HIGH CORE INFLATION NUMBERS PUNISH BONDS -- NEGATIVE YIELD CURVE MAY BE HURTING BANKS WHICH FALL SHARPLY -- WORLD STOCK INDEX STILL LOOKS WEAK
BOND PRICES ARE FALLING AGAIN ... For the second day in a row, core inflation numbers came in higher than economists were expecting. Yesterday it was the PPI. Today's core CPI reading for May rose to 0.3%. [The actual CPI rose .4% during May]. Core inflation (excluding food and energy) has risen over the last three months by the most since 1995. That increases the odds for more rate hikes from the Fed. And, not surprisingly, it's pushing bond prices lower today and bond yields higher. That's taking an especially heavy toll on financial shares. Bank stocks, which had been holding up recently, are taking a big hit today. That may be due to the fact that the yield curve has turned negative again. That means that short-term rates have moved higher than long-term rates which hurts the profit margins of banks. Chart 1 shows the 7-10 year Treasury Bond ETF having experienced a minor bounce since mid-May on a flight to quality from a falling stock market. The IEF, however, is pulling back from last November's low at 81. Falling bond prices mean higher bond yields.
Chart 1
BOND YIELDS ARE AT CRITICAL CHART POINT ... The weekly bars in 2 show the uptrend in the 10-year T-note yield that started last summer. During April, the TNX moved above its April 2004 peak (see circle) to reach the highest level in four years. [That upside breakout helped pave the way for the stock market drop a month later]. Despite a modest pullback in bond yields over the last month, the TNX has stayed above the 2004 peak at 4.90%. That means that the trend for bond yields is still upward. The monthly bars in Chart 3, however, show that bond yields are testing a twelve-year down trendline starting in 1994. If fears of economic slowing are going to stop the advance in bond yields, this would be the logical spot for that to happen. If, however, bond yields break through that long-term down trendline, that would put even more downside pressure on bond prices and, most likely, stocks as well.
Chart 2
Chart 3
BANKS AND BROKERS WEIGH ON FINANCIAL SECTOR ... Financial stocks are taking this week's higher inflation numbers very badly. That because they're especially interest-rate sensitive. Yesterday brokerage stocks tumbled below their 200-day average (Chart 4). Today the Financial Sector SPDR (XLF) is breaking its 200-day line (Chart 5). Today's biggest financial losers are the banks. Charts 6 and 7 show the PHLX Bank Index and Bank Regional Holders (RHK) falling dangerously close to their 200-day lines. Their relative strength lines had been holding up pretty well during the recent market downturn. That may have been due to the recent bounce in bond prices and the pullback in bond yields. It now appears that investors are selling banks as well.
Chart 4
Chart 5
Chart 6
Chart 7
NEGATIVE YIELD CURVE MAY BE HURTING BANKS ... One of the reasons bank stocks have started to fall may be due to the fact that the yield curve has turned negative again. Chart 8 shows the spread between the 2-year and 10-year treasury yields (through Monday). A negative yield curve is present when the 10-year yield falls below the 2-year. And that's exactly what's happened this week. The yield curve appeared to bottom in late February as bond yields started to climb. That probably gave a boost to bank stocks. That's because banks pay out short-term yields (in the form of interest) and lend at long-term yields (like mortgage rates). Banks make money when the yield curve is steepening (rising). They lose money when it's falling (flattening). They lose even more when the yield curve turns negative because banks are paying out more than they're taking in.
Chart 8
CRB TESTS 200-DAY LINE... Last Tuesday I wrote an article headlined: "Rising Rates and Falling Stocks Aren't Good for Commodities" (June 06, 2006). I wrote that the Reuters/Jefferies CRB Index had broken its 50-day average and appeared headed for a test of its 200-day line. Chart 9 shows the CRB closing slightly below that long-term support yesterday. [The CRB closed modestly higher today]. That puts commodities at a dangerous chart point. An even more important support level is the March low at 316. It's important that the CRB stay above that level. If it doesn't, commodities could be in for an even tougher time. [I also wrote on Monday that a falling stock market is usually bad for commodities].
Chart 9
WORLD STOCKS DON'T LOOK GOOD ... Last Friday I showed the Dow Jones World Stock Index failing a test of its 2000 peak. I showed the DJW testing its 200-day moving average. A weekly version of that index has since broken its 40-week (200-day) average in pretty convincing fashion. That's the first time that's happened in nearly two years. Weekly MACD lines are negative and show no sign of improvement. The 12 week Rate of Change (ROC) line beneath the chart has fallen to the lowest level in two years. That doesn't tell us how far world stock markets could fall. It does tell us, however, that market momentum has turned decidedly negative. All the more reason to keep a defensive posture on global stocks. Try to resist the pressure from the financial media to view this as a great buying opportunity. On the contrary, any decent bounces should be used to do even more selling.
Chart 10
