COPPER PLUNGES TO SIX-YEAR LOW -- FREEPORT MCMORAN PLUNGES ALONG WITH IT -- 10-YEAR BOND YIELD FALLS TO 20-MONTH LOW ON DEFLATION -- FALLING BOND YIELDS HURT BANK STOCKS -- RISING VIX SUGGESTS PERIOD OF LOW VOLATILITY MAY BE ENDING
COPPER FALLS TO SIX-YEAR LOW... It seems all we've hearing about lately is the plunge in the price of oil. That has led to a debate as to whether the plunge in crude is just the result of increased supply, or a sign of a weakening global economy. A big point missed in that debate is the fact that other economically-sensitive commodities are also falling. That would seem to argue that falling commodities are more than just an oversupply situation in one key commodity. It further suggests that the drop in commodities is a sign of global weakness. Today's big commodity story is the 5% plunge in copper to a nearly six-year low. The weekly bars in Chart 1 also show that copper peaked in 2011 and has been dropping since then. The red metal hit a multi-year low at the start of 2014. Its most recent slide started last July, right around the time that oil started dropping. While oil lost more ground over those seven months, copper in fact has matched the drop in crude since 2011. The recent breakdown in copper may actually carry a more serious warning. That's because copper is considered to be the commodity with the best track record of measuring the strength of the global economy (which is why it's called Dr. Copper with a PhD in economics). That's bad for copper shares.
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Chart 1
FREEPORT-MCMORAN TUMBLES WITH COPPER... Falling copper is bad for stocks that produce that commodity. That explains why the biggest percentage loser in the S&P 500 today is the world's biggest copper producer -- Freeport-McMoran (FCX). The weekly bars in Chart 2 show FCX tumbling to the lowest level in six years as well. [The stock is down -21% for the week]. Its underperformance is nothing new. The dotted line, which plots the FCX/SPX ratio, has been dropping for the last three years and has been falling faster than the stock. Other base metal stocks being pulled lower today are aluminum (Alcoa) and steel (Nucor). Since those metals are the building blocks of economic growth, their declining trend is a bad sign for global demand.
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Chart 2
FALLING COPPER ALSO PULLS BOND YIELDS LOWER ... Chart 3 shows that falling copper (red line) since the start of 2014 is one of the reasons Treasury yields have been falling. I've been using crude oil in previous examples of a falling commodity pulling bond yields lower. Today's I'm using copper to reinforce that point. Falling copper implies global economic weakness and an increasing threat of global deflation. That pulls bond yields lower all over the world -- especially in Europe and Japan. The green line in Chart 3 shows the 10-Year Treasury Note yield ($TNX) falling today to 1.81% which is the lowest level since May 2013. That's a vote of no confidence in the global economy. Which is why investors are buying bonds and selling stocks.
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Chart 3
FALLING RATES HURT BANKS ... Banks are selling off especially hard today. The daily bars in Chart 4 show the PHLX Bank Index ($BKX) falling to the lowest level in three months. It has also fallen well below its 200-day moving average. A big reason for today's drop was a earnings miss by J.P. Morgan which has fallen more than 5%. Another (and larger reason) for bank selling is falling bond yields. The link between banks and yields can be seen better by looking at the banks' "relative" performance. Chart 5 compares the trend of the 10-Year Treasury yield (green line) to a relative strength ratio of the Bank Index divided by the S&P 500 (black line). The correlation between the two lines is obvious. Banks did better (rising ratio) during 2013 as bond yields rose. Banks have shown relative weakness (falling ratio) since the start of 2014 when yields started dropping. In today's trading, both lines have fallen to the lowest level since May 2013. Banks usually do better when bond yields and the yield curve is rising. The widening spread increases their "net interest margin" between short and long term rates. Falling bond yields have the opposite effect.
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Chart 4
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Chart 5
STOCK VOLATILITY IS RISING ... A caution sign for the stock market entering 2015 is the fact that volatility appears to be on the rise. That rising trend can be seen in the daily chart of the CBOE Volatility (VIX) ratio. Chart 6 shows the VIX in a rising trend since the middle of 2014. Its 50- and 200-day exponential moving averages are rising. In addition, the 50-day EMA line has crossed above the 200-day line. Historically low volatility over the past several years has supported rising stock prices. The rising VIX suggests that the going may start to get a lot tougher. That's because a rising VIX is usually associated with lower stock prices. Let's take a longer term look.
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Chart 6
VIX IS TESTING MAJOR RESISTANCE LINE... Chart 7 compares the trend of the VIX (black line) to the S&P 500 (gray area) since 2008. It can been seen that they generally trend in opposite directions. A rising VIX during 2008 coincided with a major stock plunge. A late 2008 peak in the VIX led to start of a six-year uptrend in stocks. Since late 2008, the major trend of the VIX has been down. VIX upturns in 2010 and 2011 led to stock corrections. Since late 2011, however, the VIX traded consistently lower until the middle of last year. The VIX started rising last July (when crude oil peaked) and has since been rising in a pattern of "rising peaks" and rising troughs". More importantly, the VIX is now challenging a major resistance line drawn over its 2008/2011 peaks. A decisive move above that resistance line would suggest that the trend of falling volatility has ended, and that a period of rising volatility lines ahead. That's not normally good for stocks.
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Chart 7
LOWER WORLD INDEX MAY INCREASE RISK FOR U.S. STOCKS ... Yesterday's dramatic downside reversal day has led to more stock selling today. Chart 8 shows the S&P 500 trading back below its 50-day average and bearing down on a test of potential support levels at 1992 and its mid-December low at 1972. That lower level coincides with its (red) 200-day moving average. Chart 9, however, shows the Dow Jones World Index (which includes the U.S.) showing a much weaker pattern of "lower peaks" since September. The DJW is also trading below its moving average lines and nearing a test of its recent lows. That shows that the global trend is weakening. Although the U.S. has outperformed the DJW over the past few years, they have tended to rise and fall together. Their 60-day Correlation Coefficient is a relatively high .82. That being the case, the downturn in the DJW raises the risk level for U.S. stocks. Strong as the U.S. is, it isn't immune from a weakening global environment and deflationary pressures. Falling Treasury bond yields are already telling us that. So is the plunging price of copper along with the rest of the commodity complex.
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Chart 8
