LOWER YIELDS PUSH REITS AND UTILITIES TO RECORDS -- BANK SPDR MEETS SELLING AT 50-DAY LINE -- S&P 500 STILL LOOKS OVEREXTENDED -- WITH A SHORT-TERM NEGATIVE DIVERGENCE
10-YEAR TREASURY YIELD CONTINUES TO WEAKEN... Treasury yields are down again today, and are losing some of the gains made over the last two weeks. The daily bars in Chart 1 show the 10-Year Treasury Yield losing 3 basis points today to 1.58%. The pennant-like shape of its sideways pattern since the end of January doesn't look much like a bottom being formed; in fact, it looks more like lower yields may lie ahead. That means that investors are still buying safe haven Treasury bonds. That may be due to renewed coronavirus concerns going into a long weekend with markets closed on Monday. They're also favoring defensive bond proxies like consumer staples, utilities, and REITS which are ending the week in record territory. Falling yields increase the appeal of dividend-paying stocks. But that can be bad for bank stocks which are running into some selling. The fact that investors are buying Treasury bonds, along with defensive market sectors, suggests that investors are still hedging their bets against any sudden surprises.
REITS END THE WEEK IN RECORD TERRITORY... Defensive dividend-paying stock groups have been the stock market's strongest sectors all week. Both an on absolute and relative basis. Chary 2 shows the Real Estate Sector SPDR (XLRE) surging to record highs this week. It's today's strongest sector SPDR. The solid line in the upper box shows the XLRE/SPX relative strength ratio also rising to the highest level in three months. Notice that its rise concided with a downturn in the 10-Year Treasury yield (green bars). That's because lower bond yields usually favor dividend-paying stocks which compete with Treasuries for higher yields. The same is true with utilities.
UTILITIES ALSO HIT NEW RECORD... Chart 3 shows the Utilities SPDR (XLU) also surging this week to a new record. Its relative strength ratio in the upper box has also jumped since the start of the year. In this case, the green line represents the 7-10 Year Treasury Bond iShares (IEF) which have been rising as well. As bond yields have dropped, bond prices have risen. Reits and utilities usually rise with them. That's why they're also called bond proxies because they usually trend in the same direction of bond prices. Consumer staples, which pay dividends, also benefit from their close ties to bond prices and are hitting new highs as well. Bank stocks, however, are struggling.
FALLING BOND YIELDS HURT BANK PERFORMANCE...Bank stocks usually do worse when bond yields are dropping. And that's just what they've done. The daily bars in Chart 4 show the S&P 500 Bank SPDR (KBE) peaking in mid-December and losing ground since the start of the year. In addition, its rally attempt this month has fallen well short of its December high; and is meeting resistance at its 50-day moving average (blue arrow).
Its relative strength ratio in the upper box shows how badly it's underperformed the S&P 500 this year. That's due mainly to the simultaneous drop in the 10 Year Treasury yield (green line) over the same time span. That's because lower bond yields reduce the net interest margin for banks by reducing what they can charge for longer-term loans versus what they have to pay depositors. Since the start of the year, financials have been the market's third weakest sector (behind energy and materials). While banks have been the second weakest group in that rate-sensitive sector.
S&P 500 STILL LOOKS OVER-EXTENDED...My message from two weeks ago (February 1) argued that the stock market looked over-extended on the upside which left it vulnerable to some profit-taking resulting from the coronavisus. So far, stocks have been very resilient to that threat; especially with the three major U.S. stock indexes hitting new records this week. But those concerns about an over-extended market still remain.
Chart 5 is an updated version of the chart used in that earlier message which plots the S&P 500 Percent of Stocks Above 200-Day Moving Averages. The red horizontal trendline shows potential overhead resistance along that indicator's highs formed between 2016 and 2018. In addition, values above 80% usually signal an over-extended market. So far, the pullback from that resistance line has been relatively mild. But the line is still there. Let's take a closer look.
POSSIBLE SHORT-TERM DIVERGENCE... Chart 6 compares the same indicator to the S&P 500 over the last six months. And they've generally risen together. The black daily bars show the S&P 500 rising to a new record this past week (along with the Dow and Nasdaq). The red line, however, has fallen well short of its mid-January peak. That suggests that this month's stock rebound might not be as broad as advertised (with fewer SPX stocks above their 200-day average). That possible negative short-term divergence may act as restraining influence on short-term market gains. And may explain why investors are entering the long weekend with more defensive positioning. That includes some bond buying; rotating into more defensive corners of the stock market; and prospecting for some gold.
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