Option Investor
Market Wrap

Banks "Key" as Yields Move Higher

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After a sharp move higher in Treasury yields and some weakness in equities last week, Treasuries and stocks looked to settle in on Monday.

NASDAQ actually looks to be trying to take on a bullish leadership role in recent sessions. Followers of both the NYSE and NASDAQ NH/NL ratios have been more accustomed to seeing the NASDAQ's NH/NL ratio indications reverse lower, then have the NYSE NH/NL ratios follow, but of late, the table has turned.

Broader market breadth as depicted by StockCharts.com's NYSE Summation Ratio ($NYSI) that fell 44.02 today and remains in a column of "O" (decliners outnumbering advancers) to close at a measure of +403.33 today, and gives a "sell signal" at +420 suggests near-term internal damage has been done at big board. Tonight's closing measure violates the March'07 low a/d summation reading of 440 on a 20-point box chart.

Investors and traders are welcome to visit StockCharts.com and view a point and figure chart. I've been updating this chart on a 20-point box chart.

NASDAQ's Summation Ratio ($NASI) remains in a column of "X", but has started to slip with a closing measure of -31.01 at tonight's close. Earlier this month, this indicator of broader breadth at the NASDAQ reversed up from a -100 measure to reach +20 (envision 0.00 as a waterline), but would reverse back lower into a column of "O" and become more defensive once again with a -40 reading.

U.S. Market Watch - 06/11/07 Close

Energy prices rebounded after Friday's sharp sell off that saw July Crude Oil (cl07n) fall 3.24% to settle at $64.75%. Today's rebound in July Crude ($+1.21, or +1.87%) to $65.97 may have been attributed to state-owned Saudi Arabian Oil Co., or Aramco, informing Asian and European consumers of Saudi oil to expect a cut of 9.5% to 10% in supply in July.

Sector action had the Oil Service HOLDRs (AMEX:OIH) $169.90 +1.47% recouping the bulk of Thursday's declines, while the sometimes rate-sensitive Utilities HOLDRs (AMEX:UTH) $141.69 +1.09% may have seen some short-covering with the longest-dated 30-year yield ($TYX.X) holding near the 5.25% level, a level that currently marks the Fed's target on fed fund of 5.25%.

The Utilities HOLDRs (UTH) have fallen 6.85% from their recent all-time closing high of $152.12 on May 21.

Homebuilders as depicted by the Dow Jones Home Construction Index ($DJUSHB) are right back at their April and May option expiration lows of 600, where psychology of higher mortgage rates adds to lackluster commentary from sector CEO's.

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Late this evening, after the market closed, homebuilder Standard Pacific (NYSE:SPF) $19.88 -1.82% said cancellation rates for the first two months of its Q2 were up 28% vs. +35% a year ago. The builder cited continued weakness in Florida and Arizona, but said California bucked the trend, with new orders up 13% compared to a year ago. The company said California's cancellation rate was +29%, but down from the +42% last year.

Bank of America's Daniel Oppenheim said he expects lower new home prices as expectations for cancellations worsen. Mr. Oppenheim thinks buyer will wait things out near-term, looking for another round of incentives/price cuts offered by builders.

One stock that was on the move today, and atop the NYSE's list of most actives was telecom service provider Qwest Communications (NYSE:Q) $9.36 -7.96%. After closing above the $10 for the first time in 5-years, the company's CEO Richard Notebaert said he will leave the Denver-based telecommunications company. Mr. Notebaert did not give a specific timetable for his departure until the company's board selects a replacement.

Mr. Notebaert has been credited with saving the telecom giant from bankruptcy amid a multibillion-dollar accounting scandal that saw shares of Qwest trade as low as $1.07 in 2002.

S&P Depository Receipts (SPY) - Weekly Intervals

There wasn't a lot of action in the S&P 500 Depository Receipts (AMEX:SPY) $151.30 +0.17% today, but last week's trade saw a hefty 779.7 million shares trade hand into this week's quarterly expiration.

Seeing some further deterioration in the NYSE Summation ($NYSI) of late, and a NASDAQ Summation ($NASI) at roughly zero (O), I think bulls holding full positions should scale back to 1/2 position exposure.

A quick glance at Dorsey/Wright and Associates S&P 500 Bullish % (BPSPX), which simply takes the 500 point and figure charts of those components, and stacks them into two piles (one pile contains charts that are on a "buy signal" and one pile those charts containing a "sell signal") shows a net loss of 4.61%, or 23 stocks to reversing lower point and figure sell signals. On June 1 and June 4, this important indicator of supply/demand was at 78.96% and still "bull confirmed," where a reversing lower measure of 72.00% would show some sign of supply outstripping demand with a "bull correction" reading.

