SMALL CAPS AND TRANSPORTS CONTINUE TO WEAKEN -- ENERGY STOCKS CONTINUE TO DROP ON FALLING OIL PRICE -- COMMODITY SELLOFF WEAKENS INFLATION TRADE -- HIGH YIELD BONDS SELL OFF ON COMMODITY WEAKNESS
SMALL CAPS AND TRANSPORTS WEAKEN ... Bond yields are hitting multi-year highs in anticipation of a Fed rate hike tomorrow. Stocks remain in an uptrend, but weakness in some stock groups is sending short-term caution signals. Small caps and transports continue to weaken. So do energy shares along with falling oil prices. The drop in energy (and mining) shares are weighing on high-yield bonds. Let's start with small caps and transports. Messages from the two previous Wednesdays showed deterioration in small caps and transports. Chart 1 shows the Russell 2000 iShares (IWM) continuing to trade below its 50-day average. It may retest its January low. That would be an important test. The IWM:SPX ratio (top of chart) shows small caps underperforming large caps by the widest margin since November. Chart 2 shows Transportation Average iShares (IYT) trading below its 50-day average as well. Next potential support is at its January low. The falling transport/industrials ratio (top of chart) shows the former underperforming the latter by the widest margin in several months as well. Both are short-term caution signals for the market.
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Chart 1
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Chart 2
ENERGY SHARES TUMBLE... The downturn in energy shares shown last Wednesday has gotten worse. Chart 3 shows the Energy Sector SPDR (XLE) trading below its 200-day moving average for the first time since last April. The XLE/SPX ratio (top of chart) has fallen to the weakest level since last spring. Energy shares helped lead the market higher last year. But it's a drag on the market this year. The Fibonacci retracement lines show the next potential support level at its November low (66.65). That would represent a 38% retracement of last year's gains. A 50% retracement would take the XLE down to last summer's low near 64.
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Chart 3
CRUDE OIL SLIPS BELOW 200-DAY LINE... The selling in energy shares is the direct result of a sharp drop in the price of crude oil. Chart 4 shows Light Crude Oil ($WTIC) falling below $48 today to the lowest level in four months. It's also slipped below its 200-day for the first time this year. Next potential support is a rising trendline drawn under its August/November lows. Oil isn't the only commodity dropping. Commodity indexes are also weakening.
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Chart 4
BLOOMBERG COMMODITY INDEX IS FALLING... Chart 5 shows the Bloomberg Commodity Index falling to the lowest level in four months. The commodity rally since November was part of the reflation trade. This month's downturn suggests some rethinking of the inflation outlook over the near term. Chartwise, commodities are in a broad trading range. Having failed at the upper end of the range last month, the commodity index may now retest the lower end. Support around last November's low may attract new buying. Although record inventories have hurt oil, expectations for higher interest rates, and a firmer dollar, may also be contributing to the selloff. That's been especially true of precious metals. Base metals have also weakened.
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Chart 5
JUNK BONDS CONTINUE SELLOFF... Last week's message expressed some concern over the drop in junk bonds. Chart 6 shows the iBoxx High Yield Corporate Bond iShares (HYG) continuing that selloff and trading below its 50-day average. A lot of that selling is the result of falling energy (and mining) shares which are a big part of the high yield universe. I also take that as a short-term warning for stocks. That's because junk bonds are positively correlated with stocks. The big news this week is what the Fed does (and says) tomorrow. And how the market reacts to it. A rate hike is pretty much a given and may be priced into bond and stock prices. What Ms. Yellen says in the news conference afterwards could attract more attention (and reaction).
