INTEREST RATES CLIMB ALONG WITH THE DOLLAR -- INVESTMENT GRADE CORPORATES WEAKEN -- DROP IN JUNK BONDS MAY BE SHORT-TERM WARNING FOR STOCKS -- SMALL CAPS THREATEN 50-DAY LINE -- ENERGY SPDR PLUNGES ON FALLING CRUDE OIL
BOND YIELDS CONTINUE TO CLIMB... Chart 1 shows the 10-Year Treasury Yield (TNX) climbing to 2.55% which is the highest level this year. The 2-Year Treasury yield (most sensitive to a Fed rate hike) has climbed to 1.35% which is the highest level in seven years. Odds for a Fed rate hike next week are just about 100%. Naturally, that's pushing bond prices lower. Chart 2 shows the 7-10 Year Treasury Bond ETF (IEF) trading lower. That's just a mirror image of the rising 10-Year yield. What's a little concerning, however, is that corporate bonds are starting to weaken. Chart 3 shows the iBoxx Investment Grade iShares (LQD) falling below its 50-day average for the first time this year, its biggest drop since November. High yield bonds are doing even worse.
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Chart 1
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Chart 2
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Chart 3
HIGH YIELD BONDS TURN DOWN ... Chart 4 shows the iBoxx High Yield Corporate Bond iShares (HYG) having the worst week since the start of November. It's in danger of falling below its 50-day average for the first time in three months. And it's falling in heavy trading. Its 14-day RSI line (top of chart) has fallen below its 50-day line from overbought territory over 70 at the end of February. Other short-term indicators (like daily MACD lines) have turned down. That's not only a sign that high yield bonds are entering a correction. It's also a warning for stocks. That's because high yield bonds and stocks are highly correlated. Their 60-day Correlation Coefficient is 0.86%. Both have been rising together since the election. They may be ready to pull back together.
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Chart 4
SMALL CAPS ALSO WEAKEN ... Last Tuesday, I expressed concern that relative weakness in small caps could be a warning sign of a pullback in the broader market. A jump in stocks following Tuesday's presidential speech pushed those concerns aside for the time being. But we're back where we were before the speech. Chart 5 shows the Russell 2000 iShares (IWM) retesting their 50-day moving average. A close below that line would be short-term setback. Daily MACD lines also look dangerously weak. That's not normally a good sign for large cap stocks which remain over-extended.
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Chart 5
ENERGY STOCKS TUMBLE... Another negative warning may be coming from today's plunge in energy stocks. Chart 6 shows the Energy Sector SPDR (XLE) falling to the lowest level in four months, and in danger of ending below its 200-day average. A big drop in energy prices is the main reason why. Most other commodity prices are also in the red today. Precious metals turned down last week. Base metals have also weakened. A bouncing dollar may be part of the reason.
