BOND YIELDS REACH FIVE-YEAR HIGH -- REITS AND HOMEBUILDERS CRUMBLE -- MARKET INDEXES THREATEN 50-DAY AVERAGES

BOND YIELDS BREAKOUT ... The upward climb in bond yields continued again today. Both the 10-year and the 30-Year Treasury yields closed at the highest level in five years. Chart 1 shows the 10-Year Treasury Note Yield ending just above the high reached in the middle of last year. The next upside target is the 5.45 to 5.50% level. If that higher trend continues through the balance of the week, it will also break the thirteen-year down trendline that I showed yesterday. Once again, the catalyst for higher U.S. rates came from abroad. Higher price inflation in China and Japan increased the odds for higher rates in those economies. The UK also threatened to raise rates again. That kept downward pressure on global stocks. While all market sectors in the U.S. lost ground, two of the hardest hit were homebuilders and REITS.

Chart 1

HOMEBUILDERS HURT BY RISING RATES ... Last Tuesday I showed an inverse relationship between rising bond yields and falling housing stocks. I suggested that rising mortage rates would weaken the housing sector even further. And it has. Chart 2 shows the Homebuilders SPDR (XHB) falling hard over the last week and bearing down on its April low. Its relative strength ratio (bottom of chart) has already fallen to a new yearly low. That means that the economy (and the market) can't expect any relief from housing. Or real estate.

Chart 2

REIT ETF NEARS NEW 2007 LOW ... Real Estate Investment Trusts (REITs) have been the weakest part of the market over the last week. And they were again today. The daily bars in Chart 3 show Real Estate iShares losing 2% and close to hitting a new low for the year. Downside volume has also been heavy. Chart 4 shows why further REIT weakness has long-term implications. That because the Dow Jones REIT Index is testing an uptrend line going back to the spring of 2004. Also discouraging is the fact that weekly MACD lines have already fallen to a three-year low. As is usually the case, the real drama is seen in relative terms. The relative strength ratio of the DJR versus the S&P 500 (Chart 5) has shattered a major support line and fallen to a one-year low. Real estate is no longer a good location for investment funds.

Chart 3

Chart 4

Chart 5

MARKET WEAKENS ON MORE VOLUME ... The market lost more ground today. And it did so on rising volume. The volume pattern shown in Chart 6 is symptomatic of the last week's trading. After falling last week on rising volume, the S&P 500 SPDR bounced Friday and Monday on light volume. Today's price fall brought out more volume. That's not a good sign. Chart 6 also shows the SPY threatening its 50-day moving average. I suspect that it will be broken. That would set the stage for a further decline to the February peak at 146. That would constitue a 5% pullback from the recent high and would be the first significant test of the ongoing uptrend. Although short-term indicators have turned negative, intermediate and major trends are still up. As I suggested yesterday, however, an upside breakout in bond yields does mean that the four-year bull market has entered a more dangerous (read vulnerable) stage. It is time for more caution.

Chart 6

INTERMARKET WRAPUP ... Here's how I see the intermarket picture unfolding over the last week. Rising global rates are pulling U.S. rates higher. That's pushing bond prices lower and yields higher. That's hurting stocks and rate-senstive stocks (like housing) in particular. The sudden jump in U.S. rates, however, is giving some support to the U.S. Dollar which has rebounded to a two-month high (Chart 7). That's caused some profit-taking in commodities and gold in particular (Chart 8). It's interesting to see new inflation concerns coming from Asia. I expressed the view yesterday that the ability of Japan to emerge from a decade of deflation was one of the factors pulling global rates higher. In the years from 2000 to 2003, the threat of Asian deflation was the main factor driving U.S. bond yields to 50-year lows. The threat of Asian inflation appears to be the new catalyst driving U.S. rates higher. That's why it's necessary to take a global view of things. Global rates tend to rise and fall together. Right now, U.S. rates are being pulled higher by outside global forces.

Chart 7

Chart 8