Out-of-Sync Markets May Be Sending a Message
A rising stock market, rising Treasury yields and a firming dollar seems like an abnormal trading relationship post-financial crisis, but the recent correlation between these markets may be signaling more confidence in the U.S. and more 'normal' times ahead.
The question is whether this trend will last, while for so many years the markets moved in lock step – either "risk on" or "risk off." When the markets were risk on, the dollar weakened and riskier assets rose, such as commodities and stocks. The dollar would strengthen in "risk off" times, when fear gripped markets, and Treasury yields would go lower as investors rushed into bonds. But now it is the yen wilting, and commodities are going lower, not higher, as U.S. stocks soar to record highs.
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"The funding currency is the currency most apt to go down as equities go up," said Alan Ruskin, head of G-10 currency strategy at Deutsche Bank. "People are reluctant to use the dollar just because its fundamentals are better than a lot of other currencies. All of this relationship is about fundamentals."
The Dow and S&P 500 closed at new highs Tuesday. The S&P was up 16 at 1650, and the Dow was up 123 points at 15,215. At the same time, bond yields ripped higher, with the 10-year reaching 1.98 percent in late trading. The yen continued to weaken with dollar/yen trading at 102.28. The euro also weakened slightly against the dollar. Gold and metals moved lower, and West Texas intermediate crude was down about a percent.
Weakening commodities prices are being affected by the rising dollar, but also concerns about weakness in China and other markets. "It's fascinating that three markets (bonds, stocks and commodities) are completely in disagreement about the fundamental, economic and policy backdrop," said Jeffrey Kleintop, chief investment strategist at LPL Financial.
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U.S. economic data has been spotty as the economy weakened this spring, but some important data, like jobless claims, have been surprising positively. Kleintop watches the Citigroup economic surprise index, which moves higher when economic data begins to surprise on the upside, and stocks generally move higher with it.
"I think we've finally gotten economists' expectations low enough that we're in the bottoming process for that index," he said. Kleintop, who had been expecting a market correction, said some sectors have been correcting, and in the past several weeks, the previously lagging cyclical sectors have been pulling ahead.
"We could get another month or two or maybe three of the cyclicals leading this market. They're not tired yet," Kleintop said. "We could see this market higher if we get new leadership from cyclical stocks."
Kleintop said the normal behavior of the dollar has been to rise when investors looked for safe havens, but that's not the case now. "The fact the dollar goes up at the same time as stocks, that's a good sign. It may mean buyers are coming in from overseas to buy stocks. The individual investor doesn't appear to be buying this market," he said, adding companies are no longer buying back as much of their own stock since stock prices have risen.
"Corporate insiders appear to be selling at a record-breaking pace. who's buying the market? well we're seeing foreigners coming into the market." He said the market could still see a pullback, and this new correlation between markets could be temporary.
Yields have been rising since the April jobs report came in better than expected on May 3. They have moved another leg up since rumors circulated Thursday about a possible Wall Street Journal story about the Fed tapering back its $85 billion quantitative easing program. A story finally appeared that did say the Fed was considering its exit strategies, but it was the rumor that stoked yields.
Low yields had been driving investors to equities, but Ruskin said he found in a study back to 1973 that there were many times when the stock market was able to rise with the dollar. "I hesitate to use the word 'normal' because the correlations can shift around. The view of normality can shift around, but this would not be seen as particularly unusual behavior," Ruskin said.
"We're now in an environment where the market can smell the end of QE coming up, or at least a tapering," Ruskin said. "They can see a market where bond yields are higher." Ruskin said the markets would react more if they thought it were the end of zero interest rates.
What to Watch
Producer prices and the Empire State survey are released at 8:30 a.m., while industrial production and capacity utilization are released at 9:15 a.m. ET. The National Association of Home Builders survey is released at 10 a.m.