BANK STOCKS ARE LEADING FINANCIAL SECTOR LOWER -- WHY REITS ARE BEING SOLD ON FEARS OF RISING INFLATION
BANK INDEX HITS FIVE-MONTH LOW ... Heavy selling in bank stocks is pulling the entire financial sector lower today. Chart 1 shows the PHLX Bank Index (BKX) falling to a new four-month low. Part of the financial selling may be coming from heightened fears of inflation which encourages the Fed to keep raising short-term rates. At the same time, fears of slower economic growth are weighing on long-term rates. The result is a continued flattening of the yield curve which occurs when short-term rates rise faster than long-term rates. Back on August 31, I wrote an article with a headline: "Flattening Yield Curve is Hurting Banks" (August 31, 2005). That's because banks have to pay out higher short-term rates while earning less on lower long-term rates. The BKX/S&P ratio line has been dropping ever since the Fed starting tightening over a year ago. That underperformance by banks can be seen more clearly in Chart 2 (see arrow). The weekly chart is an updated version of the chart I plotted on August 31 which warned that the chart pattern had the look of a major head and shoulders topping pattern. To make matters worse, the BKX is bearing down on the "neckline" drawn under the spring 2004/spring 2005 lows. Chart watchers know that a decisive break of that support line is a very bearish development.
Chart 1
Chart 2
Chart 3
FINANCIAL ETF IS ALSO WEAKENING... The weekly bars in Chart 3 show that the Financial Sector SPDR (XLF) has held up better than the Bank Index over the last year. But it too has been an underachiever versus the S&P 500 over the last year as shown by the falling XLF:S&P ratio (black line). The entire financial group is one of today's weakest market sectors. What's especially worrisome is that the weekly MACD histogram (green bars) are turning negative (red arrow). And as I pointed out a couple of weeks back, financial stocks are usually considered to be a leading indicator for the rest of the market. Draw your own conclusions from that.
WHY REITS ARE FALLING ON FEARS OF INFLATION ... It seems like all stocks tied to interest rates are coming under heavy pressure including REITs. The bearish chart pattern for the Real Estate iShares continues to weaken even further as shown in Chart 4. The group fell sharply in August on massive volume. The low-volume rally attempt met new selling around the 50-day moving average. The IYR is falling again on rising volume. That's a weak combination. I've written recently that REITs and homebuilders were especially vulnerable to fears of higher inflation (and the threat of rising interest rates). A couple of readers suggested that real estate should do well in an inflationary environment as was the case during the 1970's. Unfortunately, that's not the case now. What has kept the housing market so hot since 2000 hasn't been inflation but historically low bond yields. In reality, it was the threat of global deflation starting in 1998 that pushed global rates to historic lows which contributed to the housing boom. If inflation is picking up (as the seventeen year high in gold is suggesting), it's just a matter of time before interest rates follow. That's going to hurt housing and real estate. That's also why it's no coincidence that interest-sensitive stocks are leading the market lower at the same time that gold prices are soaring.
Chart 4
