PLUNGE IN GLOBAL BOND YIELDS AND INVERTED YIELD CURVE PUSHES BOND PRICES HIGHER AND STOCKS LOWER -- FALLING BOND YIELDS REWARD UTILITIES WHILE HURTING BANKS -- WEAKNESS IN SMALL CAPS AND TRANSPORTS MAY BE WARNING OF MORE PROFIT-TAKING TO COME
PLUNGE IN BOND YIELDS CAUSES YIELD CURVE TO INVERT ... Weak economic numbers from the eurozone and the U.S. on Friday pushed bond yields here and in Europe sharply lower and caused heavy profit-taking in global stocks. The 10-Year German bond yield fell into negative territory (below zero) for the first time since 2016, while the 10-Year Treasury yield fell to the lowest level since January 2018. That caused the 10-year Treasury yield to fall below the three-month T-bill rate for the first time since August 2007. Chart 1 shows the spread between the 10-Year and 3-month yields falling below zero (red circle), which means that the 3-month yield is now higher than the 10-year yield. That inverted yield curve has preceded every U.S. recession since 1975. Falling bond yields had been viewed as a positive sign of more dovish central bankers which could prolong the economic expansion. This week's plunge in bond yields, however, may be sending a warning that global growth is slowing faster than expected.
Chart 1
PLUNGING BOND YIELDS PUNISH BANKS AND FINANCIALS ... In addition to causing a sudden preference for bonds over stocks, this week's bond yield plunge had a notable effect on a couple of stock sectors. Rising bond prices made utilities the week's strongest sector, and pushed the Dow Utilities to a record high. The drop in bond yields, however, was especially punishing for financial stocks, and banks in particular. Chart 2 shows the Financial Sector SPDR (XLF) ending the week below its 50- and 200-day moving averages after losing -4.8% during week. Banks fell almost twice as hard. Chart 3 shows the KBW Bank Index falling to a two-month low after failing a test of its 200-day average (red line). The bank index also ended the week below its 50-day average (blue line) after losing -8.2% during week. Falling bond yields are bad for banks because they narrow the net profit margin between short and long term rates. A couple of other stock groups are showing signs of weakness. That includes small stocks and transports.
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Chart 2
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Chart 3
SMALL CAPS AND TRANSPORTS FALL TESTS OF THEIR 200-DAY LINES... Recent selling in small cap stocks and the transports are also warning that the first quarter stock market rally may be weakening. Chart 4 shows the Russell 2000 Small Cap Index ending the week below its 50-day average after two failed attempts to clear its 200-day average. Since small stocks usually signal changes in the direction of bigger stocks, this week's downturn in the RUT may be a warning signal for both. The same is true with the transports. Chart 5 shows the Dow Transports also ending the week below both moving average lines after failing a test of their red line. Transportation stocks are viewed as one of the bellwethers for the U.S. economy and usually trade in tandem with the Dow Industrials. This week's downturn in the transports may be a warning sign for both. It's especially troubling to see money flowing out of economically-sensitive transportation stocks and into defensive bond proxies like utilities which hit a record high this week. And with U.S. stocks having rallied so far so fast during the first quarter, some profit-taking shouldn't be too surprising. The debate about whether this year's stock gains are the start of a new upleg, or part of a major topping process, continues. So far this year, the bulls have had their say. This past week's developments suggest that the bears may now get their turn.
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Chart 4
