DIVIDEND PAYING STOCKS LIKE UTILITIES AND TELECOM DO BETTER IN A DEFLATIONARY CLIMATE -- AT&T AND VERIZON LEAD TELECOM HOLDERS HIGHER -- GOLD NEARS UPSIDE BREAKOUT -- STOCKS ON SHORT-TERM SELL AS VIX TESTS OVERHEAD RESISTANCE
STOCK DIVIDENDS ARE MORE ATTRACTIVE WHEN RATES TUMBLE ... I've read a lot of articles recently about which asset classes (or stock groups) do best in a deflationary environment. In past market messages (which warned of the deflationary threat), I've explained that two asset classes that usually do best are bonds and gold. Two that don't do well are commodities and stocks. This week's move by the Fed to buy more Treasuries was an admission that the economy is growing weaker with an increasing deflationary threat. It should come as no surprise then to see bonds and gold rise with stocks and industrial commodities falling. That's the usual deflationary intermarket script. Today, I'm going to focus on stock market groups that also hold up best in a deflationary climate of falling interest rates. The common theme that runs through the deflationary winners is dividends. When short-term rates are near zero, and bond yields tumbling, stock dividends become more attractive to investors. Most of those stock groups are also defensive in nature (which explains why investors buy them when the stock market is weakening as it is now). They include consumer staples, healthcare, telecom, and utilities. The "relative" performance of those four defensive groups is plotted in Chart 1 (versus the S&P 500) since the start of 2008. All four groups outperformed the S&P 500 during the selloff of 2008, underperformed during the rally during 2009, and are outperforming since this April (when the market peaked). The two top performers during those two years are consumer staples (green line) and healthcare (pink line). At the moment, however, I'm more focused on the two groups that have rallied the most since April -- telecom and utilities.
Chart 1
UTILITIES EXCEED SPRING PEAK... The reason I'm focusing more on telecom and utilities is because they also show the strongest chart patterns of the four defensive groups. In other words, they're showing "absolute" as well as "relative" strength. Chart 2 shows the Dow Utilities Average having recently exceeded its spring high. It's also trading above its 50- and 200-day moving averages. It's relative strength line turned up in April just as stocks and bond yields started to weaken. That's normally a winning combination for a defensive group like utilities that pays dividends. Let's deal with stocks first. Chart 3 shows a relative strength ratio of the utilities versus the S&P 500 over the last three years. Notice that utilities outperformed the S&P 500 during most of 2008, underperformed during 2009, and has started to outperform again. That simply shows that investors turn to utilities in times of stock market weakness. The direction of interest rates also plays a role.
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Chart 2
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Chart 3
UTILITIES DO BEST WHEN BOND YIELDS FALL ... Chart 4 compares the same Utilities/S&P 500 relative strength ratio (black line) to the trend of the 10-Year T-Note Yield (green line). The chart shows that utilities do better (rising black line) when bond yields are falling -- like during the second half of 2008 and the spring and summer of 2010. Utilities do worse when bond yields are rising (like during most of 2009). That makes sense for a lot of reasons. Falling bond yields (rising bond prices) are associated with economic weakness which is also bad for stocks. Falling stocks push investors into defensive groups like utilities, while falling interest rates make dividend paying stocks (like utilities) more attractive as well. The same is largely true for telecom stocks.
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Chart 4
TELECOM HOLDERS HIT 52-WEEK HIGH ... Telecom stocks are doing even better than utilities. Chart 5 shows Telecom Holders (TTH) having reached a new 52-week high. In fact, the TTH is the day's strongest ETF in the face of a falling market. That's a bullish breakout. The intermarket pattern is similar to utilities -- only stronger. Notice also that the (blue) 50-day average has crossed over the (red) 200-day which is another bullish sign (utilities haven't done that yet). The line below the chart shows the telecom relative strength ratio turning up during April just as the bond yields (green line) started to tumble. That's because telecom stocks also pay dividends.
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Chart 5
AT&T CHART LOOKS BULLISH... It isn't hard to see where most of the telecom strength is coming from. One of the places is AT&T which is the biggest holding in the TTH. The daily bars in Chart 6 show the telecom leader having broken through its spring high (and finding support at that breakout point). Its relative strength line (below chart) has turned up as well. The weekly bars in Chart 7 paint an even more bulllish picture. They show AT&T moving to challenge major resistance just above 27 going back two years. Needless to say, a close at 28 or higher would be a very bullish breakout for the stock and the group. Verizon is another big contributor to telecom strength.
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Chart 6
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Chart 7
VERIZON NEARS 52-WEEK HIGH ... Verizon is doing even better than AT&T. The daily bars in Chart 8 show Verizon challenging its December intra-day high at 30.41. Its relative strength ratio (below chart) has already broken out. A close over that barrier would put VZ at the highest level in two years. It's (blue) 50-day average is also about to crossover its (red) 200-day line. That's known as a "golden cross" and is a bullish sign. So is the point & figure boxes in Chart 9. They show Verizon in a p&f uptrend with a close at 31 needed to register another bullish breakout. Add dividend paying stocks, especially telecom and utilities (and in that order), to your list of places to be in a deflationary environment along with bonds and gold.
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Chart 8
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Chart 9
GOLD EXCEEDS 50-DAY LINE... Speaking of gold, Chart 10 shows the Gold Trust (GLD) trying to close above its (blue) 50-day average. That would be a bullish sign for bullion. Chart 11 shows the Market Vectors Gold Miners ETF (GDX) trying to do the same. I've pointed out before that gold stocks were one of the few stock winners during the last deflation of the 1930s.
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Chart 10
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Chart 11
OIL AND STOCKS ON SHORT-TERM P&F SELLS -- VIX NEARS UPSIDE BREAKOUT... While gold usually benefits from deflation, oil and other economically-sensitive commodities don't. Neither do most stocks. It's no surpise then to see the price of oil (Chart 12) and the S&P 500 (Chart 13) both on short-term point & figure sell signals. [I wrote on Tuesday that a close at 1105 or lower in the SPX would trigger a sell]. I also wrote that the VIX Index needed a close at 28 or higher to trigger a p&f buy signal in volatility. Chart 14 shows the VIX testing resistance (previous X column) at 27. A buy signal in volatility is usually a bad sign for stocks.
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Chart 12
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Chart 13
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Chart 14
BOND YIELDS CONTINUE TO DROP ... We'll end today's message with perhaps the most important chart of all. Chart 15 shows a p&f downtrend in the 10-Year Treasury Note Yield (TNX). That downtrend started during May and hit new lows again this week. The Fed has indicated that it's going to concentrate its buying in 2- to 10-year bond maturities which is what the TNX is measuring. Falling bond yields translate into higher bond prices. Falling bond yields also imply economic weakness (and some deflation) which is normally bad for most commodities and stocks. Gold is the one commodity that normally rises in a deflationary envirnment. Defensive stocks that pay dividends also become more attractive to investors. That's why they're buying telecom and utility stocks. Both stock groups benefit from a weaker stock market and falling bond yields.
