05/13/15   Ignore the Fear Mongers

Editor’s Corner

Ron Rowland

Many market watchers seem to be convinced the bond market will tank the day the Fed initiates “liftoff,” which is its own terminology for when it begins raising interest rates.  Six months ago, my email inbox was littered with warnings about an impending bond market disaster in April.  When the consensus shifted from April to June for when the Fed would begin raising interest rates, those dire forecasts moved to June too.  Now, with a June option nearly off the table for the Fed, the fear mongers will be forced to shift gears again.

Meanwhile, US Treasury bonds have been in a decline since the end of January.  Forget about trying to guess the day the Fed raises interest rates – the market is already sending rates higher in anticipation of that day.  I’m not saying there won’t be additional market gyrations upon liftoff, but the market often moves prior to widely anticipated events.

The 10-year Treasury yield stood at 1.68% as January came to a close.  Today, the yield is north of 2.28%.  A rise of 0.6% might not seem like much, and it’s not if you are talking about yields moving from 8.1% to 8.7%.  However, when you are starting at 1.68%, it represents a 35.7% change in less than three-and-a-half months.

When bond yields rise, bond prices fall.  The iShares 7-10 Year Treasury Bond ETF (IEF) has lost more than 3.7% of its value in that time.  Again, that might not seem like much, but it represents more than two years of dividends at its current yield of 1.8%.  Bond funds offering higher yields have been hit even harder.  The Vanguard Extended Duration Treasury (EDV) has plunged more than 19% since January, which is the equivalent of more than six years of dividends from its current 3.0% yield.  Just think, a 19% drop in value, and the Fed hasn’t raised interest rates at all yet.

There is no need to wait around to see whether or not the forecasters are correct about when the Fed will raise interest rates and what the bond market’s reaction will be.  The bond market is sending a signal now.  It doesn’t appear to care about the forecasters’ predictions.

Investor Heat Map: 5/13/15

Sectors

A few sectors are undergoing a rapid rotation, while others remain in their prior trends.  The rise of Materials was noted in last week’s update, and today it sits at the pinnacle.  However, its future is unclear.  It could have a long reign at the top, similar to that of Health Care for most of this year.  Or, it could be a one-week wonder by following the path of Energy.  Energy completed a five-week climb from last place to first a week ago, but it fell all the way back to sixth place today.  Meanwhile, in another example of rapid change, Health Care rebounded from sixth to second this week.  Telecom was at the top two weeks ago and is now just two steps off of the bottom with negative momentum.  One example of a sector in a steadier trend is Consumer Discretionary, which finds itself in third again this week.  Unfortunately, most of the other steady-trend examples are found in the lower portion of the rankings.  Real Estate and Utilities are on the bottom, sporting double-digit negative momentum readings.  Consumer Staples has also been relatively steady, but its trend is a sideways one.

Styles

Last week, the style rankings were experiencing rapid rotation much like the sector rankings.  However, this week’s snapshot looks very similar to a week ago and requires a keen eye to spot the subtle differences.  The top-six categories are in the same identical order they were last week.  Suggesting a defensive posture, Mega-Cap is providing the leadership, and all three Large-Cap categories are tucked inside the top five.  Likewise, Micro-Cap and the three Small-Cap categories are among the bottom five.  As for changes this week, Small-Cap Growth moved ahead of Mid-Cap Value, and Small-Cap Blend climbed above Micro-Cap.  Additionally, three of the four segments that were in the red last week edged over the line to green, leaving Small-Cap Value as the only one with negative momentum.

Global

Chinese stock prices have stabilized the past week after the sharp rise in early April and the pullback during the first week of May.  Momentum is still strong for the global leader, although down from the triple-digit readings of a month ago.  UK stocks and the British Pound both jumped higher following last week’s election victory by Prime Minister David Cameron.  On a relative strength basis, the UK was on the bottom of our global rankings five weeks ago and surged from eighth to second over the past week.  Japan and Latin America held steady, EAFE climbed a notch, and Emerging Markets slipped four places lower.  Our Europe benchmark focuses on Euroland and excludes the UK, but it still managed to climb three spots higher.  Canada fell from fifth to ninth as a result of its large Energy sector exposure.  The US pulled out of last place after spending two weeks in the dubious position, and the US Dollar now appears to be in an intermediate downtrend after months of making headline news about its strength.  Pacific ex-Japan often exhibits strong positive correlation to the Materials sector.  However, this is not one of those times, with Materials sitting at the top of the sector rankings and Pacific ex-Japan falling four spots to the bottom of the global rankings.

Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

 


“The Fed is closing in on the exit, it’s been heavily projected, and now it’s entering the horizon of short-term traders.”

Mike Englund, chief economist at Action Economics


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