Weekly Wrap: With This Market, The Devil Is In The Details

This week the yield of the 10-year Treasury reached over 3.12%, a level not seen since 2011 and the 2-year rose over 2.5%, to levels last seen in 2008. The spread between the 2-year (2.573%) and the 30-year Treasury yield (3.246%) remains near multi-year lows. With the market pricing in a more than 50% likelihood of three additional 25 basis point rate hikes by the end of the year, up from 33% just a month ago, the potential for an inverted yield curve in 2018 is a material possibility. Looking at the charts for the 10-year, the next potential upside targets are around 3.75% and 4.0%, the peaks formed from 2011 to 2010.

The rising yields are a headwind to rate sensitive sectors such as real estate and utilities, causing the iShares US Real Estate ETF (IYR) to fall -3.5% over the prior five trading days as of Thursday close and the Dow Jones All Equity All REIT Index (REI) lost 3.0%. The Utilities Select Sector SPDR ETF (XLU) was the second worst performer, down -2.6%. While the rate sensitive shares were punished, growth stocks were back in fashion as the iShares Nasdaq Biotechnology ETF (IBB) gained 3.7% for the week, followed by the Energy Select Sector SPDR (XLE), up 2.8%.

Rising rates have seen the dollar continue to strengthen with the Amex Dollar Index (DXY) up 5.7%, (as of mid-day Friday) since its mid-February lows. This has helped small cap stocks, whose revenue is primarily domestic, outperform the large cap S&P 500, that generates roughly 60% of revenue internationally, by 5.56% since the DXY bottomed out. In fact, the S&P 500 SmallCap iShares ETF (IJR) has been the only major index ETF to record a 52-week high in May and has the strongest breadth indicators. Over the prior 5 trading days as of Thursday’s close, the Russell 2000 has continued to outperform, gaining 0.6% while the S&P 500 lost 0.1%, and the Nasdaq lost 0.3%.

Despite the lack of material progress over the last week, the S&P 500 has been able to move into the top of its downtrend channel and is within striking distance of its first “lower high” at 2,787 it reached after the correction began on January 26th, (a lower high refers to an interim peak within a downward slide). Breadth levels are improving with five cyclical sectors outperforming the overall S&P 500. That being said, according to the 10-day Advance/Decline line, the S&P 500 is slightly in overbought territory, which means more sideways moves are likely in store for a bit before any meaningful gains.

The Economy: Distilling the Mixed Signals Its Giving Us

While the stock market looks like it still has legs, the economy continues to give mixed signals, some improving and some degrading. Our view is that the longer-term indicators are flashing warnings signs, but we don’t see, barring any kind of geopolitical lunacy, material threats within the next quarter or two.

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Moon Kil Woong 2 years ago Contributor's comment

We will see if Amazon can stay above the fray as other companies are trying to go their direction. Amazon has one thing they don't, a lucrative data warehousing business.