PLUNGE IN JAPANESE BOND YIELD PULLS TREASURY YIELD TO NINE-MONTH LOW -- THAT HELPS EXPLAIN WHY BONDS RALLIED WITH STOCKS ON FRIDAY -- FALLING BOND YIELD IS GOOD FOR UTILITIES AND OTHER DIVIDEND PAYERS, BUT BAD FOR BANKS AND INSURERS
10-YEAR TREASURY YIELD FALLS TO NINE-MONTH LOW... A seemingly strange thing happened on Friday. The Bank of Japan surprised everyone by adopting a negative interest rate for the first time by pushing its short-term rate below zero. Not surprisingly, the Japanese yen plunged 2% and Japanese stocks jumped 2.8%. That strong stock rebound helped support stock prices around the globe which ended the week (and month) on a strong note. What seemed strange was the big jump in bond prices along with stocks. Normally, bonds sell off when stocks rally. When bond prices rise, bond yields fall. Chart 1 shows the 10-Year Treasury Yield ending the week at 1.94% which was the lowest yield since last April. Part of the drop in yields was a weak fourth quarter GDP report which followed a weak durable goods report. But just as Friday's stock rebound started in Japan, I suspect the fall in bond yields started there too.
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Chart 1
JAPANESE YIELDS LEAD WORLD LOWER... The direction of the U.S. Treasury yields is highly dependent on the direction of foreign bond yields. Chart 2 compares the trend in 10-Year bond yields in the U.S., Germany, and Japan. [The yields are plotted on a log chart to make for easier comparison]. On Friday, the Japanese 10-Year yield plunged from .22% to .10%. That's a big drop in percentage terms as the log chart reflects. That started the move lower in bond yields in Europe and the U.S. The German 10-Year yield fell from .40% to .32% to the lowest level since last April. If that last phrase sounds familiar, that's because the 10-Year Treasury yield also fell to the lowest level since last April. There's another reason why Treasury yields are falling, and Treasury prices rising. Global investors move into bond markets with the highest yield. As Chart 2 shows, the Treasury yield is much higher than Europe and Japan. That makes Treasuries attractive to global investors. A stronger dollar also makes U.S. Treasuries more appealing. As long as foreign yields keep falling, Treasury yields will continue to follow them lower.
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Chart 2
FALLING YIELDS HELP UTILITIES, HURT BANKS... The drop in bond yields explains why dividend paying stock groups like consumer staples, telecom, utilities, and REITs have been attracting money. Not only are they defensive in nature, but they are also dividend-payers. As such, they compete with bonds for yield. Falling bond yields increase the appeal of dividends. Utilities were the only sector to gain ground during January. Chart 3 shows the Utilities Sector SPDR (XLU) closing the month at the highest level in nearly a year. The chart shows that the surge in utilities started when the 10-Year yield (green line) started falling. That also explains the recent move into consumer staples and telecom stocks like AT&T and Verizon. It also explains the bad performance in financial stocks like banks and insurers.
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Chart 3
BANKS TUMBLE WITH RATES ... Falling bond yields are bad for bank stocks. Chart 4 shows the KBW Bank SPDR (KBE) tumbling to a 52-week low during January. The KBE lost -12% during January. Life insurers, which are also hurt by falling yields, lost -14%. REITs were the strongest part of the financial sector which was the second worst monthly performer (next to materials). Chart 4 shows the strong positive correlation between the KBE and the 10-Year Treasury yield (green line). Both fell together between June and August and again between December and January. Banks are hurt by falling bond yields because it lowers the rates they can charge on bank loans. Lower yields also lower their net interest margin which is the difference between what they pay depositors (short-term rates) and what they change for loans (long term yields).
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Chart 4
DOW ENDS THE WEEK ON AN UPNOTE ... Global stocks ended the week and month on a strong note. Japan no doubt helped. So did the fact that a lot of global stocks were in oversold conditions and in potential support zones. Chart 5 shows the Dow Jones Industrial Average climbing nearly 400 points on Friday on rising volume. That keeps the Dow above chart support formed last summer. The 14-day RSI line (above chart) is rebounding from an oversold condition, while daily MACD lines (below chart) turned positive. The chart also shows the Dow closing above its 20-day average (green line) for the first time in January. That's the good news. The bad news is that the 50- and 200-day lines are still negative as are weekly MACD lines. There are still a lot of headwinds facing the stock market. Not the least of which is the fact that defensive stocks are still in a leadership position, while economically-sensitive stocks are underperforming. That will have to change if the market is going to make any serious headway. In the meantime, falling global bond yields may help in the short-run, but aren't a vote of confidence on the state of the global economy.
