From the desk of Steve Strazza @Sstrazza and Ian Culley @Ianculley
I was talking to the team earlier this week and mentioned that I was having a hard time writing. Grant and Ian were quick to remind me that it's probably because "nothing new is happening!"
They were right. Until now...
We finally got a major resolution in what we consider one of the most important charts in the world these days.
I'm talking about the US 10-year yield reclaiming that critical 1.40% level this week. And this begs the question as to what a rising rate environment might mean for investor portfolios.
Well, one thing we know for sure is we want to stay away from bonds... unless we're shorting them.
But how do we want to position ourselves in the stock market if yields are breaking out?
It's simple really. Some stocks do better with rising/higher rates, while others thrive in markets characterized by low growth and low yields. If this is the beginning of a fresh move higher for yields, then we want to be focused on buying the stocks that are likely to benefit the most.
It all goes back to the global growth, reflation, and reopening trade these days. It's cyclical and value stocks. Those are the groups that should outperform.
Meanwhile, growth and tech stocks--and any long-duration assets, for that matter--could come under pressure, as they become relatively less attractive during periods where more economically sensitive areas are offering more appealing growth prospects.
I discussed many of the charts in this post with Patrick from The Chart Report in our weekly video yesterday. Check it out.
We're going to dive into this theme below, but first, let's start by revealing last week's Mystery Chart.
The responses were pretty mixed. But doing nothing was the best position, in our opinion, as the chart is simply basing beneath an area of potential resistance. This is the Proshares Equities For Rising Rates ETF $EQRR: And... it's still basing beneath those former highs. Seeing this chart move higher and break out of this multi-year base would provide strong confirmation for the recent price action from yields.
At the same time, even if it does break out, this is a very illiquid fund, so it's NOT what we want to use to express a thesis on rising rates via the stock market.
But, no worries, there are other ways!
When we looked under the hood of this ETF, we learned that over 50% of its holdings are from the Financial and Energy sectors. And it shows when you contrast EQRR with this equal weight custom index of the Energy and Financial sector ETFs, $RYE and $RYF: The two look identical.
So, if you're looking to bet on higher rates, Energy and Financials are excellent places to start.
To illustrate how strong a relationship these stocks have with yields, take a look at this overlay chart of the US 10-year with EQRR relative to the S&P 500: Once again, they look almost identical.
What this is showing us is that, when rates are moving higher, these stocks are typically outperforming. Alternatively, when the 10-year is falling, these stocks generally are lagging the broader market.
Something worth noting about this relationship is that, while sometimes EQRR/SPY has given a leading or coincident signal for rates, the ratio had lagged the action in yields last year. And that's exactly what we're seeing once again.
We often like to look at the 5-year yield to confirm what we're seeing from the 10-year. As you can see below, it sure looks as though they're both ready to make a move higher: The 5-year is breaking out of a year-to-date base to its highest level since February of last year.
Meanwhile, the 10-year is resolving higher from a tight coil and ripping back above our risk level at 1.40%. Like the 5-year, it's also trading at its highest level since last February.
Here's a zoomed-out view to better illustrate just why this zone is so important. Unlike the above charts, this one includes today's data as well. Look at all the price memory at those 2012, 2016, and 2019 lows around 1.40%. And check out the strong follow-through today, as the 10-year is currently trading above 1.45% intraday as I write this.
Financials are showing improving momentum and appear to be hooking up and to the right toward the leading quadrant as well. The same can be said for Industrials and Transports.
Meanwhile, growth sectors like Tech and Communications are headed lower and left toward the lagging quadrant. That tells us these groups are likely to underperform for the foreseeable future. The same can be said for Utilities and other defensive or "bond-proxy" sectors like Real Estate and Staples.
One last thing to note is the recent relative strength from High Beta. That's another group, along with value stocks in general, that we'd expect to do well with rates moving higher. Read more about this and what it might mean for the broader market in JC's post from this morning.
While you could argue that yields are only one data point, it's a very pivotal one. For this reason, it deserves some extra weight. Rising rates could have some very positive implications for risk assets, so we can't stress just how bullish of a development this decisive breakout in the 10-year is.
So, what are some of these implications?
Maybe these upside resolutions in yields are what the market needs to kick start a fresh leg higher. What we're watching for now is whether or not we finally start seeing similar resolutions in some of the key stock charts we're watching, such as Small-Caps, Financials, diversified international indexes, even Crude Oil.
We're also watching our ratio charts for signs that risk appetite may be picking back up.
As for how we want to position ourselves to capitalize on a potential rising rate environment, it's Energy, Financials, and all the other cyclical sectors. Value, High Beta, and international stocks should also be beneficiaries.
We'll have plenty more on these areas in the coming weeks if this move in rates is the real deal.
On that note, be sure to check out this week's Bond Report below.
With fixed income markets finally seeing some action, it's full of some great charts right now.
