RISING BOND YIELD BOOSTS THE DOLLAR WHICH HURT COMMODITIES, ESPECIALLY GOLD -- RISING BOND YIELD HURTS DIVIDEND-PAYING STOCKS -- BUT HELPS ECONOMICALLY-SENSITIVE GROUPS -- STEEPENING YIELD CURVE GIVES LIFT TO BANK STOCKS
BIG JUMP IN BOND YIELD STRENGTHENS THE DOLLAR ... An unusually strong employment report on Friday, following an uptick in GDP growth on Thursday, helped push bond yields sharply higher this week. Chart 1 shows the 10-Year Treasury Note Yield (TNX) climbing to the highest level since September (2.75%) and back above its 50-day moving average. [My last two messages show technical evidence that bond prices were overbought and starting to weaken]. The jump in bond yields caused intermarket ripples among other asset classes. One of the those ripples is a stronger dollar. Chart 2 shows the U.S. Dollar Index climbing to a two-month high and clearing a falling resistance line extending back to July. The dollar got some help from a falling Euro which resulted from the European Central Bank cutting its benchmark rate to .25% after European inflation fell to the lowest level in four years. Chart 3 shows the Euro falling to a two-month low. One natural side-effect of a stronger dollar is weaker commodity prices which are hovering near 17-month lows.
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Chart 1
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Chart 2
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Chart 3
RISING DOLLAR HURTS COMMODITIES ... Chart 4 shows the negative impact the firmer dollar has had on commodity prices over the last two years. A bottom in the Dollar Index (green line) in the spring of 2011 coincided with a peak in the CRB Commodity Index. Commodities bounced during the third quarter of this year as the dollar weakened. This week's dollar rebound, however, pushed the CRB Index to the lowest level since spring 2012. Gold was hit especially hard by the combination of rising rates and a stronger dollar. Chart 5 shows the Gold SPDR (GLD) falling sharply at week's end. Gold usually falls when the dollar rebounds. Since gold is also a non-yielding asset, it also gets hurt when interest rates rise. Which is exactly what happened this week.
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Chart 4
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Chart 5
RISING RATES HURT DIVIDEND-PAYING STOCKS... Dividend paying stocks compete with Treasury bonds for income (yield). As a result, low bond yields are good for dividend-paying stocks, while rising yields are bad. Chart 6 demonstrates the inverse relationship between bond yields and the relative performance of dividend paying stocks during 2013. The black line is a "ratio" of the DJ Dividend Index iShares (DVY) divided by the S&P 500. The green space is the 10-Year Treasury Note yield. Earlier in the year, falling bond yields caused the dividend ETF to outperform the S&P 500 (rising ratio). Starting in May, however, a big jump in bond yields caused the DVY/SPX ratio to fall sharply. The ratio rebounded between September and October as rates pulled back. This week, however, the jump in bond yields pushed the ratio sharply lower. Notice that the ratio also failed to exceed the peak formed during August (horizontal line). That's similar to the price patterns seen in interest-sensitive groups like utilities, homebuilders, and REITs which were among the week's biggest losers. Chart 7 shows the Dow Utility Average (which is often used as a proxy for bonds) backing off from chart resistance along its summer high. The lower lines show homebuilders (ITB) and REITS (RWR) backing off from similar resistance barriers. While dividend-paying stocks fell, more economically-sensitive stocks rebounded.
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Chart 6
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Chart 7
RISING RATES FAVOR CYCLICAL STOCKS -- STEEPER YIELD CURVE BOOSTS BANKS ... When bond yields are rising on strong economic news (as they did this week), sector rotation strategies usually favor more economically-sensitive cyclical stocks. That may explain why this week's strongest sectors were basic materials, industrials, technology, and financials. The first three sectors usually do better in a stronger economy. By contrast, three of the week's weakest sectors were utilities, healthcare, and staples which are defensive in nature. Friday's surge in financial stocks (banks in particular) may be partially explained by a steepening yield curve resulting from the jump in bond yields. Chart 8 shows the PHLX Bank Index (BKX) surging 3.4% on Friday to close at a new three-month high (after bouncing off its 50-day average). That made banks one of the week's strongest groups. The green line above Chart 8 plots the 10 year - 3 month yield curve ($YC3MO). [The yield curve plots the difference between long and short rates. A rising yield curve is normally associated with economic strength]. The reason a steepening yield curve benefits banks is because banks borrow short (paying lower short term rates) and lend long (charging higher rates to borrowers). Banks started doing better this spring when the bond yields started to climb (causing the yield curve to steepen). They did the same this week.
