HIGH PPI NUMBER MAY BOOST BOND YIELDS -- RISING COMMODITY STOCKS AND WEAK FINANCIALS ARE A DANGEROUS COMBINATION FOR STOCK MARKET -- CONSUMER STAPLES SHOW RESILIENCE -- STAPLE LEADERS ARE ADM, HEINZ, KELLOGG AND WAL MART
YES, FOOD AND ENERGY COUNT ... I think it's time that the Fed (and the economic community) stopped the charade of not counting food and energy in their inflation calculations. That's where most of the inflation is located. This morning's PPI inflation report was a shocker. March producer prices climbed 1.1% from the month before. That's an annual gain of 10.2%. Core prices (ex food and energy) rose 0.2% for the month (for an annual rate of 5%). Either way, those are big inflation numbers. A radio report this morning stated that the core number showed that inflation was "contained". With energy prices at a record high and skyrocketing food prices causing riots in some parts of the world, anyone who thinks inflation is contained is out of touch with reality. Here's why that's a problem. The Fed has been lowering interest rates to combat a slowing economy. Lower rates weaken the dollar and push commodity prices higher. That increases inflation. Sooner or later, the Fed is going to have to start fighting inflation either by not lowering rates any further or even raising them. The latter course wouldn't be good for the economy or the stock market. Inflation fears are especially bad for bonds.
Chart 1
LOW BOND YIELDS LIMIT PRICE POTENTIAL ... Bond prices have rallied since last summer for two reasons. The Fed has been lowering rates to combat a slowing economy. And money coming out of stocks has moved into the safety of Treasury bonds and notes. A weak stock market is normally good for bonds. Chart 1 shows, however, that the 10-Year T-Note Yield has fallen to the lowest level since 2003. Those are historically low levels. In addition, the 9-month RSI line shows bond yields to be the most oversold since 1998. In order for the bond price rally to continue, bond yields would have to fall a lot further. That seems unlikely with commodity prices hitting record highs and inflation pressures intensifying. If bond "yields" start to rise, bond "prices" will fall.
Chart 2
BOND PRICES UP AGAINST RESISTANCE ... Chart 2 shows the 10-Year T-Note Price soaring since last August. The $UST is now up against chart resistance formed by the spring 2003 peak around 120. In addition, the 9-week RSI has reached overbought territory over 70 (for the first time since 2002) and weekly MACD lines (below chart) are starting to pull back from their 2002 highs. Those factors (along with rising inflation) suggest that the bond rally may be nearing completion. In the past, money coming out of bonds moved right back into stocks. This time, it may just move into commodities. Rising commodities and rising rates aren't a healthy combination for stocks either.
Chart 3
PRODUCERS ARE GETTING SQUEEZED... With producers paying much higher prices for raw materials, one of two things has to happen. If they pass their higher costs onto their customers, the result will be higher consumer inflation. Higher inflation will cause higher interest rates. If producers absorb those costs, their bottom line suffers. Either way, rising inflation isn't good for the stock market. Neither is the combination of rising commodity stocks and falling financials. Sector rotations also tell us a lot about the state of the market and the economy. Chart 3 shows the two strongest market sectors over the last year and the weakest. [The lines are plotted around the S&P 500 which is the flat zero line]. The two strongest have been energy (red line) and basic materials (blue line). Stocks in those two sectors are tied to rising commodities. The two weakest groups are banks and brokers. Those are normally considered to be leading indicators for the rest of the market. Strong commodity stocks and weak financials aren't a good combination for the market.
CONSUMER STAPLES SPDR SHOWS RELATIVE STRENGTH... Outside of basic materials and energy, the only other market group that's held up reasonably well this year has been consumer staples. Chart 4 shows the Consumer Staples SPDR (XLP) having recently reached a three-month high and trading over its moving average lines. While that may not seem overly impressive, its rising relative strength ratio (bottom of chart) is. That's not surprising. In a week stock market, consumer staples are usually considered one of the safer havens. Several individual staple stocks have done even better.
Chart 4
CONSUMER STAPLE LEADERS ... Chart 5 shows Archer Daniels Midland moving above its 50-day average in a triangular-shaped pattern. Its relative strength line is rising as well. Chart 6 shows Heinz moving up to challenge its 2007 highs. Its relative strength line has been a steady climber all year. A close over 48 would also push HNZ over its 1998 peak to a new record high. Chart 8 shows Kellogg bouncing off its 200-day average. Its relative strength line is hitting a new high.
Chart 5
Chart 6
Chart 7
WAL MART IS TOP STAPLE PERFORMER... Wal Mart carries a lot of weight in the Consumer Staples SPDR. That's mainly because it's the biggest holding in the ETF. It's also one of the best performers. The monthly bars in Chart 8 show WMT having recently broken out to a new four-year high. In so doing, it has also broken an eight-year down trendline extending back to 2000. Its relative strength line (top of chart) has turned up for the first time in five years. That's a bullish combination. The fact that Wal Mart is a big discounter makes it an ideal choice at a time when consumers are watching their pennies.
Chart 8
