BOND YIELDS ARE CLIMBING AGAIN -- BASIC MATERIALS ARE STARTING TO OUTPERFORM FINANCIALS -- RISING INFLATION AND RISING RATES COULD CAUSE 2006 PROBLEMS
YIELDS ARE BOUNCING OFF SUMMER HIGHS... After pulling back during the month of November, bond yields are starting to climb again. More importantly, they're bouncing off the previous peaks hit during August. That's important in chart work because short-term pullbacks shouldn't fall below previous peaks. Charts 1 and 2 show the 10-Year T-Note yield (TNX) and the 30-Year T-Bond Yield (TYX) bouncing off their August highs (4.40% in the 10-year and 4.60% in the 30-year). They're also bouncing off their respective 50-day moving averages. In so doing, long-term yields are maintaining the pattern of higher highs and higher lows that starting during June. That may be setting the stage for another challenge of their 2005 highs. Those early 2005 highs (4.69% in the 10-year and 4.93% in the 30-year) represent important chart benchmarks. Closes above those levels would leave little doubt that long-term rates have turned higher.
Chart 1
Chart 2
LONGER TERM LOOK AT BOND YIELDS ... The weekly bars in Chart 3 put the current position of the 10-Year T-Note Yield in better perspective. It shows that the TNX bottomed in the spring of 2003 and has been moving sideways with an upward bias. The flat green line is the same one shown in Chart 1. A close above that chart barrier would set in motion a possible challenge of last year's yield peak at 4.90%. A close over that barrier would confirm that the major trend for bond yields has turned higher. [The yield shown in Chart 3 is the same one that determines mortgage rates. For that reason, any upside breakout would undoubtedly have a negative impact on the housing and real estate sectors]. We're still a ways from an upside breakout. But the fact that bond yields are starting to rise is already hurting bond prices and is causing some concerns in an over-extended stock market. Rising oil prices are helping either.
Chart 3
BASIC MATERIALS STARTING TO DO BETTER THAN FINANCIALS ... Last week I showed the CRB Index bouncing off its 200-day moving average which suggests more upward pressure on commodity prices. Over the weekend, I wrote that energy prices appeared to have bottomed as well. Another way to measure how the market views the trend of inflation and interest rates is to compare the relative performance of the rate-sensitive financial sector with the inflation-sensitive materials sector. Chart 4 does that by plotting a ratio of the Materials Sector SPDR (XLB) divided by the Financials Sector SPDR (XLF) since the beginning of the year. The ratio peaked in March and dropped until November. That suggested that the market wasn't overly concerned about inflation or rising interest rates. That perception may be changing. Over the last month, the XLB/XLF ratio has broken the 2005 down trendline and is now rising (see circle). [In today's market pullback, financials are weakening while materials are trading higher]. In the past we've seen rising commodity prices without rising interest rates. If both start rising together in 2006, it's doubtful that the stock market will be able ignore both. That may not be enough to prevent the market from climbing higher between now and yearend. But it may be enough to start causing problems as we start moving further into 2006.
Chart 4
T-BOND ETF HAS PEAKED ... I've shown this chart before but I thought it worth repeating because it tells an important story. It's the 20-Year T-bond IShares (TLT) over the last eighteen months. Since it represents what had been the strongest part of the yield curve (the long bond), it's recent breakdown is a telling clue about the direction of bond prices and bond yields. The chart shows a clear "double top" formation (see arrows) which was completed during October when bond prices broke the lower line. The November rebound attempt fell short of that overhead resistance zone, failed a test of its 200-day moving average (red circle), and is starting to fall again. This is the first significant sign of a top in bond prices since the start of 2004, and suggests that a trend change is taking place in bond prices (turning down) and bond yields (turning up). That's because bond yields move in the opposite direction of bond prices. The relative strength ratio along the bottom is also disturbing. It's the TLT divided by the S&P 500. Bond prices have actually done better than stocks since the middle of 2004. As long as that's the case, the market needn't worry about rising rates. The bond/stock ratio has, however, broken the rising trendline. That's bad news for bonds now. And could become bad new for stocks a little further out in time. That's because stock market peaks are usually preceded by bond market peaks.
Chart 5
