DOW AND S&P 500 LOSE GROUND WHILE NASDAQ HOLDS FIRM -- STRONG JOBS REPORT AND BOUNCING DOLLAR BOOST SMALL CAPS -- 10-YEAR TREASURY YIELD SURGES TO EIGHT-MONTH HIGH AND BREAKS DOWNTREND LINE -- 2-YEAR YIELD NEARS FOUR YEAR HIGH
DOW AND S&P 500 SLIP WHILE NASDAQ HOLDS FIRM... U.S. stocks lost ground during the week, but not enough to do any serious chart damage. Chart 1 shows the Dow Industrials falling to the lowest level in a month and sliding below its 50-day moving average (in rising volume). But the Dow has yet to break a rising support line drawn under its April/May lows. Chart 2 shows the S&P 500 looking pretty much the same. The Nasdaq, however, held relatively steady. Chart 3 shows the Nasdaq Composite Index bouncing on Friday to end the week essentially flat. It also remains above its 50-day moving average. Although the broader market lost ground, it's doubtful that it will fall very far as long as the Nasdaq market continues to hold up. A lot of negative divergences pointed out over the last week remain intact (like the falling MACD lines on top of Chart 1). That situation will have to improve to signal that the market is out of danger.
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Chart 1
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Chart 2
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Chart 3
RISING DOLLAR BOOSTS SMALL CAPS... While large caps sagged this week, small caps fared better. The daily bars in Chart 4 show the Russell 2000 Small Cap Index ($RUT) ending the week on a strong note, and above its 50-day moving average. I suspect the reason for that divergence was Friday's strong jobs report and a rebound in the U.S. dollar. The solid line above Chart 4 is a "ratio" of the RUT divided by the S&P 500 Large Cap Index. After dropping during April (small cap underperformance), the ratio has been rising over the last month (small cap outperformance). One possible explanation for that is the trend of the U.S. dollar (green bars). Since the start of the year, the rising dollar has given small caps an edge over large caps. The dollar drop during April benefited large caps. The dollar rise over the last month has benefited small caps. Here's why. A rising dollar is a negative for large cap multinationals who do a lot of foreign business. Large caps are more sensitive to trends in foreign markets, most of which fell this week (especially in Europe). Small caps, by contrast, do most of their business in the U.S. As a result, they're less impacted by a rising dollar (and troubles abroad). Friday's strong jobs report signaled a stronger U.S. economy and boosted the dollar. That helped small caps, while weighing on large caps. As with the Nasdaq, the ability of small caps to hold up is a positive factor for the U.S. market.
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Chart 4
GET READY FOR HIGHER RATES... Treasury bond yields surged to the highest level in eight months. Chart 5 shows the 10-Year Treasury yield also breaking a falling trendline extending back to the start of 2014. The surge in global bond yields started in Europe during April and continued again this week. The 10-Year German Bond yield has doubled since April and has pulled European bond yields sharply higher. Bond yields are also rising in Asia. The 2-Year Treasury yield (below chart), which is more sensitive to Fed policy, jumped 12 basis points during the week to end just shy of a four-year high. [Although both maturities rose, the 10-Year yield gained 29 basis points, which was more than double the 12 basis point gain in the 2-Year. That kept the yield curve rising]. The surge in bond yields is obviously bad for bond prices which fall when yields rise. I suspect the surge in bond yields is also starting to worry global stock investors, which may account for this week's selling. The biggest impact of rising yields, however, is seen in various stock market sectors.
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Chart 5
RISING RATES HURT CONSUMER STAPLES ... Several previous messages (including this past Wednesday) have explained why rising bond yields benefit bank and insurance companies, while hurting bond proxies like utilities and REITs. With bond yields spiking again this week, financials were the market's top sector. Bank and insurance stocks were the biggest gainers. At the same time, REITs were the biggest financial losers. No surpise there. Utilities were the weakest sector. No surprise there either. What may be a surprise is the negative impact rising rates are having on consumer staples which had a bad week. The daily bars in Chart 6 show the Consumer Staples Sector SPDR (XLP) tumbling to a three month low and threatening its 200-day average. [Its weekly loss of -2.5% was second only to the 4% loss in utilities]. Next to utilities and REITs, consumer staples are the highest dividend payers. And dividend payers are hurt by rising bond yields. The black line on top of Chart 6 plots the XLP/SPX ratio which has been falling all year. Notice that the staple relative performance line started falling in January and has fallen each time the 10-year Treasury yield has spiked (like this week). The staples' decline was led by tobacco, soft drinks, and food stocks.
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Chart 6
TOBACCO STOCKS TUMBLE... Tobacco was the week's biggest loser in the consumer staple space. Chart 7 shows the Dow Jones US Tobacco Index losing 2.7% on Friday to plunge below its 200-day average to the lowest level in two months. Three of Friday's biggest market losers were tobacco stocks -- Altria (-3.3%), Reynolds American (-2.6)%, and Philip Morris (2.6%). Chart 8 shows Altria (MO) plunging below its 200-day average to the lowest level in five months (in heavy trading). [Philip Morris (PM) also ended below its 200-day line]. Altria is one of the market's highest dividend payers (4.3%). Lorillard (LO) and Reynolds American (RAI) are right behind with yields of 3.7%. Soft drinks are other staple dividend payers which also had a bad week (-2.7%). Chart 9 shows Pepsico (PEP) falling below its 200-day line on Friday. PEP is another high dividend payer at 3%. [Coca Cola (KO) also fell below its 200-day line]. Food stocks also came under pressure. Chart 10 shows General Mills (GIS) falling to a two-month low. GIS pays a dividend yield of 3.2%. The reason is relatively simple. Historically low bond yields pushed investors into dividend paying shares in the search for yield. Higher bond yields make dividend paying stocks a lot less attractive. Add consumer staples to the list of places to avoid in a climate of rising yields -- along with utilities and REITs. Banks and insurers are the two best places to be.
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Chart 7
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Chart 8
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Chart 9
