BOND YIELDS REACHING NEW RECOVERY HIGH IS A SIGN OF ECONOMIC OPTIMISM -- THAT'S WHY ECONOMICALLY-SENSITIVE CYCLICAL STOCKS ARE OUTPERFORMING CONSUMER STOCKS -- AUTOS CONTINUE TO SHOW MARKET LEADERSHIP AS FORD NEARS MAJOR BULLISH BREAKOUT
BOND YIELD REACHES NEW TWO-YEAR HIGH... The weekly bars in Chart 1 show the 10-Year Treasury Note Yield ($TNX) reaching a new two-year high today and very close to breaching the psychologally important 3% barrier for the first time since early 2011. The TNX has also cleared a five-year resistance line extending back to 2007 (see circle). That leaves little doubt that bond yields are headed higher, and bond prices lower. Chartwise, the next potential upside targets are 3.22% (which is a minor peak formed during summer 2011) and 3.74% (which is a more prominent peak formed in early 2011). I've expressed the view that rising bond yields are a positive sign because it suggests more economic optimism. One way to measure that more bullish sentiment is to compare the recent performance of ecomically-sensitive stocks to more defensive consumer stocks.
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Chart 1
CYCLICAL STOCKS SHOW RELATIVE STRENGTH ... Chart 2 shows the Morgan Stanley Cyclicals Index ($CYC) climbing above its 50-day average in an attempt to resume its uptrend. The CYC includes 30 stocks from 25 industries that are economically-sensitive which include autos, metals, papers, machinery, chemicals and transportation. The CYC/SPX relative strength ratio (below chart) has been rising since June. By contrast, Chart 3 shows the Morgan Stanley Consumer Index ($CMR) lagging behind and trading well below its 50-day line. The CMR includes 30 stocks in stable consumer stocks like beverages, food, drugs, tobacco, and personal products. Its relative strength line (below chart) has been dropping. That shows the investors are favoring stock groups that do better in a stronger economy. An even better way to show that is by comparing the two groups directly.
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Chart 2
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Chart 3
RISING RATES ARE BETTER FOR CYCLICALS ... The black line in Chart 4 is a "ratio" of the MS Cyclicals Index (CYC) divided by the MS Consumers Index (CMR). The green area plots the 10-Year T-Note Yield (TNX). The CYC/CMR ratio turned up last summer (2012) along with bond yields. An even stronger ratio upturn took place starting in April of this year when bond yields turned up in more dramatic fashion. Since mid-April (as bond yields were rising), the cyclicals index has gained 13% versus a 2% gain for consumer stocks (the CYC doubled the 6.7% gain in the the S&P 500 during the same period). The stronger performance by the index of economically-sensitive stocks appears to support the idea that investors are interpreting the rise in bond yields as a sign of economic strength. Stocks usually do better than bonds in a rising rate environment. Stocks also usually do better when cyclical stocks are leading them higher. Like autos.
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Chart 4
AUTO INDEX REACHES EIGHT-YEAR HIGH ... Auto stocks are one of biggest contibutors to the upturn in cyclical stocks. Chart 5 shows the Dow Jones US Automobiles Index trading at the highest level since 2005. The auto index has cleared its early 2011 peak and a "neckline" drawn over its 2007/2011 highs. That's an impressive bullish breakout. The Auto/SPX ratio (gray line) bottomed in mid-2012 and is rising as well. Autos reported the strongest August sales in six years. Despite its name, the $DJUSAU includes foreign auto stocks. Tesla Motors' gain of 400% dwarfed 2013 gains in auto stocks. The monthly bars in Chart 6 show Ford Motor (F) nearing a test of its early 2011 peak and very close to reaching the highest level since 2001. Its relative strength ratio (gray line) has been rising all year. [Ford has gained 36% during 2013 versus a 16% gain for the S&P 500].
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Chart 5
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Chart 6
OIL SERVICE ETF NEARS UPSIDE UPSIDE BREAKOUT... With crude oil continuing to rally, energy stocks have assumed a market leadership role. Chart 7 shows the Market Vectors Oil Services ETF (OIH) having a strong day and moving very close to a new two-year high. The OIH/SPX ratio (dashed line) has turned up as well. Although several big stocks in that group (including Halliburton and Schlumberger) continue to lead the group higher, today's chart standout was Rowan. Chart 8 shows Rowan Companies (RDC) surging more than 3% today to a new 52-week high. Its relative strength ratio (dashed line) is rising as well. Despite today's breakout, Rowan is still one of the cheaper stocks in the OIH. The performance lines in Chart 9 show OIH leaders over the last two years to be Halliburton (HAL) and Schlumberger (SLB). Rowan is just emerging from a potential basing pattern (red circle). [While oil has held up, most other commodities have suffered from a bouncing dollar (owing to rising U.S. bond yields). Precious metals (and their stocks) have turned down from an overbought condition].
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Chart 7
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Chart 8
Chart 9
S&P 500 REMAINS IN SHORT-TERM DOWNTREND... Stock gained a little more ground today. The hourly bars in Chart 10, however, show that the S&P 500 is still in a short-term downtrend that started in early August. To turn its short-term trend higher, the SPX needs to clear initial chart resistance at 1669. That would also break a falling resistance line drawn over the August peaks. A close over 1669 would also put the SPX back above its 50-day average which now sits at 1664.
