STRONG ECONOMIC NEWS PUSHES TEN-YEAR BOND YIELD TO ONE YEAR HIGH -- BOND PRICES TUMBLE AS STOCKS RISE -- AUTO STOCKS HAVE BECOME MARKET LEADERS -- UTILITIES AND REITS ARE HURT BY RISING RATES
TEN-YEAR BOND YIELD JUMPS TO HIGHEST LEVEL IN A YEAR ... The backup in bond yields that started a month ago took a more serious turn today. Chart 1 shows the 10-Year Treasury Note Yield ($TNX) climbing above its March peak. That upside breakout puts the bond yield at the highest level since April of last year. The main reason behind today's bond yield surge is a climb in consumer confidence to the highest level since 2008, and the biggest jump in home prices in seven years. That strong news is normally bad for bond prices, but good for stocks. That helps explain why stock prices climbed along with bond yields (as bond prices fell). Most stock groups were higher today -- especially those tied to the strength of the economy. Autos are leading the charge among consumer cyclicals. Financial stocks were one of the day's strongest sectors, led by bank and brokerage stocks. Banks are helped by a strong housing sector, since they lend out home mortgages. Banks also gain when the yield curve steepens (rising bond yield), since they can charge more for loans than they pay out in deposits. Utilities, telecom, and REITs, however, are being hurt by rising rates.
(click to view a live version of this chart)
Chart 1
STOCKS RISE AS BOND PRICES FALL ... Stock prices normally rise when bond prices fall -- even despite the Fed. And that's what's been happening over the last year. And especially over the last month. The red bars in Chart 2 show the 20+Year Treasury Bond iShares (TLT) closing at the lowest level in a year today. The long end of the yield curve falls the fastest when yields rise. Bond prices peaked last July and have been falling since then. The green dashes, however, show the S&P 500 rising while bond prices fell. By comparing the arrows, you can see that stock upturns last summer, last November, and this month (up arrows) coincided with falling bond prices (down arrows). That was especially true over the last month when bond prices really tumbled. The 20-day Correlation Coefficient (below chart) has been negative for most of the last year (below zero line). After rising during April, however, the correlation line fell sharply during May to a minus -.91 which is about as strong a negative correlation as we can get. It may just be that stronger economic news is finally forcing investors to sell bonds and buy stocks. And they have a lot of bonds to sell.
(click to view a live version of this chart)
Chart 2
AUTOS LEAD WHILE UTILITIES LAG... One of the reasons bond yields rise is because of increased optimism on the economy. Consumer cyclicals stocks usually become market leaders in that environment. That group has been lead by housing stocks over the past year. Recent cyclical leadership, however, is coming from autos. The blue line in Chart 3 plots the Auto Index ($DJUSAU) relative to the S&P 500 (flat line) over the last year. Autos have been rising faster than the SPX since last summer, and especially over the last two months. The two falling relative strength lines belong to Utilities (XLU) and REITS (RWR), which have underperformed during the last month. Since the start of May, autos have gained 16% versus an S&P 500 gain of nearly 5%. Utilities have been the weakest sector during May (-6%) while REITs have lost -1%. [Bank stocks (not shown here) have gained 10% during May, twice as much as the S&P 500].
Chart 3
STOCK/BOND RATIO REACHES FIVE-YEAR HIGH ... Fed policy of keeping bond yields near historically low levels has had mixed results. For one thing, low rates have forced investors to look for higher yields in stocks (especially those that pay higher dividends). At the same time, Fed policy has kept bond prices from falling (low bond yields support bond prices). That policy has kept too much money in bonds. As a result, most investors (and institutions) still hold too many bonds and too few stocks. Sooner or later, that has to change. My recent book, Trading with Intermarket Analysis, describes how the last era of Fed "financial repression" ended. The Fed kept bond yields unusually low during the 1940s. It finally let bond yields follow their normal course higher during 1951. Over the following decade, bond yields rose and bond prices fell. Stocks began a rally during 1951 that lasted until 1966. The recent upturn in bond yields suggests that the Fed may be loosening its grip on bond yields (or the market believes it may start cutting back on bond purchases). Either way, rising rates should accelerate the long-awaited "great rotation" out of bonds and into stocks. Chart 4 plots a ratio of the S&P 500 divided by the 7-10 Year Treasury Bond iShares (IEF). The SPX/IEF ratio has been rising all year, but has just exceeded its early 2011 peak. The upside breakout puts the stock/bond ratio at the highest level since 2008. I believe it will eventually climb a lot higher.
