RISING RATES CAUSES PROFIT-TAKING IN UTILITIES AND DIVIDEND PAYING STOCKS -- CHINA AND EMERGING MARKETS STUMBLE -- S&P 500 SUFFERS SHORT-TERM DETERIORATION NEAR ITS 2000 HIGH
RATE-SENSTIVE UTILITIES SELL OFF ... It's no coincidence that the recent jump in bond yields is causing profit-taking in utilities. That's because utilities are often considered to be the stock market equivalent of bonds. In other words, utilities do better when bond yields are falling, and get sold when yields are rising. Arthur Miller mentioned yesterday that relative weakness in financial shares (especially banks) is also attributed to rising rates. Chart 1 shows the 10-Year Treasury Note Yield threatening its late January peak at 4.90%. That's an important test because a close over that chart barrier would turn the trend of bond yields higher. Rising bond yields are usually negative for stocks and especially those tied to interest rates. Like utilities. Chart 2 shows the Utilities Sector SPDR (XLU) falling 2.4% today to make it the market's weakest sector. This week's drop in the XLU was occurred on very heavy volume, which isn't a good sign. Neither is the downturn in the XLU/SPX relative strength ratio (top of Chart 2). The close below the 50-day moving average by the XLU is another warning of a deeper utility correction.
Chart 1
Chart 2
RISING RATES HURT DIVIDEND PAYING STOCKS ... The best way to measure the true impact on a market sector is with a relative strength ratio. And Chart 3 is no exception. The green line is the 10-Year T-Note Yield over the last two years. The red line is a ratio of the Utilities SPDR (XLU) divided by the S&P 500. The chart shows that utilities underperform the S&P when bond yields are rising (mid-2005 to mid-2006). The XLU/SPX ratio turned up in mid-2006 when bond yields peaked and have remained relatively strong until this month. Rising bond yields are pushing the ratio lower for the first time in five months. Higher bond yields also make dividend-paying stocks less attractive to investors. Chart 5 shows the DJ Dividend iShares (DVY) losing more than one percent today. Its relative strength ratio (bottom of chart) has been falling for two months. The reason for that is the upturn in bond yields (green line). Two of the largest groups in that ETF are banks and electric utilities which are leading it lower. That's the market's way of telling us that it's starting to take the jump in bond yields seriously.
Chart 3
Chart 4
CHINA AND EMERGING MARKETS WEAKEN ... Global stocks are also more nervous about the possibility of a significant pullback in Chinese stocks, especially after Mr. Greenspan's warning yesterday afternoon. Part of the selling is also technical. Chart 5 shows the Xinhua China Index Fund (FXI) falling 2.9% today to make it the day's weakest global ETF. The fact that the pullback is starting from the early January peak is also some cause for concern. So is the fact that the relative strength ratio of the China ETF versus the S&P 500 (bottom of Chart 5) peaked in January. That loss of Chinese leadership is spilling over to other emerging markets which are also down well over 2% today. Chart 6 shows the MCSI Emerging Markets iShares (EEM) falling today on rising volume. The solid line in Chart 6 is the EEM/SPX ratio. Notice that the May ratio peak is lower than the April peak. That non-confirmation by the RS line also hints at some nervousness in emerging markets and some loss of upside leadership. The last time that happened was in February when China and other emerging markets led global markets lower.
Chart 5
Chart 6
S&P 500 BACKS OFF FROM RECORD HIGH ... The recent jump in bond yields, combined with profit-taking in emerging markets, is catching the U.S. market at a vulnerable point. That's because the S&P 500 (which is the main benchmark for the U.S.) is testing potential resistance at its 2000 high. On May 3, I gave three numbers to watch in the S&P 500 testing process. One was the March 24, 2000 record close at 1527. Two others were intra-day highs at 1553 (March 2000 high) and 1530 (September 2000 high). At the very least, it would be normal to expect an over-tended stock market to meet some profit-taking around those numbers. This week's intra-day high has been 1532 (Wednesday) and the closing high at 1525 (Tuesday). In other words, the market has tested the 2000 highs and is pulling back. The weekly bars in Chart 8 give another reason why. The spring rally pushed the 9-week RSI into overbought territory over 70, but below its December high. That negative divergence between the RSI and the S&P hints at some selling (see arrow). The short-term trend is where most of the downside action is taking place.
Chart 7
Chart 8
S&P 500 SPDRS SELL OFF ON VOLUME ... Chart 9 shows some short-term deterioration on the daily bars for the S&P 500 SPDRS (SPY). First of all, downside volume has picked up. Secondly, the daily MACD lines (top of Chart) are rolling over after failing to hit a new high. That's a short-term negative divergence and hints at more downside pressure. So far, the major uptrend is in no danger. All we've seen is some normal profit-taking in an area of major chart resistance. Given how far the market has come, and the fact that the S&P is testing its old high, however, it's not a bad time to turn a little cautious. That's especially true during the month of May when seasonal trends usually turn weaker.
Chart 9
