Short and Long Term Yields Diverge, Junk Bonds Break Out, Water Holds Strong, MJ Tries to Bottom, Emerging Markets ETF Goes for Breakout (Premium)

Today’s commentary starts with Treasury yields by highlighting the divergence between short-term and long-term yields. We then look at the yield curve and its correlation with the Regional Bank ETF. Even though KRE has underperformed the last three months, it became quite oversold last week and got a bounce. We then turn to the breakout in the Junk Bond ETF and highlight the strong positive correlation to small-caps. The commentary ends with some setups in the Russell Microcap ETF, the Water Resources ETF, the Alternative Harvest ETF and four Asian ETFs.  

5yr and 10yr Yields Diverge

There is a battle raging for the heart and soul of the bond market. Short-term yields are rising and long-term yields are falling. As a result, the difference between the two is narrowing and the yield curve is flattening. The first chart shows the 5-yr yield surging from late February to early April, consolidating into June and breaking out of this consolidation. The breakout signals a continuation of the bigger uptrend and higher short-term yields are expected. A rising 5-yr yield would be bearish for the 3-7 Yr Treasury Bond ETF (IEI).

The next chart shows the 10-yr yield with a long basing process from April 2020 to December 2020 and a breakout at the beginning of 2021. The yield surged above 1.7% (17 on chart) and then fell back with a falling channel, which is viewed as a correction within a bigger uptrend. This is also a bullish continuation pattern and a breakout at 16.5 (1.65%) would signal an end to this correction. I would then target a move toward the 2% area. A breakout and move higher in the 10-yr yield would be bearish for the 7-10 Yr Treasury Bond ETF (IEF).

Banks Following Yield Curve Lower

The 10-yr yield, the Yield Curve (10yr-2yr), the Russell 2000 ETF (IWM) and the Regional Bank ETF (KRE) peaked in March. Correlation does not always imply causation, but there is a clear link. A rising 10yr and/or steepening yield curve benefits banks and small-caps, while a falling 10yr and/or flattening yield curve is negative for banks and small-caps.

The chart above shows the 10-yr yield moving modestly lower since late March (top window) and the 2-yr yield bottoming in early February, and then surging in mid June (second window). These movements brought the two yields closer together, which is why the yield curve flattened (third window). The bottom window shows KRE trading flat since mid March, maybe even slightly down. Keep in mind that KRE was up over 100% from late September to mid March and the ETF is entitled to a corrective period after such an advance. Thus, I view the three month trading range as a correction or rest within the bigger uptrend.  

KRE: oversold versus OVERSOLD

The next chart shows KRE with the Momentum Composite (bottom window) and the five indicators that make up the Momentum Composite. This indicator is part of the TIP Indicator Edge Plugin for StockCharts ACP and this chart was created in Amibroker. The five indicators are listed below and you can read more about them at StockCharts.

-RSI (10): overbought > 70 and oversold < 30
-%B (20,2): overbought > 1 and oversold < 0
-StochClose (20): overbought > 95, oversold < 5
-CCI Close (20): overbought > 200, oversold < -200
-Normalized ROC (20): overbought > 3%, oversold < -3%

The chart shows all five indicators becoming oversold last Friday and this is the most oversold since late September. KRE is ripe for at least a bounce.

Junk Bonds and Small-caps

The yield curves and Fed balance sheet are updated every Friday on the Market Regime page (here). Junk bond spreads are very narrow and hit a 10+ year low last week. This is positive because it shows no signs of stress in the corporate bond market. The chart below shows the  Junk Bond ETF (JNK) forming a big triangle and breaking out to new highs over the last few weeks. The middle window shows the Russell 2000 ETF (IWM) with a triangle as well and a breakout in early June. I labelled this breakout a failure previously, but IWM moved right back up this week and the breakout is back on.

The lower window shows the correlation between JNK and IWM. This is the correlation of price changes (percentage), which is different from the StockCharts correlation. There is a very strong positive correlation between junk bonds and small-caps. This makes sense because junk bonds and small-caps are sensitive to economic conditions. Thus, the breakout and new high in junk bonds bodes well for small-caps.

IWC Holds Breakout

The Russell Microcap ETF (IWC) broke out of a falling wedge with a big move from mid May to early June and then fell back to the breakout zone with a falling flag last week. IWC broke out of the flag on Wednesday and this keeps the bigger wedge breakout alive. With IWC in a long-term uptrend, the wedge is viewed as a normal correction and the breakout signals an end to that correction. This flag formed on the first pullback since the breakout and this suggests that it is an “early” stage flag.

You can learn more about my chart strategy in this article covering the different timeframes, chart settings, StochClose, RSI and StochRSI.

PHO Consolidates within Uptrend

The Utilities SPDR (XLU) is not a happy camper with a 6% decline from its mid April high, but the Water Resources ETF (PHO) is holding up much better with a triangle consolidation since early May. The big trend is up and this is viewed as a correction within a bigger uptrend or a bullish continuation pattern.

MJ Channels Clean Energy

The chart for the Alternative Harvest ETF (MJ) looks similar to the charts for the Global Clean Energy ETF (ICLN) and Clean Energy ETF (PBW), which were featured on Thursday. All three are high risk and high reward so trade accordingly! MJ surged over 200 percent with the last bit fueled by the Reddit army. The line chart in the upper left shows MJ retracing 50-67 percent of this advance with a move that held well above the rising 200-day. Thus, the big decline is still within the norms for a correction/retracement. MJ bounced from mid May to early June and formed a higher high on the bar chart. The ETF then pulled back rather hard, but held above the prior low and broke out with a StochRSI pop on the candlestick chart. The early stages of a trend reversal are in play.

Asian ETFs Perking Up: EWY, ASHR, EWT, IEMG

The South Korea ETF (EWY) formed a big triangle within an uptrend and looks poised to break out.

The China A-Shares 300 ETF (ASHR), which is priced in Dollars, fell back rather hard from late May to mid June, perhaps because the Dollar surged. A strong Dollar weighs on ETFs that hold non-Dollar denominated assets/shares. The chart in the upper left shows the Shanghai Composite ($SSEC), which is not based on US Dollars. SSEC held its 200-day throughout spring and broke out in mid May. The breakout is holding as SSEC remains well above its rising 200-day. ASHR is still holding its rising 200-day and getting an oversold bounce within a bigger uptrend.

The Taiwan ETF (EWT) was doing just find after its triangle breakout in late March and new high in late April, but got bushwhacked and plunged below the March low. This kind of volatility is the cost of doing business these days. EWT rebounded with a sharp surge above 60 and then formed a bull flag. A breakout would signal a continuation higher and open the door to new highs.

And finally, the Core Emerging Markets ETF (IEMG) is going for a breakout. Note that the top three geographical holdings are China (34%), Taiwan (14.7%) and South Korea (13.7%). On the price chart, IEMG broke out of a triangle and exceeded its April high in May. The ETF fell back to the breakout zone with a throwback to the rising 50-day SMA and bounced the last two days. The candlestick chart shows a StochRSI pop as well.

Thanks for tuning in and have a great day!

-Arthur Hill, CMT
Choose a Strategy, Develop a Plan and Follow a Process

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