FED SURPRISE HAS PREDICTABLE INTERMARKET RESULT -- STOCKS RISE AS BOND YIELDS TUMBLE -- RATE-SENSITIVE STOCKS SURGE -- PLUNGING DOLLAR BOOSTS GOLD AND OTHER COMMODITIES -- FALLING DOLLAR ALSO GIVES BIG BOOST TO FOREIGN MARKETS

RATE SENSITIVE STOCKS SURGE ON BOND RALLY... The Fed surprised everyone yesterday by deciding not to start its widely anticipated tapering of bond purchases. Although that decision was a surprise, market reactions weren't. In fact, each market did pretty much was one would expect. Bond yields tumbled and bond prices soared. Stocks surged around the world. The dollar plunged along with bond yields which pushed gold and other commodities higher. Foreign stocks surged, especially in emerging markets, which had been hit especially hard by rising U.S. bond yields and a stronger dollar (more on that later). Within market sectors, yesterday's biggest gainers were rate-senitive stock groups that had been weakened by rising bond yields since May -- including homebuilders, REITS, and utilities. Chart 1 shows the Utilities Sector SPDR (XLU) surging nearly 3% yesterday to end back above both moving average lines. The gray areas shows the XLU/SPX ratio falling since the start of May. That's when bond yields started to surge and bond prices collapsed (green line). Yesterday's collapse in bond yields, and bond price rally, turned those trends around. Chart 2 shows the Dow Jones REIT Fund (RWR) surging 3.5% on rising volume. Chart 3 shows the Dow Jones U.S. Home Construction iShares (ITB) jumping nearly 5% on rising volume.

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Chart 1

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Chart 2

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Chart 3

FALLING DOLLAR BOOSTS GOLD... Falling U.S. bond yield pushed the US Dollar Index Fund (UUP) below chart support at its June low (Chart 4). As usually happens, a falling dollar gave a big boost to commodities, and gold in particular. Chart 5 shows the Gold Trust SPDR (GLD) surging on strong volume yesterday. Despite that strong action, GLD still remains below initial chart resistance drawn along its June/August highs (see line) and its 200-day average. It would need to clear both barriers to turn its trend higher. Since gold is a non-yielding asset, it gets hurt by rising rates. It thrives on falling rates which explains yesterday's surge. If the long-term trend of rates is higher (as I believe it is), however, it will be hard for gold to regain its major bull market status.

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Chart 4

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Chart 5

VANGUARD ALL-WORLD EX-US STOCK INDEX EXCEEDS 2011 HIGH... My favorite barometer of foreign stock performance is the Vanguard FTSE All-World ex-US ETF (VEU). The VEU includes the world's major developed foreign markets and a 25% weight in emerging markets. [The VEU also includes Canada which is excluded from EAFE iShares]. The good news is that Chart 6 shows the VEU breaking through its 2011 peak to reach the highest level in five years. That upside breakout puts foreign stocks in sync on the upside with a stronger U.S. market which has already reached record territory. The gray area in Chart 6 plots the VEU/SPX ratio which has been falling over the last two years. In other words, foreign stocks have been global underperformers since 2011. That may be changing. And a big reason for that may lie with the direction of the dollar. Chart 7 compares the same VEU/SPX ratio (gray area) to the trend of the U.S. Dollar Index (green line) since 2011. Notice their inverse correlation. A rising dollar has generally coincided with weaker foreign performance (compare up and down arrows). Foreign underperformance has coincided with a stronger dollar since summer 2011. The weaker dollar since mid-year 2013 (last green arrow) has resulted in a rising foreign/U.S. ratio (last gray arrow). It remains to be seen if this week's dollar breakdown (red circle) results in stronger foreign stock performance.

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Chart 6

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Chart 7

EMERGING MARKETS ARE RISING AGAIN ... Emerging market assets have been hit especially hard by the jump in bond yields since the spring. Rising bond yields pulled global funds out of higher-yielding emerging market assets. That includes foreign bonds, currencies, and stocks. That situation has improved. The green line line in Chart 8 shows the WisdomTree Dreyfus Emerging Currency Fund (CEW) bouncing sharply off chart support along its 2011/2012 lows (green line). A close correlation usually exists between emerging market currencies and stocks. That helps explain why emerging market stocks are rallying as well. The red line shows Emerging Markets iShares (EEM) surging during September as well. A lot of that rebound is the result of a weaker U.S. Dollar since mid-year. It's also worth noting that many of the large emerging markets (Brazil, Russia, and South Africa) benefit from rising commodities resulting from a weaker dollar. A stronger Chinese market (which I showed recently) is also increasing demand for those same commodities.

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Chart 8

HOW LONG CAN THE FED KEEP RATES DOWN?... Consider what the Fed did yesterday. It refused to cut back on its bond buying program in an attempt to keep bond yields at historically (and artificially) low levels. The reason for doing that is the Fed doesn't believe the unusually slow growing U.S. economy can withstand higher rates. And that reasoning pushed riskier assets sharply higher in a global celebration. That's like a hospital patient celebrating when the doctor tells him he isn't well enough to stop taking his medicine and go home. It's nice to see the markets rallying which, of course, is our main interest. Sooner or later, however, it seems like the Fed is going to have to start letting bond yields take their normal course higher. The stock market may not like that immediately, but I believe that will benefit stocks in the long run. When bond yields do start to rise, and bond prices fall, some of that money will have to move into stocks. One of the side-effects of getting better is that you don't need to keep taking medicine. That's normally a good thing.