HINT AT RATE PAUSE RALLIES MARKET -- FINANCIALS LEAD -- CHINESE RATE HIKE WEAKENS COMMODITIES
CHINESE RATE HIKE WEAKENS COMMODITY MARKETS ... The Chinese central bank raised interest rates for the first time since October 2004. They did that to prevent the Chinese economy from overheating. One of the immediate reactions was a selloff in most commodity markets. It's no secret that China has been a major buyer of commodities. The reasoning is that a slower Chinese economy might dampen commodity demand. I've suggested recently that energy and metals and their stocks were dangerously overbought and in need of a breather. We saw heavy selling in gold and silver last week and profit-taking in energy markets earlier this week. So a further pullback shouldn't be too surprising. The CRB Index lost more than six points today to fall below its January peak at 350. Some of the bigger percentage losers were natural gas, gasoline, copper, gold, and silver and stocks tied to those commodities. Chart 2 shows the Materials Sector SPDR falling today on the heaviest trading in six weeks. Alcoa and US Steel were two of the bigger percentage losers. Chart 3 shows the Gold & Silver (XAU) Index backing off from resistance near its January high. That's a logical spot to expect some short-term profit-taking. With inflation-sensitive stocks falling, interest-sensitive stocks led the rest of the market higher.
Chart 1
Chart 2
Chart 3
BANKS LEAD FINANCIALS HIGHER THANKS TO BERNANKE ... The Fed chairman testified today that it might be nearing a pause in its rate-hiking campaign. While the market rallied on that prospect, the biggest gains came in the financials. The next chart shows the Financials Select SPDR (XLF) soaring to a new record high on very strong volume. Its relative strength line also hit a new 2006 high. Banks were the biggest gainers among the financials. Chart 5 shows the Bank Index (BKX) also soaring to a new high. Part of the bank buying is tied to the steepening yield curve. A few months back I wrote that the flattening yield curve was hurting backs. With long-term rates rising, however, and the prospect for a peak in short-term rates, banks are benefiting from a steepening yield curve. Although it may seem counter-intuitive, the recent surge in bond yields to a new four-year high has strengthened the balance sheets of most banks. That's because the bond yield is what they charge for their loans. One of the side-effects of the comments by Mr. Bernanke was a falling dollar which fell to another seven-month low today. While that would normally be supportive for commodities, the rate-hike in China more than offset the normally bullish impact of a falling dollar.
Chart 4
Chart 5
COMPARISON OF FINANCIALS AND MATERIALS ... Before rushing out to sell all of your basic material stocks and loading up on financials, take a look at the following relative strength line. It's a ratio of the Financials SPDR (XLF) divided by the Materials SPDR (XLB) over the last year. The ratio saw a big jump today owing to the material selling and financial buying. As the chart shows, however, the trend in the ratio is still down. That suggests that today's rotation has to be viewed at this point as short-term in nature. To signal a more serious and lasting rotation out of basic materials and into financials, the ratio line would have to break its six-month down trendline at the very least.
Chart 6
MARKET RALLIES ON GOOD VOLUME ... Today was the second day in the last eight that the market rallied on prospects for an end (or pause) to higher short-term rates. As was the case the previous Tuesday, the market rallied on strong volume. The next three charts show that positive combination. The Dow Diamonds (DIA) are the closest to a new high. The S&P 500 SPDRs (SPY) scored an upside reversal day near its 50-day moving average. The Nasdaq 100 Shares (QQQQ) did pretty much the same. In the case of the latter, today's upside turnaround also prevented a violation of its mid-April low. It's hard to argue with that kind of positive market action. I've expressed skepticism about the staying power of the current rally. At this point, however, it would take a downside violation of 50-day moving averages -- and/or the mid-April lows -- to reverse the current uptrend.
Chart 7
Chart 8
Chart 9
