SHARP REBOUND IN BOND YIELDS CONTRIBUTES TO ROTATION INTO VALUE STOCKS -- WITH SMALL CAP VALUE ISHARES IN THE LEAD -- STRONGER FINANCIALS AND INDUSTRIALS ARE MAIN REASONS WHY
TEN-YEAR TREASURY YIELD BOUNCES OFF MAJOR CHART SUPPORT... My Wednesday message showed the 10-Year Treasury yield bouncing off major chart support at its 2012 and 2016 lows and in a very oversold condition. That made a rebound in bond yields more likely. The weekly bars in Chart 1 show the 10-Year Treasury yield ($TNX) bouncing sharply off its 2016 low to gain 35 basis points on the week. That its biggest gain in six years. The upper box shows the 14-week RSI line also rebounding from oversold territory below 30. So this week's rebound wasn't that much of a surprise. But it had a number of ripple effects throughout the bond and stock markets. For one thing, profit-taking in an overbought bond market caused some money to rotate back into stocks. But not just any stocks. Money moved into smaller value stocks, transports, and financials; and especially banks.
A strong rebound in bank stocks helped make financials the week's strongest sector. While bond proxies like real estate, utilities, and staples were the weakest. Economically sensitive industrials also had a strong week, as did transportation and small cap stocks. There's some linkage there as well. A big jump in transportation stocks helped push the Industrial SPDR (XLI) to a record high. While small cap value stocks were the week's biggest gainers. Financials are the biggest part of small cap value (30%); with industrials the second biggest (12.7%). A rotation into larger value stocks was also led by financials; while profit-taking in technology contributed to weaker growth stocks. Most of which can be attributed to the week's strong rebound in bond yields and more optimism on the U.S. economy. Energy and materials were also weekly sector leaders. Materials were led higher by economically-sensitive industrial metal stocks. That also showed more optimism on the global economy.
WEEKLY SECTOR ROTATIONS...Chart 2 shows the change in sector leadership accompanying the jump in bond yields this week. The biggest rotation was into financials; while dividend-paying bond proxies like real estate, staples, and utilities slipped to the bottom of the list. So did technology which suffered from the rotation out of growth and into value stocks like financialsand industrials. Industrials rose to fourth place with a lot of help from rising transportation stocks. More optimism on commodities helped put energy and materials near the top of the list (although oil lost ground). Aluminum and copper producers rose while gold miners fell (more on that shortly). Soybean prices jumped along with agricultural commodities after China waived tariffs on U.S farm products. Renewed trade optimism and higher commodity prices may have also boosted bond yields.
WEEKLY SHIFT TO VALUE...Chart 3 shows the broader rotation that took place over the last week into cheaper value stocks. The week's strongest group was the Russell 2000 Small Cap Value iShares (IWN). The Dow Transports came in second. Russell 2000 Growth iShares (IWO) came in third. So even though small caps led the week's advance, the biggest gains came in small cap value stocks (led by banks and other financials). The Russell 1000 Value iShares (IWD) also outperformed while the Russell 1000 Growth iShares (IWF) lost ground. That also showed a preference for large value stocks (caused mainly by stronger financials and weaker technology stocks). The rate-sensitive Dow Utilities also lost ground (while transports surged).
Chart 4 shows the Russell 2000 Small Cap Value iShares (IWN) jumping to the highest level in four months; and clearing a falling trendline drawn over its May/July highs. The upper box shows the IWN/SPX ratio also breaking a six-month period of IWN underperformance versus the S&P 500. Chart 5 shows the Dow Transports also rising above a five-month falling trendline and testing their July high. The upper box shows the transports ending four months of underperforming the Dow Industrials. Both charts reflect more optimism on the U.S. economy. Which is consistent with higher bond yields and a stronger stock market.
COPPER/GOLD RATIO STARTING TO RECOVER...Here's one more intermarket relationship that may be reversing for the better.Chart 6 plots a relative strength ratio of the price of copper divided by gold. While safe haven gold has risen to a six-year high, economically-sensitive copper has fallen to a two-year low. That reflected concerns about a weaker global economy. This week, however, the price of copper gained +2.5%, while gold lost -1%. That caused the ratio to bounce. And it's coming at a good time.
The weekly bars in Chart 6 show the copper/gold ratio bouncing near chart support above its 2016 low. In addition, it 14-week RSI line (lower box) has moved out of deeply oversold territory below 30. Both suggest that the relationship between the two metals has fallen too far and is due for some recovery. That would suggest more buying of the industrial metal copper (which is viewed as a barometer of global growth); and some profit-taking in gold (which has benefited from falling bond yields). I've overlaid the 10-Year Treasury yield (green area) over the copper/gold ratio for comparison purposes. And it shows a strong correlation between the two. Falling bond yields for most of this year favored safe haven gold over economically-sensitive copper. Rising bond yields could reverse that relationship. That also explains why copper shares had a strong week while gold miners sold off.
