stocks are doing relative to the rest of the market. The market has a history of peaking in stages. The first group to peak are rate-sensitive stocks like financials (and REITS). The last group are commodity-related stocks. That's why in the latter stages of a bull market it's usually better to concentrate on inflation-sensitive stocks and to avoid rate-sensitive stocks. Charts 1 and 2 compare the S&P 500 since the start of 2004 to the Financial Sector SPDR (XLF). While the S&P recently hit a new high, the XLF has failed a test of its early 2004 peak. And it's shown a pattern of falling peaks since the start of 2005 as the S&P has been rising. The poor performance by the financials is better seen by the relative strength line at the bottom of Chart 2. It peaked last spring and again in September. It's now trading at the lowest level in more than a year. That's consistent with rising rates and is an early sign of a peaking stock market.
Chart 1
Chart 2
Chart 3
RISING RATES ARE ALREADY HURTNG FINANCIALS ... Charts 2 and 3 compare the Financial SPDR to long-term rates. The spike in rates last spring coincided with a peak in the XLF/S&P ratio line. The September peak in the financial relative strength line coincided with a more modest upturn in rates. The more recent drop in the ratio since the start of 2005 has coincided with another upward surge in bond yields. That's the market's way of telling us that it expects interest rates to keep rising and that it will begin to hurt the stock market in time. It appears that financial stocks have already peaked. That's the way market tops usually start.
REITS AND FINANCIALS TURN DOWN ... With long-term rates hitting a seven-month high today, financials and REITs are being sold pretty heavily. Chart 4 shows the Financials SPDR (XLF) falling under its 50-day moving average. It peaked at the end of December. Notice the big drop in its relative strength line since February. Downside volume is also starting to pick up. Earlier today I wrote about REITs being hurt by rising rates. Chart 5 shows the Cohen & Steers Realty iShares (ICF) also falling on heavy volume after peaking in late December. It's falling relative strength line also shows that money is moving out of this rate-sensitive group. When investors see inflation on the horizon, they sell rate-sensitive groups (like REITs and financials) and buy inflation hedges -- like basic materials, gold, and oil shares. That's exactly what I've been recommending.
Chart 4
Chart 5
THE SCALE HAS TIPPED TOWARD INFLATION ... This is the same headline that I used back on Friday, February 18 when I showed the following chart February 18, 2005. It's a ratio of the Materials SPDR (XLB) divided by the Financials SPDR. The point of the chart was to show that the forces of inflation and deflation had been pretty evenly balanced for the last three years. That helped keep long-term rates low. The upside breakout in mid-February (see circle), however, signaled that the scale had tipped in favor of inflation and that one of the consequences of that would be higher short and long-term interest rates. The closing paragraph also wrote that "it'll be better to be in inflation-sensitive stocks (like basic materials) than deflation-sensitive stocks (like financials). Recent market action certainly supports that view.
Chart 6
