BANKS ARE PLAYING CATCH-UP -- UPTURN IN HOUSING IS A BIG HELP -- SO IS THE RECENT UPTURN IN THE YIELD CURVE -- FALLING LUMBER MAY BE HINTING AT HOUSING PULLBACK -- AUTOS ARE BECOMING MARKET LEADERS -- IF INVESTORS AREN'T SELLING BONDS, WHO IS?
BANKS BREAK OUT ... My Tuesday message mentioned a number of sector influences that deserve more explanation. I'll try to do that in this message. I've written recently about the impressive upturn in bank stocks, and some reasons for that upturn. Chart 1, for example, shows the PHLX Bank Index having broken above its early 2010 peak to achieve a bullish breakout. The rising green line also shows banks outperforming the S&P 500. That's a good sign for both. Upside leadership by banks is normally a good sign for the economy and the stock market. One important factor that has supported the resurgence in banks has been a strong housing sector.
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Chart 1
BANKS AND HOUSING ARE LINKED... It shouldn't come as a surprise to read that banks are closely tied to the fortunes of the housing industry. In order to buy new homes, people have to get mortgages from banks. Banks and homebuilders plunged together during the 2007-2008 housing crisis. They've both been rising together since 2009. Chart 2 compares the two. The brown bars show the PHLX Housing Index bottoming during 2009 and again during the fourth quarter of 2011 (more on that second bottom shortly). The green line plots the Regional Bank SPDR (KRE) which tracks the HGX very closely. [I'm using the KRE because regional banks are more closely tied to the mortgage industry]. There again, banks bottomed during 2009 and again during the fourth quarter of 2011. Both have risen together since then. The 50-week Correlation Coefficient (below chart) shows a positive correlation of .90 between the two markets, which is very strong.
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Chart 2
PLUNGE IN YIELD CURVE STARTED HOUSING RALLY... In order to properly understand what ignited the housing rally, we have to discuss the yield curve. The yield curve shown in Chart 3 plots the difference between 10-Year and 2-Year Treasury yields. Since short-term rates have been anchored near zero since 2008, yield curve swings are caused mainly by the direction of longer-term bond yields. And they have a big influence on housing. Generally speaking, a falling yield curve boosts housing. During the second half of 2011, a dramatic plunge in bond yields pushed the yield curve to the lowest level in years (down arrow). [That plunge in bond yields was caused by the start of Operation Twist when the Fed sold short-term bonds to buy longer ones]. That pushed mortgage rates to record lows and help ignite the rally in housing. Which brings us to the present situation. The recent upturn in the yield curve (yellow circle) has caused some minor profit-taking in homebuilders (more on that shortly). Which brings us to banks. I mentioned on Tuesday that banks do better when the yield curve is rising. [That's because they can charge more for loans, while still paying near zero rates on deposits]. Chart 4 compares the yield curve (green line) with regional banks. As a rule, banks do better when the yield curve in rising. It's not a concidence that the recent upside breakout in bank stocks has coincided with a 13-month high in bond yields and the yield curve. And that banks are now outperforming homebuilders for the first time in two years. That suggests to me that banks are in a better position to withstand any short-term housing pullback.
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Chart 3
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Chart 4
PLUNGE IN LUMBER MAY ALSO HINT AT HOUSING CORRECTION... Another short-term housing warning is coming from a plunging lumber prices. Chart 5 shows the close correlation between the Housing Index and the price of lumber. After falling together during 2008, both bottomed in early 2009 and have risen together since then. Two short-term lumber peaks in spring 2010 and 2011 coincided with correction in stocks tied to housing (see down arrows). Which is why the 2013 plunge in the price of lumber is worrisome. That may be hinting that the demand for new lumber for new building is slowing. The combination of falling lumber, together with rising mortgage rates, may be enough to stall the homebuilding rally. I doubt, however, that either or both factors is enough to end the housing recovery. For one thing, bond yields are still historically very low. It could even be argued that the recent uptick in mortgage rates will tempt prospective homebuyers off the sidelines -- on fears that they may be missing the boat on historically cheap mortgage rates.
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Chart 5
AUTOS SHOW NEW MARKET LEADERSHIP... I also mentioned on Tuesday that while homebuilders led the last year's rally in consumer discretionary stocks, autos were taking over that cyclical leadership. Chart 6 plots the Dow Jones Automobile Index ($DJUSAU). [Despite its name, the index includes foreign auto stocks]. The chart shows the auto index on the verge of breaking through a huge "neckline" drawn over its 2007/2011 highs. That would be a very bullish breakout. The green plots a relative strength ratio of the auto index divided by the S&P 500. That RS line turned up last summer and has just reached the highest level in more than a year. At the moment, autos may be a stronger bet than homebuilders. Auto strength is consistent with a stronger economy and rising interest rates. Car buyers also have to take out loans which is good for banks.
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Chart 6
SOMEONE IS SELLING BONDS... I happen to believe that we're still in the early stages of a "great rotation" out of bonds and into stocks. The only thing preventing that from happening (or slowing it down) is the Fed. I keep hearing media experts, however, claiming that investors aren't really selling bonds, and that most of the money going into stocks is coming out of money market funds. No doubt, a lot of money is moving out of cash. How then do we explain Chart 7 which shows the TIPS Bond Fund (TIP) plunging to the lowest level in a year. Every other bond category has dropped during May, with long Treasuries suffering even bigger losses. Here's my question. If investors aren't selling bonds, why are bond prices falling?
