BIG JUMP IN BOND YIELDS IS PUSHING FINANCIAL SECTOR TO A RECORD HIGH -- BANKS AND BROKERAGE ETFS ARE ALSO ACHIEVING BULLISH BREAKOUTS -- UTILITIES ARE REITS ARE FALLING WITH BOND PRICES
10-YEAR TREASURY YIELD SURGES TO TWO-MONTH HIGH... The green bars in Chart 1 show the 10-Year Treasury Yield ($TNX) jumping 8 basis points today to reach the highest level since the end of July. The chart also shows the TNX having risen above a falling trendline drawn along its March/ July highs. Short-term yields are climbing as well. The solid line in Chart 1 shows the 2-Year Treasury yield rising to 1.48% today which is the highest level since 2008. The rise in the 2-year yield reflects growing odds for a rate hike later this year. And that growing expectation is helping to boost longer maturity bond yields. The jump in yields is having a ripple effect throughout various market sectors. As is usually the case, rising yields are giving a big boost to financial stocks which are the day's strongest sector. The Financial SPDR (XLF) is trading at a new record high. On the downside, rising yields (and falling bond prices) are pushing dividend-paying utilities and REITs sharply lower. The fact that Treasury yields are rising faster than yields in foreign developed countries is helping to boost the U.S. Dollar. That's hurting the price of gold and gold miners. The combination of rising rates and a firmer dollar are also pushing small cap stocks further into record territory. A number of financial ETFs are also achieving bullish breakouts.
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Chart 1
THREE FINANCIAL ETFS ACHIEVE BULLISH BREAKOUTS... Chart 2 shows the Financial Sector SPDR (XLF) breaking out today to a new record. The XLF is also trading back above its 2007 high for the first time in ten years. Its relative strength line (top of chart) is breaking out to the upside as well. That reflects the decisive rotation into financial stocks over the last month on expectation for higher interest rates. Banks and brokerage stocks are leading the financial rally. And that's being reflected in their respective ETFs. Chart 3 shows U.S. Broker-Dealers & Securities Exchanges iShares (IAI) also rising into record territory. Banks are also having a strong chart day. Chart 4 shows the S&P Bank SPDR (KBE) rising above its July peak to the highest level in more than six months. Although banks had been lagging behind the rest of the sector, their stronger percentage gains today show them catching up. The rising KBE/XLF ratio (top of chart) also shows banks gaining on the broader financial sector.
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Chart 2
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Chart 3
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Chart 4
REITS AND UTILITIES ARE FALLING... When bond yields rise, bond prices fall. And so do dividend-paying stocks like REITs and utilities. Dividend paying stocks compete with Treasuries for yield. When bond yields are rising (as they are now), dividend stocks fall out of favor. The black bars in Chart 5 show the Real Estate Sector SPDR (XLRE) falling well below its 50-day average. More importantly, the red line shows the XLRE/SPX ratio falling to the lowest level since the spring. Chart 6 shows the Utilities SPDR (XLU) also falling below its 50-day line. The XLU/SPX ratio (red line) is also falling. Consumer staples are also underperforming.
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Chart 5
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Chart 6
RISING RATES ARE ALSO HELPING SMALL CAPS ... Small caps continue to get a boost from the rotation into financial shares. That's because financials are their biggest sector. Chart 7 shows the Russell 2000 iShares (IWM) surging 2% today and well into record territory. Small caps may also be getting a boost from a rebound in the U.S. Dollar Index to the highest level in six weeks (green line). A firmer dollar makes domestic-oriented small caps more attractive than large cap stocks that rely on foreign revenue. A rising dollar makes their exports more expensive.
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Chart 7
TAX REFORM IS ALSO BOOSTING SMALL CAPS... The Republican plan for tax reform was introduced today. That's contributing to today's buying of stocks and the selling of bonds. The prospect for lower corporate and personal taxes would be good for the U.S. economy which, in turn, would boost bond yields (and encourage the Fed to keep raising rates). That may also explain the sudden preference for small cap stocks. That's because they're more closely tied to the U.S. economy than large cap multinationals that are more dependent on foreign markets. Small caps are also among the highest taxed companies. Yesterday's record high in the Russell 2000 Small Cap Index was led by the small cap value ETF (IWN) which is heavily weighted to financial shares. Today's record high in the RUT, however, is being supported by both growth and value stocks. Chart 8 shows the Russell 2000 Growth iShares (IWO) surging more than 2% into record territory. That's mainly due to a rebound in technology shares today. The IWO has a 24% weight in technology shares. It's a good sign when small cap growth and value stocks are setting new records together. That's usually a vote of confidence in the U.S. economy.
