Asset Allocation: Rotate This

DOW + 236 = 18,000
SPX + 25 = 2105
NAS + 62 = 5076
10-YR YLD + .06 = 2.48%
OIL + 1.29 = 61.43
GOLD + 9.20 = 1186.60
SILV + .07 = 16.11

The yield on 10-Year German government bunds broke above 1% overnight yesterday, for the first time since September 2014; part of a broader global bond sell-off that’s been deepening since late April. Last week, ECB President Mario Draghi said investors should get used to periods of higher bond market volatility and stated the central bank wouldn’t do anything about it. US government bonds are selling off – which is sending yields higher as they move inversely to price – as part of the global bond rout that was started back in April. The size of the US corporate-bond market has ballooned by $3.7 trillion during the past decade, further siphoning demand from US Treasuries. And some of that money is just getting out of bonds, which might explain the rotation into stocks currently.

Of course, I have no idea why the stock market moved higher yesterday. I don’t know, you don’t know, and the talking heads on TV don’t know. It is nearly impossible to know what might spur or spook the herd of millions of investors to suddenly move in any given direction at any given time. Is it a new trend or just a bounce on pent-up demand? We don’t know. What we do know is that markets fluctuate, and they also rotate.

And while US equity markets have been trading in a tight range , there’s still plenty of action under the surface. A closer look at the 10 main sectors in the S&P 500 index reveals that investors have continued to move out of one sector into another, rotating in an anticipation of an interest-rate hike this year and subsequent rise in borrowing costs. The process of dumping interest-rate sensitive stocks such as utilities and consumer staples has accelerated over the past few weeks thanks to gyrations in the government bond markets. The utilities sector is already in correction territory, having dropped more than 10% from its late-January peak, and down 4.6% since the start of the month.

Internal rotation isn’t the only problem with the current market. Deterioration in market breadth – markets rising on the back of fewer and fewer stocks – is something a lot of investors are watching. Less than 60% of S&P 500 components are trading above their 200-day moving average. Trading above the average implies an upward trend while trading below it implies that the stock may be losing support and is likely to fall further.

Yesterday, the 10 main sectors in the S&P 500 were all higher. Tuesday, the Dow Industrial Average went negative year to date, bouncing back into positive territory yesterday with all 30 Dow stocks posting gains. Pfizer (NYSE:PFE), Apple (NASDAQ:AAPL), UnitedHealth (NYSE:UNH) and Disney (NYSE:DIS) have posted double digit returns this year. Wal-Mart (NYSE:WMT), Intel (NASDAQ:INTC), and American Express (NYSE:AXP) have posted double digit losses for the year.

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The selloff in bonds has G7 agree to cut carbon emissions a record amount in the next three-and-a-half decades and end fossil fuel use altogether this century. In the past few years, we have already seen an extended flat period in oil demand, due to the financial crisis, that has only recently shown modest gains as prices dipped. The age of oil has now begun to end; that may seem like an exaggeration and it doesn’t mean the age of oil is dead today; it will take time and at the very least it means more volatility, so be aware and beware, because the world is changing in a massive way.

Written By: Marvin Clark