BOND PRICES SELL OFF AS YIELDS RISE -- HIGH YIELD BOND ETF BACKS OFF FROM CHART RESISTANCE WHICH MAY CAUSE SOME SHORT-TERM STOCK SELLING -- RISING YIELD ALSO THREATENS EMERGING MARKETS
BOND PRICES SELL OFF FROM CHART RESISTANCE ... My market message from October 31 showed bond ETFs starting to back off from overhead resistance barriers while in an overbought condition. Those ETFs have fallen since then as bond yields have risen. Chart 1 shows the Barclays 7-10 Year Treasury Bond iShares (IEF) failing at its 50% retracement line and its 200-day moving average. It has since fallen sharply. Chart 2 shows the iBoxx Investment Grade Corporate Bond iShares (LQD) turning back from chart resistance along its first quarter lows (horizontal line) and its 200-day line as well. Both bond ETFs are now threatening to fall below their 50-day averages. Of more concern to stocks, however, may be the pullback in high yield bonds.
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Chart 1
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Chart 2
HIGH YIELD BONDS PULLBACK FROM SPRING HIGH ... That same Halloween message also raised a warning about high yield bonds, which were in the process of testing chart resistance along spring highs while also in an overbought condition. Chart 3 shows the iBoxx High Yield Corporate Bond iShares (HYG) falling back from chart resistance at its May peak (yellow circles). Its 14-day RSI (red) line is in danger of slipping below its 50 line. As explained in the earlier message, that's important because high yields bonds are closely correlated to stock market direction.
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Chart 3
HIGH YIELD BONDS AND STOCKS ARE HIGHLY CORRELATED... Chart 4 shows a close correlation between the HYG fund shown in the previous chart (green bars) to the S&P 500 (black line) since the start of the year. Both have a strong tendency to peak and trough together. The previous three drops in the HYG (during May, August, and September) coincided with stock pullbacks (green arrows). The 60-day Correlation Coefficient (below chart) has a high reading of .94. That means that a pullback in the HYG would most likely lead to some short-term profit-taking in stocks.
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Chart 4
RISING RATES ALSO HURT EMERGING MARKETS ... Many of the short-term rotations that we're now seeing in stocks (resulting from higher bond yields) are similar to those seen in the spring. Within the U.S. stock market, that means some rotation out of interest-sensitive (dividend-paying) stocks which we've seen over the last week. Another side-effect of rising rates is weakness in emerging markets. Chart 5 shows an inverse correlation between Emerging Markets iShares (red bars) and the 10-Year T-Bond Yield (green bars) since May. The solid red area (below chart) plots a relative strength ratio of the EEM divided by the S&P 500. The sharp upturn in bond yields during May caused heavy selling in emerging markets both on an absolute and relative basis. A pullback in yields helped boost emerging markets during September and October. Over the past couple of weeks, however, rising U.S. bond yields are hurting emerging markets once again. The reason being that higher bond yields in the states (and elsewhere) diminish the appeal of higher-yielding (and riskier) emerging markets. Weakness there often leads to some softening in global stocks in general.
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Chart 5
TRANSPORTS OUTPERFORM UTILITIES ... While rising rates often cause short-term profit-taking in the major stock indexes, not all stocks act the same. Rate-sensitive stock groups like utilities are usually hurt by rising rates (since utilities are closely correlated with bond prices). Economically-sensitive stocks groups (like transports) are often helped by rising rates since that implies a stronger economy. The black bars in Chart 6 plot a "ratio" of the Dow Transports divided by the Utilities. The green line is the 10-Year T-Note Yield. Notice that the utilities did better (falling ratio) when bond yields fell during 2011 and first half of 2012. The transports did better (rising ratio) since rates starting rising in mid-2012. Rising rates since May has also favored transports over utilities (a rising ratio). The solid line on top of Chart 6 plots the Dow Industrials. Notice that the industrials have done better when the transport/utility ratio is rising. That suggests a number of things. First, rising rates favor economically-sensitive stocks (like transports) while hurting interest-sensitive stocks (like utilities). Secondly, rising rates favor stocks over bonds. A third effect of rising bond yields is that a stronger dollar hurts foreign stocks (like emerging markets) more than U.S. stocks.
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Chart 6
RAIL INDEX HITS NEW HIGH -- CSX IS CLOSE... Last Tuesday's message showed an index of rail stocks testing the top of its 2013 price range in a bullish "ascending triangle". The daily bars in Chart 7 show the Dow Jones US Railroad Index ($DJUSRR) having since then broken out to a record high. That confirms the recent upside breakout in airline and air freight stocks, and gives more impetus to the transportation group. Chart 8 shows CSX nearing a record high. The rail leader just recently climbed above its 2011 peak. Rails are one of the most economically-sensitive stock groups.
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Chart 7
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Chart 8
DOW STRUGGLES TO HOLD UPSIDE BREAKOUT... The Dow Industrials hit a record high last week, but are now struggling to hold that breakout. Chart 9 shows the Dow stalling at last Wednesday's intra-day high, but remaining well above last week's lows. The Dow is also trying to stay above September's intra-day high at 15709 which it broke through last Wednesday. Previous peaks usually act as support on pullbacks. The Dow may not have traveled far enough above its September peak, however, for that to take hold. It seems more reasonable to suggest that the Dow hasn't yet achieved a decisive upside breakout and is still going through a testing process. The hourly bars in Chart 10 show the Dow meeting some resistance at last Wednesday's intra-day high at 15797, but remaining well above last Friday's intra-day low of 15579. While the Dow is being pulled higher by the transports, it's being held back by the weaker utilities. It usually does better when all three are rising.
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Chart 9
