DEFENSIVE SECTORS LEAD THIS WEEK -- FLATTER YIELD CURVE MAY BE HURTING BANKS -- YIELD CURVE NEARS INVERSION
STOCKS HAVE WORST QUARTER IN TWO YEARS...The month of March has seen a rebound in stocks. Even with that rebound, however, the first quarter of this year has been the weakest in two years. Which raises the bigger question of whether or not the recent rebound is the start of another upleg in the market, or part of a major topping process. All things considered, I lean toward the more negative view. Which suggests that stocks could be forming a major top. Energy stocks have been the strongest part of the market so far this year. Other leaders include utilities, financials, consumer staples, and materials. Communications, consumer discretionary, and technology have been the biggest losers.
DEFENSIVE SECTORS LEAD... Chart 1 shows sector performance over the last week which may be telling us something about the strength of the current rally as we end the first quarter. What's most concerning is that the top four sectors are defensive in nature. They include real estate, utilities, consumer staples, and health care. Their leadership suggests more caution over the shorter run. While financials, materials, energy, and industrials have slipped in the weekly ranking. A pullback in the price of crude oil has slowed the advance in energy shares which has been a positive for stocks in general. By contrast, financials were the weakest sector this week, with banks leading them lower. That may be the result of a flattening yield curve which is also raising larger concerns about the health of the economy and stock market.
BANK STOCKS WEAKEN ON FLATTER YIELD CURVE... Chart 2 shows the S&P Bank SPDR (KBE) having a weak quarter and falling below its 200-day moving average. Banks were the weakest part of the weakest sector over the past week. That may be due to a flattening yield curve. The green line plots the spread between 10-Year and 2-Year Treasury yield and has fallen to the lowest level in two years. While rising bond yields are normally good for banks, rising short-term yields can hurt their earnings. During the first quarter, short-term yields have risen faster than longer-term yields which has caused the spread between them to flatten. That explains why the version of the yield curve shown in Chart 2 has been falling. While that's a negative factor for bank stocks, the flattening yield curve is also raising broader concerns about the state of the economy. That's because that version of the yield is close to inverting.
YIELD CURVE NEARS INVERSION... The green line in Chart 3 shows how far the spread between the 10 year and 2 year Treasury yield has fallen this year. The spread between the longer and shorter yield has fallen to the lowest level since 2019 which was the last time this version of the yield curve inverted (see green circle). That takes place when the green line dips below the zero line into negative territory (see flat green line). That means that the shorter yield has risen above the longer yield. The main reason for the falling yield curve is the steep jump in the 2-year yield (red line) on expectations that the Fed is embarking on a more hawkish policy of raising short-term rates to combat rising inflation. Long term yields have also risen but at a slower pace than shorter yields. An inverted yield curve would be a warning of a possible recession. That would a warning for stocks which usually peak months before the start of an economic recession.