While overseas market action certainly seems to be "driving" some weakness here in the U.S. equity and Treasury markets, I want to put some things in perspective, as it relates to Treasury yields, mainly the benchmark 10-year Yield ($TNX.X).

Still, per my Tuesday, 5/29/07 Market Wrap and SPY chart there, the SPY refuses to see a close below its 5/11/07 doji close of 5/11/07.

10-year Treasury Yield - Weekly Intervals

Last week's decision by the European Central Bank to raise rates there to 4.0%, looks to have "accelerated" selling in the benchmark 10-year Treasury Yield ($TNX.X) last week.

While the benchmark bond's yield had been creeping higher, last week's rise was rather sharp, up 25.8 basis points.

I've said before that market participants get "jittery" anytime a currency, or a major bond makes a sharp and sudden move. Last week was no exception.

But is the "jump" in the 10-year ($TNX.X) a sign of doom and gloom?

I don't think so.

As "smart" as I believe bond traders are, and the $TNX.X a reflection of that market, things seem to get out of skew from time to time.

It amazes how quickly even the benchmark 10-year YIELD can move when it hits some point of "pain" for the wrong side of the trade, where a sudden group think sends YIELDS higher, or lower in quick fashion.

From here, or current yield, traders and investors of bonds and equities will likely see shifts in their psychology. Should yield continue to rise toward 5.25%, which just so happens to be the Fed's current target on fed funds, I would think equity traders might play things a bit more "defensive," looking to see if another rapid move higher is in the making.

The "big picture," which the WEEKLY interval chart allows, we can see the last time the Fed raised rates was back on 6/29/06. From there, the 10-year bond found strong buying, driving yield lower (for bonds, as prices RISE, yields DECLINE).

One could say the bond market is probably getting back closer to where it "should be," given Fed commentary, and the current fed funds rate.

Remember! When Treasury yields were FALLING, well below the current fed funds target, some were certain it was a signal from the bond market that the economy was slowing and had entered recession.

And yes, this is where the banks, once again, become "key."

It has been my long-held belief that the banks can be one of the best reads on the bond market and broader economy.

Banks can RISE in price, even as Treasury YIELDS rise.

Actually, since last summer, as Treasury YIELDs fell, a bank that lends money to consumers (business and individuals) like you and I, have probably seen their "gross margins" squeezed a bit.

Many loans' interest rates are derived from Treasury bond yields, and as YIELDS fell, despite a fed funds rate of 5.25%, that "spread" narrowed.

The other "variable," which makes the banking sector a pretty good read on the economy is this.

HOW MUCH LOAN activity is there, even as a bank's margins improve? For the banks, it is a POSITIVE that they are now getting back some "margin" from higher YIELD in the bond market, but what, if any NEGATIVE impact will it have on the number of LOANS generated.

I can sell one Mercedes Benz for $100,000, mark it up from my cost of $30,000 from the manufacturer, but if I only sell one at that HEFTY margin, can I really make any money and keep my dealership open? Selling 20,000 Mercedes with a $10,000 markup margin would be more profitable.

S&P Banks Index (BIX.X) - Weekly Intervals

The 10-week, or 50-day SMA (blue), the 30-week, or 150-day SMA (brown) and 40-week, or 200-day SMA (red) all converge at, or around the 400 level. You can feel the pressure building here.

In October'05 as the 10-year Yield ($TNX.X) rose from 43.00, or 4.3%, the BIX.X was under selling pressure, and it Fed critics were roaring that the Fed would have to raise rates rapidly, mirroring the move in the 10-year at that time.

The BIX.X reverses course from those October'05 lows and surged from 335 to 370, an incredible 10.5% in just six weeks as the 10-year yield ($TNX.X) rose from 4.3% to as high as 4.682% during the same time period.

The BIX.X will likely be a "key" sector to monitor during the next couple of weeks.

Fundamentals that are bullish for banks is that loan demand stay steady, as they get some "margin relief" from rising Treasury yields, which many loan interest rates are eventually derived.

The bearish fundamentals, that haven't played out as witnessed by the technicals, is that the RISE in Treasury bonds, would be too great that LOAN DEMAND suffers significantly enough, that no matter how great the "margin relief," the loan demand works against that relief.

Key levels look to be 390 support and 405 resistance. A break of that range will likely see the major indexes follow.
 

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