From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
Benchmark yields have moved in a vertical line higher since the beginning of March. This isn't just the case in the US; we're seeing similar action all across the globe.
But as rates rally higher and higher, more and more classic intermarket relationships are failing to confirm the move.
Yes, commodities and commodity-related stocks remain resilient, and bonds are an absolute dumpster fire.
Most other assets we would expect to do well in a rising rate environment simply aren’t. This is especially true for the banks!
Meanwhile, those groups that we'd expect to underperform in this kind of environment, such as utilities and other defensive stocks, are actually outperforming.
All of this speaks to risk-aversion, not risk-seeking behavior.
Let’s take a look at some of our favorite intermarket ratios and put these bearish divergences into perspective.
First up is an overlay chart of the US 10-year yield $TNX with the copper/gold ratio and Regional Banks $KRE relative to REITs $IYR:
Throughout history, both ratios have moved in the same direction as yields over the long run.
With interest rates on the rise, KRE should outperform IYR. Instead, the KRE/IYR ratio is catching lower and undercutting its pivot lows from last December.
To make matters worse, banks are also breaking down from a short-term top on absolute terms. This is not supportive of the new highs in the US 10-year.
The same can be said for Dr. Copper…
We would expect copper futures and the copper/gold ratio to rise along with rates. But this hasn't been the case. As rates have steadily climbed higher, the ratio has been a sideways mess for over a year now.
The lack of upside participation from copper and regional banks -- both key economic barometers -- raises questions about the overall health of the market and the validity of the recent surge in yields.
This chart of banks underperforming utilities paints a similar picture:
This is another piece of evidence that tells us to be weary of the ramp-up in rates.
The overwhelmingly positive correlation in the lower pane tells the story. When the 10-year yield is on the rise, banks have a strong propensity to outperform utilities. When rates are falling, banks tend to underperform utilities.
Today, that strong positive correlation is breaking down as banks lag their defensive counterparts even while rates continue to rise.
Not only are banks showing relative weakness, but they can’t catch a bid on an absolute basis. Here’s a chart of all the banking ETFs -- $KBE, KRE, and $QABA -- resolving lower from short-term tops:
These divergences question the recent rise in rates as well as the general risk appetite of markets.
Underperformance from banks and copper and outperformance from safety sectors and gold is the kind of price action we see in bear markets, not bull markets.
If we’re going to see a fresh leg higher in stocks, it's likely happening in an environment where risk assets are outperforming their alternatives. For now, we're seeing a lot of the opposite.
In the meantime, we can keep buying the stocks going up, selling the ones that are going down, and staying away from the ones going nowhere.
On balance, the market remains a mess.
Thanks for reading.
Countdown to FOMC
Following the Federal Reserve's recent rate hike, the market is pricing in a 50-basis-point hike at the May meeting.
Here are the target rate probabilities based on fed funds futures:
This data is from the CME FedWatch Tool as of April 6, 2022.
Let us know what you think. And be sure to download this week’s Bond Report!
