ENERGY STOCKS BREAK 50-DAY AVERAGE -- CRB INDEX VIOLATES JUNE LOW -- ECONOMIC SLOWING FAVORS BONDS OVER STOCKS
SHORT-TERM ENERGY TREND TURNS DOWN... With energy prices continuing to drop, selling pressure has intensified in energy stocks. On Monday, I warned that the Energy Sector SPDR (XLE) was headed for a test of its 50-day moving average. Chart 1 shows the XLE breaking that support line today. That's enough to justify some profit-taking in that sector. In fact, energy stocks are the day's weakest sector. Chart 2 shows the sharp slide in gasoline prices since the start of August. Energy weakess is weighing on the entire commodity price level.
Chart 1
Chart 2
NEW CRB INDEX BREAKS JUNE LOW ... The next two charts show two different versions of the CRB Index. Chart 3 shows the Reuters/Jefferies CRB Index which is a revised version of the old CRB Index. The two main differences in the newer version are a much heavier energy weighting (40%) and more economically-sensitive industrial metals. Chart 3 shows the new CRB Index trading below its June low. A lot of that weakness is coming from energy. The old CRB Index in Chart 4 (which has a smaller energy weighting) is holding up better. But it too is starting to show weakness. Because of the importance of energy prices and industrial metals, I prefer the newer version shown in Chart 3. But commodity analysts differ on that point. If a commodity peak is unfolding, that carries two messages. One is that inflation is moderating, which is good. The other is that the economy is slowing, which is bad. That's a good environment for bonds.
Chart 3
Chart 4
BOND YIELDS FALL BELOW 200-DAY AVERAGE... Bonds benefit from lower inflation expectations and a slower economy. In both cases, bond yields usually fall while bond prices rise. And that's exactly what's been happening since May (when the stock market started to weaken). Chart 5 shows the 10-year Treasury Note yield falling to the lowest level in five months and trading beneath its 200-day average for the first time this year. Chart 6 shows the 7-10 year Bond ETF surging since May to the highest level since January. [Bond "prices" move up when bond "yields" drop]. Treasury bonds have done better than stocks since the start of May. That's not unusual either. Bonds usually do better than stocks in a slowing economy.
Chart 5
Chart 6
BOND PRICES ARE RISING FASTER THAN STOCKS ... Stocks usually do better than bonds in an expanding economy, while bond prices do better than stocks when the economy is slowing. Chart 7 compares the two asset classes over the last eighteen months. The green line is the price of the 7-10 year T-Bond ETF (IEF) while the red line is the S&P 500. Notice that they've been trending in opposite directions. Bond prices fell from the spring of 2005 to May of 2006 as the stock market was rallying. The upturn in bond prices (green line) since May has been the strongest in a year and a half. Interestingly, the S&P 500 peaked in May as bond prices turned up. That suggests a more pessimistic view of the economy and the stock market. Although both are moving up at present, bond prices have done better than stocks over the last four months. It's not a sign of confidence when investors prefer bonds to stocks.
Chart 7
