LONGER-DATED TREASURY BONDS LEAD FIXED INCOME MARKETS LOWER -- HIGH YIELD BONDS ARE MORE CLOSELY TIED TO STOCKS -- MONEY IS FLOWING INTO TIPS FOR INFLATION PROTECTION -- RISING COAL SHARES ARE ANOTHER SIGN OF A COMMODITY REVIVAL
MORE BOND CHARTS ... I've been writing about how the recent upturn in bond yields has been pushing bond prices lower (primarily due to rising commodity prices). Not all bond categories are falling at the same rate however. When inflationary pressures are starting to pull bond yields higher, longer maturity Treasury prices usually fall the fastest. That explains why the 20+year Treasury Bond iShares (TLT) have been the biggest loser since midyear with a loss of -5%. It also has fallen below its 200-day average. So has the 7-10 Year Treasury Bond iShares (IEF) in Chart 1. The shorter duration IEF, however, has lost a smaller -2% since midyear. Corporate bonds have held up better, especially the high yield category. Chart 2 shows the iBoxx Investment Grade Corporate Bond iShares (LQD) very close to a new four-month low (with a four-month loss of only -0.4%). As a rule, corporate bonds hold up better than Treasuries in a rising rate environment, especially high yield bonds. Chart 3 shows the iBoxx High Yield Corporate Bond iShares (HYG) holding up better, but ending the week below its 50-day average. The HYG is still up 3% since midyear. That also makes sense because high-yield bonds are more closely tied to stocks than bonds. They're also benefiting from the 2016 rebound in energy shares. Plus the fact that they pay higher yields. So far, the juxtaposition of all three bond categories is consistent with expectations for higher bond yields.
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Chart 1
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Chart 2
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Chart 3
TIPS ARE DOING MUCH BETTER THAN TREASURIES... There's one other bond category that has held up better than others since midyear (+0.3% since July 1). Chart 4 shows Treasury inflation Protected iShares (TIP) trading sideways since the start of July. To my eyes, they appear to be in relatively stronger technical shape as well. They've even held up better than high-yield bonds over the last month. But they're doing much better relative to longer-dated Treasury bonds. And that's the real message of the market. Chart 5 plots a relative strength ratio of the TIPS iShares divided by the 20+Year Treasury Bond iShares (TLT) since the start of the year. The rising ratio shows TIPS doing much better since mid-year (by more than 5%). That's to be expected when fixed income investors are starting to price in higher inflation expectations. That's because TIPS offer more protection against rising inflation. The upturn in the TIPS/bond ratio began in July when bond yields started rising. It should also come as no surprise to read that the TIPS/ Treasury bond ratio is closely tied to the direction of commodity prices which are rising.
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Chart 4
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Chart 5
COAL ETF IS ALSO HAVING A VERY STRONG YEAR... Speaking of rising commodity prices, I've been writing lately about commodity stock groups that have been doing very well, including metal and mining stocks tied to base metals and steel. Coal stocks are doing even better. Chart 6 shows the VanEck Vectors Coal ETF (KOL) surging almost in a straight line since January to the highest level in eighteen months. The group has doubled in price since the start of the year (as has the price of coal). That comes as a surprise to me because I thought the coal industry was dead. Apparently not. An article in Investors Business Daily this morning explained some reasons why the coal industry is starting to improve. First, a recent court decision offering some relief on the regulatory front. Second, rising natural gas prices are making coal more competitive (see gray area). And third, rising coal demand from China. A big part of that foreign demand is for coal used to make steel. That's another sign that commodities, and stocks tied to them, are back in favor. The new inflation trade explains why investors are selling Treasury bonds and moving money into TIPS.
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Chart 6
MORE EMAILS WEAKEN STOCKS ON FRIDAY... A Friday afternoon announcement that the FBI was examining more emails tied to Hillary Clinton reversed the earlier rally after a stronger than expected third quarter GDP report. The selling also came on rising volume. Chart 7 shows, however, that very little has changed. The S&P 500 remains in a short-term downtrend and is retesting its September/October lows. A cause for concern is the fact that small caps are starting to underperform. Chart 8 shows the S&P 600 Small Cap Index ($SML) undercutting its September low, also on rising volume. The SML/SPX ratio (top of chart) has also turned down. With the presidential election just ten days away, there's still plenty of time for surprises which could effect trading. The CBOE Volatility (VIX) Index jumped 5% on Friday and 21% during the week. I wrote yesterday that the period after Halloween is usually seasonally friendlier for stocks. I'm amending that to read "after the election" (and depending on who wins).
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Chart 7
