TEN-YEAR TREASURY YIELD CLIMBS TO NINE-MONTH HIGH -- LONG-TERM TREASURY BOND CHART LOOKS BEARISH -- RELATIVE STRENGTH ANALYSIS SHOWS RISING RATES HURTING UTILITIES AND REITS -- BUT BOOSTING FINANCIALS
10-YEAR TREASURY YIELD HITS NINE-MONTH HIGH ... Chart 1 shows the 10-Year Treasury yield climbing another 3 basis points today to the highest level since March (2.49%). That's most likely tied to the impending passage of the tax bill before Congress with expectations for faster economic growth and added supply of bonds to finance the expected budget deficit. As I mentioned yesterday, however, foreign yields are also rising. In fact, they're rising even faster. The Canadian 10-year yield is up 4 basis points today, while German and UK yields are climbing 4 and 5 bps respectively. That explains why the U.S. dollar is down again today. The dollar rises when Treasury yields rise faster than foreign yields. Right now, foreign yields are either matching Treasury gains or exceeding them. The direction of bond prices (and yields) are good for some stock groups and bad for others. Some of them are pretty well known. One may surprise you. A longer-range look at the price of the Ten-Year Treasury note looks bearish.
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Chart 1
PRICE OF 10-YEAR TREASURY NOTE LOOKS BEARISH... Previous messages have used various bond ETFs to make a bearish case for bonds. Today's message is using the cash price of the 10-Year U.S. Treasury note (plotted through yesterday). And it doesn't look encouraging for bond holders. The weekly bars in Chart 2 show a huge potential "double top" having formed between 2012 and 2016 (red circles). The price of the 10-Year Treasury note is now approaching the low formed at the end of 2013. A decisive close below that previous support level would complete a major topping formation for bonds. That would be bad news for bonds and rate-sensitive stock groups that are viewed as bond proxies.
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Chart 2
RISING YIELD HURTS UTILITIES AND REITS ... Yesterday's message showed rising bond yields hurting the relative performance of utilities and REITS. Chart 3 gives a longer range view of the inter-relationship between those two rate-sensitive stock groups and bond yields. The green line plots the 10-Year Treasury yield ($TNX). The red line plots a relative strength ratio of the Utilities SPDR (XLU) divided by the S&P 500. The purple line plots the relative strength ratio for the Real Estate Sector SPDR (XLRE). Falling bond yields from mid-2015 to mid-2016 coincided with stronger relative performances by utilities and REITS (rising ratios). Since bond yields bottomed in mid-2016, however, the relative strength ratios of both rate-sensitive groups have been falling. The most recent bond yield upturn this September caused both ratios to fall even further. In other words, rising bond yields hurt the relative performance of both groups. One reason why is that they pay a high dividend rate which competes with bonds for yield. When bond yields are rising, dividend paying stocks lose favor. As a result, utilities and REITs fall with bond prices. To a slightly lesser extent, the same is true for dividend-paying consumer staples and telecom stocks. Now for the good news.
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Chart 3
FINANCIALS BENEFIT FROM RISING YIELDS ... Financial stocks usually do much better in a rising rate climate. That's shown by Chart 4 which compares the trend of the 10-Year Treasury Note (green line) to a relative strength ratio of the Financials SPDR (XLF) divided by the S&P 500 (black line). It's clear that they generally rise and fall together. After falling together during 2011, for example, both lines rose together between 2012 and 2013. Both fell together during 2014 through the middle of 2016. Both have been rising together since then. The dramatic recovery in the XLF relative strength ratio (black line) since the middle of 2016 corresponded to a similar upturn in the 10-Year yield. That was also true following the latest upturn in bond yields this September. Banks are one of the biggest beneficiaries of rising yields. One sector that doesn't benefit from rising yields is technology.
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Chart 4
RISING YIELDS AREN'T GOOD FOR TECHNOLOGY STOCKS ... The relationships discussed above are pretty well known. What isn't as well known is that rising rates can hurt the relative performance of technology stocks. To demonstrate that, Chart 5 compares the 10-Year Treasury yield (green bars) to a ratio of the Technology SPDR (XLK) divided by the S&P 500 (black line). What the chart suggests is that the XLK relative strength ratio tends to rise when bond yields are falling (like between March and May and again from mid-July to September). The uptick in bond yields during June and again in September caused the ratio to dip. Between late October through November, technology stocks did better than the market as yields weakened. Since the end of November when bond yields started climbing, however, technology has underperformed the rest of the market. Technology is the ultimate growth play which does better in a sluggish, low rate environment. Money leaving technology has moved into more economically-sensitive parts of the market like banks, retailers, industrials, small caps, and transportation stocks that do better in a stronger economy with rising interest rates. It also makes sense that investors are taking yearend profits in the year's biggest technology winners, while rotating into cheaper parts of the market. That includes energy.
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Chart 5
ENERGY SECTOR IS LEADING ... It may come as a surprise to read that energy is the day's strongest sector. But it is. The daily bars in Chart 6 show the Energy SPDR (XLE) nearing a 10-month high. Its 50- and 200-day moving averages are also in bullish alignment (with the 50 over the 200). The XLE/SPX ratio (gray line) is still relatively flat which makes energy one of the year's weakest sectors. That may be one of the reasons that money is starting to flow into energy shares. Plus the fact that energy prices are rising. Although this may be a reach, there could be a link between rising energy prices and bond yields. Rising energy prices are inflationary which isn't good for bonds. The 20-day Correlation Coefficient between the XLE and 10-Year Treasury yield is also a relatively high value of .70. Investors are looking for cheap stocks with upside potential. Energy certainly qualifies. Energy stocks are also believed to be one of the beneficiaries of the tax bill. They also stand to benefit from a weaker dollar.
