LINK BETWEEN BONDS AND STOCKS CHANGED IN 1998 -- FALLING BOND YIELDS ARE NOW BAD FOR STOCKS -- FALLING RETAIL STOCKS ARE ANOTHER SIGN OF WEAKNESS -- SO ARE DROPS IN HOME DEPOT AND LOWES -- 13 AND 34 DAY EMA LINES ARE STILL NEGATIVE
WHY I WROTE SECOND INTERMARKET BOOK ... In my 1991 intermarket book, I wrote that bond and stock prices generally trended in the same direction. That meant that bond yields and stocks trended in opposite directions. In the three decades between the 1970s and 1990s, falling bond yields were good for stocks. As my second (2004) intermarket book pointed out, however, the bond/stock relationship changed during 1998 as a result of the Asian currency crisis and the onset of global deflation. In fact, it was the change in the bond/stock relationship that prompted me to write the second intermarket book. Chart 1 compares bond yields (green line) to the S&P 500 from 1993 to 2003. Before 1998, you can see the two lines trending in opposite directions. Prior to 1998, falling bond yields (rising bond prices) were bullish for stocks. Starting in the fall of 1998, however, that relationship changed. Bond yields rose with stocks during 1999 and then tumbled with stocks during the 2000-2002 bear market. That new relationship has lasted throughout the last decade. Chart 2 shows stock prices and bond yields pretty much rising and falling together over the last ten years. The two most notable drops in bond yields took place during stock bear markets from 2000-2002 and mid-2007 to the end of 2008. Not only have they tended to rise and fall together, bond yields have shown a tendency to turn slightly ahead of stocks. Bond yields peaked before stocks in 2000 and in 2007. They did so again this year which carries a warning for stocks.
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Chart 1
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Chart 2
BOND YIELDS FALL TO NEW LOW... Chart 3 compares bond yields (green line) to the S&P 500 (red line) over the last twelve months, and shows bond yields peaking at the start of April which preceded stock market weakness by at least a month. What's even worse, bond yields have already undercut their fourth quarter lows. That's hints at economic weakness (and deflation) which is normally bad for stocks (and commodites). The only market it's good for is bonds and Treasuries in particular. That's because Treasury bond prices rise when bond yields fall. On Tuesday, I showed that the April peak in bond yields (and upturn in bond prices) coincided with a drop in copper and lumber prices (along with homebuilding stocks). [Yesterday's extremely weak housing numbers confirmed that negative trend]. Let's expand that net today to include falling retail stocks, and home improvement retailers in particular. Both also hint at economic weakness.
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Chart 3
RETAIL BREAKDOWN ... Arthur Hill started the week by pointing out new signs of weakness in retail stocks. The situation has gotten even worse since then. The next two charts present two retail ETFs. Unfortunately, both look bearish. Chart 4 shows the S&P Retail Index SPDR (XRT) threatening to break its 200-day moving average. Chart 5 shows Retail Holders (RTH) trading well below its 200-day line and already at a five-month low. Their falling relative strength ratios (below charts) show that retail stocks are helping lead the market lower. Since consumer spending accounts for two-thirds of the American economy, relative weakness in retail stocks is a bad sign for the economy and the stock market. That's also why bond yields are falling and investors are selling stocks and buying bonds. Arthur's Monday message showed downturns in Macys, Target, and Best Buy. I'm going to focus today on home improvement stocks that are tied both to retail spending and housing.
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Chart 4
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Chart 5
HOME IMPROVEMENT STOCKS TUMBLE... Home improvement stocks play a dual role. They tell us about the trend of retailers and homebuilders. Chart 6, for example, shows Home Depot (the second biggest holding in the RTH) threatening its 200-day average. Its relative strength line (below chart) has already broken down. The brown line on top of Chart 6 shows that homebuilders peaked at the same time as Home Depot. The trend for Lowes is even worse. Chart 7 shows Lowes having already broken its 200-day line and its February low. Its relative strength line looks terrible. As Arthur has pointed out, these are economically-sensitive stocks that often lead the rest of the market (as is true of consumer discretionary stocks in general). The bearish action in home improvement stocks, and retailers in general, implies economic weakness. That's why bond yields are falling and Treasury prices rising (the green line on top of Chart 7).
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Chart 6
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Chart 7
DAILY EMA LINES ARE STILL NEGATIVE... One of our readers took issue with my "much praised" 13-34 EMA combination, claimed that it was still "firmly positive" and asked what to do about it. First of all, the statement is untrue on two counts. The 13-34 day EMA combination which is shown in Chart 8 is still firmly negative -- as it's been for more than a month. The weekly bars shown in Chart 9 are still positive, but just barely so. The spread between the 13 and 34-week EMA lines is the narrowest since last August. I showed both charts last Thursday and wrote that their current alignment called for a "watch and wait attitude" which meant that it was "too soon to sell long-term holdings and too soon to initiate short-term buys". I also pointed out the uptrend on the weekly chart was tempered by the fact that monthly EMA lines were still negative. Fortunately, no short-term buy signal was triggered by the daily EMA lines. Although the weekly EMA lines are still positive (but by a narrow margin), Chart 9 shows S&P prices having fallen below both lines. That's not a bona fide weekly sell signal, but is enough for me to suggest that it's probably time to start taking some more stock holdings off the table and parking some money in cash or Treasury bonds (or a bear fund).
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Chart 8
