THIS WEEK'S JUMP IN COPPER AND BOND YIELDS MAY BE LINKED -- SO IS THE BIG JUMP IN THE GERMAN 10-YEAR BUND YIELD -- TREASURY YIELD CURVE APPEARS TO BE BOTTOMING -- RISING BOND YIELDS HELP BANKS AND INSURERS WHICH GAINED ON THE WEEK
COPPER AND YIELDS ARE WEEK'S BIGGEST GAINERS ... Two of the most significant events of the past week were the sharp rally in copper and Treasury bond yields. The two may be linked. Chart 1 shows the price of copper (red line) and the 10-Year Treasury Note Yield (green bars) bottoming together in January. Both jumped sharply this week. Rising copper prices (along with a higher oil price) suggest a boost in inflation expectations and/or global economic strength. Both are bad for bonds which fell sharply as a result. That in turn contributed to some sector rotations during the week. While material and energy stocks were the week's top gainers, rate sensitive utilities and REITs were among the weakest. At the same time, banks and life insurers were among the top financial gainers. Both stand to benefit from rising bond yields. The jump in bond yields also hurt the price of gold which fell sharply. Another contributing factor behind this week's jump in bond yields was a huge jump in eurozone bond yields, especially in Germany.
(click to view a live version of this chart)
Chart 1
GERMAN BOND YIELD HAS BIGGEST BOUNCE IN TWO YEARS... This week's heavy bond selling actually started in Europe. The weekly bars in Chart 2 show the 10-year German Bund yield jumping to 0.37% by Thursday. [The German market was closed on Friday]. That was the biggest point and percentage gain in two years. It also put the Bund yield above its 10-week (50-day) moving average for the first time in six months, and by the widest margin since the start of 2014. The 14-week RSI (top of chart) rose to the highest level in a year, while its weekly MACD lines (below chart) turned positive. While the gain may not seem that big in points, it certainly is in percentage terms. The bund yield rose 131% during the week (versus a 10% gain in the same maturity in the states). The log scale in Chart 3 gives a better idea of the magnitude of that jump. [A log scale is based on percentage gains]. Two weeks ago its yield had fallen to an all-time low of 0.08%. The jump in its value over the last two weeks from 0.08% to 0.37% amounts to an amazing gain of 362%. That means that the 10-Year German yield has more than tripled in just two weeks. Other eurozone yields jumped as well. That means that traders sold eurozone bonds very heavily. Treasury bonds are highly correlated to eurozone bonds. Falling eurozone yields over the past year have pulled Treasury yields lower. Surging eurozone yields this week contributed to higher Treasury yields.
(click to view a live version of this chart)
Chart 2
(click to view a live version of this chart)
Chart 3
RISING YIELD CURVE APPEARS TO BE BOTTOMING... One of the important side effects of this week's jump in Treasury bond yields is the simultanous steepening in the yield curve. The yield curve is the difference (or spread) between short and long term Treasury yields. Short term rates are being restrained by the Federal Reserve. As a result, most of this week's jump in the yield curve came from rising Treasury bond yields. Chart 4 plots the difference between 10-Year and 2-Year Treasury yields ($YC2YR). After falling between the start of 2014 and 2015, the 10 year - 2 year yield curve bottomed in January (along with bond yields). This week's jump puts it at the highest level this year. It remains below its 200-day average (red line), but has moved well above its rising 50-day average (blue line). In addition, this year's first quarter low coincided with a test of its 2012 low. That makes this week's upturn look more and more like a major bottom. That's good for some stocks, but bad for others. It's bad for utilities and REITS, but good for banks and insurers
(click to view a live version of this chart)
Chart 4
RISING YIELDS TIED TO BANKS' STRONGER PERFORMANCE... My Thursday message explained that bank profits are largely tied to net interest margin, which is the difference between what they pay depositors (in short-term rates) and charge borrowers (in long-term rates). That's why a steeper yield curve (higher bond yields) is good for banks. And why the direction of the yield curve influences their absolute and "relative" performance. Banks were one of the week's strongest performers (along with life insurance stocks). The weekly bars in Chart 5 show the KBW Bank Index ($BKX) rising on the week (while most other stocks lost ground). As a result, its relative strength ratio (black line) also rose. That had a lot to do with the jump in bond yields and the yield curve (green dashed line). Chart 5 also shows a close correlation between the BKX/SPX relative strength ratio (black line) and the yield curve (green dashes). Both fell together during 2014 before bottoming together at the start of 2015. And both jumped together this week. Rising bond yields should make bank stocks, which have been market laggards, a lot more "interesting" to investors. Life insurers, which had an even stronger week than banks, also stand to benefit from rising bond yields.
(click to view a live version of this chart)
Chart 5
LIFE INSURERS ALSO BENEFIT FROM RISING BOND YIELDS... Life insurers were the week's strongest financial group (banks came in second). The daily bars in Chart 6 show the Dow Jones US Life insurance Index closing above its 200-day average (red line) for the first time this year. The solid black line shows the insurance relative strength ratio turning up as well. That had a lot to do with the jump in bond yields (below chart). Chart 7 shows how closely the life insurance relative strength ratio has tracked the 10-year Treasury yield (green line) over the last three years. There's a good reason for that. Most of the income from insurance premiums is invested in Treasury bonds. Lower yields produce lower portfolio returns. Rising bond yields allow insurers to invest income from new premiums in higher yielding bonds and benefit accordingly. Genworth's 15% gain led the group higher this week. Two other leaders were Prudential (3%) and Metlife (2.6%). The daily bars in Chart 8 show Prudential Financial (PRU) climbing toward a test of its March high and 200-day average (red line). Its relative strength ratio (black line) is rising as well. Like banks, life insurers have been market laggards mainly due to lower bond yields. That may be starting to change for the better for both groups. Maybe we should thank the Germans for that.
(click to view a live version of this chart)
Chart 6
(click to view a live version of this chart)
Chart 7
