CHART ANALYSIS STILL FAVORS A HIGHER TEN-YEAR TREASURY YIELD -- WEAKER FOREIGN YIELDS HAVE HELD THE TNX BACK -- RISING RATES HURT CONSUMER STAPLES WHILE FAVORING CYCLICALS -- FALLING COMMODITY PRICES HAVE BOOSTED BOND PRICES -- OVERBOUGHT DOLLAR WEAKENS
THE MAJOR TREND STILL FAVORS HIGHER BOND YIELDS... Yesterday's message showed the 7-10 Year T-bond iShares (IEF) testing important overhead resistance at its spring highs and 200-day moving average, and the impact bond direction usually has on rate-sensitive sectors like financials, utilities, and REITS. Rising rates usually favor financials while working against dividend-paying bond proxies like utilities and REITS. I also mentioned that rising rates aren't good for consumer staples either. Today, I'm going to focus more on bond yields themselves, and tie that into the performance of staples. I also want to show that rising rates impact other market sectors. As a rule, rising bond yields favor economically-sensitive stocks that tend to do better in a stronger economy. We'll show that rising bond yields favor cyclical stocks over staples. I'll also look at commodity prices which may be influencing bond direction. Our primary focus today is the 10-Year Treasury bond yield. As usual, we'll start with a chart.
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Chart 1
TEN-YEAR TREASURY YIELD IS STILL TESTING OVERHEAD RESISTANCE ... The monthly bars in Chart 1 (above) show the 10-Year Treasury Yield ($TNX) forming a major bottoming pattern that started six years ago (2012). Its monthly MACD lines (bottom box) are at the most positive reading in ten years. That favors an eventual upside breakout. [A decisive upside breakout would also break a falling trendline going back more than three decades]. Since May, however, the TNX has been pulling back. The chart below shows one of the reasons why. The green line shows the 10-Year Treasury yield peaking at 3.11% in mid-May and trading lower since then. The blue and red lines, however, have fallen a lot more. They represent the ten-year yields for Germany (blue line) and the UK (red line). Lower foreign yields usually have a depressing influence on Treasury yields. Part of the reason is that higher Treasury yields attract foreign money which boosts bond prices and pulls yields lower. Over the last month, for example, the 10-Year Treasury has gained 5 basis points. At the same time, German yields have dropped -1 basis point, while the UK yield has dropped -7 bps. The Canadian ten-year yield has remained flat. That also explains why those currencies have weakened against the dollar. Chart 2 also suggests that an upside breakout by Treasury yields may depend on foreign yields moving higher as well.
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Chart 2
RISING BOND YIELDS HAVE ALSO HURT CONSUMER STAPLES... Yesterday's message showed that bond proxies like utilities and REITs were two of the weakest market sectors since bond yields bottomed in the middle of 2016. Consumer staples actually did worse. Chart 3 shows that the upturn in bond yields during 2016 coincided with a peak in the relative strength ratio of the Consumer Staples SPDR (XLP) divided by the S&P 500. Staples underperformed the SPX by -32% during that two years (only telecom did worse). The reason for that weaker performance is twofold. Consumer staples are one of the highest dividend paying sectors (behind telecom, utilities, and REITs). Rising bond yields lessen the appeal of dividend-paying stocks. A second reason is that rising bond yields usually accompany economic strength. That also lessens the appeal of more defensive stock groups, which include consumer staples. At the same time, those two factors increase the appeal of consumer cyclical stocks tied to a stronger economy.
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Chart 3
RISING RATES BOOSTED CONSUMER CYCLICALS ... Chart 4 compares the rising 10-year T-Bond yield since mid-2016 with a relative strength ratio of the Consumer Discretionary SPDR (XLY) divided by the Consumer Staples SPDR (XLP). The ratio line shows that rising bond yields over the past two years have favored economically-sensitive consumer cyclicals over defensive consumer staples. During those two years, cyclicals outperformed the S&P 500 by 13% (while staples lagged by -32%). For the record, consumer cyclicals were the third strongest sector during those two years (behind technology and financials). Staples were the second weakest (behind telecom). And while staples are this year's weakest sector again, consumer cyclicals have just moved ahead of technology as this year's strongest sector. That's another vote for higher bond yields.
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Chart 4
FALLING COMMODITY PRICES HAVE BOOSTED BONDS... Yesterday's message mentioned that falling commodity prices may have helped boost bond prices over the last two months. Historically, they usually trend in opposite directions. The brown daily bars in Chart 5 show the Invesco DB Commodity Index (DBC) peaking in May and having since fallen back to its 200-day moving average. The chart also shows the 20-Year Treasury Bond iShares (TLT) turning up in mid-May as commodities peaked. Falling commodities usually boost bond prices. Rising commodities have the opposite effect. The lower box shows the 9-day RSI line for the commodity index in oversold territory near 30. The fact that it's bouncing from a slightly higher level than its June low creates a short-term "positive divergence". That could support a commodity rebound from its 200-day average. A pullback in the dollar would also support a commodity bounce. Today's lower dollar might explain why commodities are bouncing and bond prices dropping.
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Chart 5
OVERBOUGHT DOLLAR IS PULLING BACK ... The U.S. Dollar Index turned up in April and has risen to the highest level in a year. That's largely due to higher U.S. interest rates. The stronger dollar put downside pressure on commodity prices which usually trend in the opposite direction. Chart 6, however, shows the Invesco US Dollar Index ETF (UUP) slipping today from its recent high. At the same time, its 9-day RSI line (top box) has been weakening. That has created a short-term "negative divergence" which could suggest further dollar weakness. The dollar is dropping today against all major foreign currencies. That may be due to the fact that foreign bond yields are bouncing today along with their currencies. That's helping boost bond yields here in the states. From an intermarket perspective, a pullback in an overbought dollar could help boost oversold commodity prices. Higher commodity prices could weaken bond prices. And that, in turn, would boost bond yields.
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Chart 6
TEN-YEAR BOND YIELD IS BOUNCING ... Global bond yields are bouncing today. Chart 7 shows the 10-Year Treasury yield ($TNX) climbing nearly five basis points to 2.89% which would be the highest yield for the month. Its 9-day RSI line (upper box) has moved above 50 which suggests rising momentum. The TNX remains above a rising support line drawn under its April/May lows. While yields are bouncing today, bond prices are starting to weaken. Chart 8 shows the 7-10 Year T-Bond iShares (IEF) pulling back from overhead resistance along its spring highs and 200-day moving average (red arrow). Its 9-day RSI line (upper box) is falling below 50 which signals falling momentum. That test of overhead resistance is where we started yesterday's discussion on bonds. A lot of things could start changing if the bond rally is ending and bond yields turn back up again. For one thing, that could boost financial stocks and undercut the rallies in bond proxies like utilities and REITS, as well as staples. It could also give a boost to economically-sensitive consumer cyclicals which hit a record high earlier this week. A pullback in the dollar might also help lift oversold emerging markets and U.S. multinational stocks which have been lagging behind small caps over the past few months. A weaker bond market might also drive some fixed income money back into stocks. As I suggested yesterday, a lot is riding on what bond prices do from here.
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Chart 7
