RISING BOND YIELDS ARE HELPING BANKS, BUT HURTING DIVIDEND PAYING SHARES -- RISING YIELDS ARE ALSO CONTRIBUTING TO WEAKER EMERGING MARKETS -- GOLD IS HURT BY RISING BOND YIELDS AND A NEW SECULAR BULL MARKET IN STOCKS
HIGHER BOND YIELDS ARE HELPING BANKS ... Banks stocks have been market leaders during the first week of the new year. Chart 1 shows the KBW Bank SPDR (KBE) recently hitting a new high. Its relative strength ratio (gray area) has also been rising. Part of that is due to expectations for a stronger economy which should increase demand for loans (like autos and homes). Another positive factor is the upturn in bond yields and a steepening in the yield curve (which plots the difference between long and short-term rates). The green bars below Chart 1 show the yield spread between 10-year and 3-month Treasury yields ($YC3MO) turning up last May and again during November. Notice how closely those two upturns in the yield curve parallel similar upturns in the bank/SPX ratio. A steepening yield curve helps banks because they can charge higher rates for loans, while continuing to pay historically low rates to their depositors. Chart 2 provides a longer-term view of bank stocks, and shows them lagging way behind the S&P 500 (dashed line) since 2009. While the SPX exceeded its 2007 high last year, the KBE only managed to clear its 2010 peak. That leaves it well below its 2007 peak. That also makes bank stocks one of the cheapest parts of the stock market.
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Chart 1
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Chart 2
RISING YIELDS HURT DIVIDEND PAYERS... While rising bond yields are helping bank stocks, they've hurt stocks that pay dividends. The daily bars in Chart 3 show the DJ Select Dividend iShares (DVY) hitting a new high. The real story in Chart 3, however, is the drop in the DVY/SPX relative strength ratio (gray area) since last April. The two peaks in the ratio in April and November coincided with upturns in the 10 year - 3 month yield spread (green bars). During the first week of the new year, the DVY/SPX ratio has fallen to the lowest level since 2012. Historically low bond yields forced investors to move into dividend-paying stocks in the search for yield. Rising bond yields reduce the appeal of those same stocks. The two biggest groups in the DVY are utilities and consumer staples, which have been among the weakest stock groups in 2014.
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Chart 3
RISING YIELDS ALSO HURT EMERGING MARKETS ... Emerging market stocks have also been hurt by rising bond yields. The daily bars in Chart 4 show MSCI Emerging Markets iShares (EEM) losing ground over the last year. Two prominent peaks are visible last May and October which coincide with upturns in the 10 year - 3 month yield spread (green bars). Low bond yields forced investors into higher-yielding (and riskier) emerging markets. Higher bond yields over the last year, however, caused investors to pull money out of emerging market stocks, bonds, and currencies. The solid red area is plots a "ratio" of the EEM divided by EAFE iShares (IEF) which represent foreign developed markets. The EEM/EFA ratio has now fallen to the lowest level in five years.
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Chart 4
GOLD HURT BY RISING YIELDS AND STOCKS... Another market behind hurt by rising bond yields is gold. That's because gold is a non-yielding asset. As a result, it becomes a more attractive alternative in an era of falling rates which has been the case since 2000. Falling bond yields (and a weaker dollar) helped launch the bull market in gold starting in 2002 which lasted for nearly a decade. [A decade-long secular bear market in stocks also added to gold's appear. More on that shortly]. Chart 5 shows gold peaking in the middle of 2011. It started falling more sharply during the fourth quarter of 2012 which coincided roughly with an upturn in the 10-Year T-Note Yield (green line). Gold tumbled to a two-year low last April after Mr. Bernanke first started talking about tapering the Fed's bond buying, which caused bond yields to jump sharply. Rising bond yields hurt gold for three reasons. One is simply that gold doesn't do as well in a rising yield climate. Secondly, rising U.S. rates should boost the dollar which hurts gold. Thirdly, and maybe most importantly, a new secular bull market in stocks has greatly diminished the need for gold as an alternative investment. The black bars in Chart 6 show the S&P 500 exceeding its 2007 high last spring to end a decade-long trading range (during which gold soared). Notice that the upside breakout in the S&P 500 last spring coincided with a breakdown in gold. Historically, gold does better when stocks are weak. It does much worse when stocks are in a bull market. Although gold will probably experience oversold rallies (especially if stocks correct), I remain bearish on bullion's longer-range trend.
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Chart 5
