Interest rates are on the move, with the 10-Year Treasury Yield breaking 3% once again after working off its failed breakout attempt from May. One relationship that is highly correlated with the 10-Year Yield is regional banks vs. real estate investment trusts (REITs). We wrote about this relationship in 2016 and 2017, but it's at an important inflection point, so today's chart is going to revisit it.
Before we get into the chart, it's worth explaining why this positive correlation exists. When market participants think interest rates are going higher, their way of expressing that through the equity market is to allocate capital to sectors that will benefit from that rise in rates like regional banks. When they think interest rates are going to fall, they're more inclined to allocate capital to high dividend paying equities like REITs to find the yield they're not getting in the bond market. By measuring the relative performance of these two sectors, we can get a feel for how equity market participants are thinking about future trends in the bond market. (For more, see: 5 Types of REITs and How to Invest in Them.)
So here is the ratio chart of the regional banks vs. REITs. In September of last year, we saw this ratio break down temporarily while momentum hit oversold conditions, but it quickly recovered support and put in a bottom with interest rates, with both eventually making new highs.
Today, we're seeing similar action, with the ratio breaking down below support at 0.777 and momentum hitting oversold conditions. With interest rates breaking to multi-month highs, the confirmation we'd want to see from an inter-market perspective is this ratio quickly reversing and going on to make new highs like it did last September.
I know this is "chart of the week" and not "charts of the week," but here's a bonus daily chart of the 10-Year Treasury Yield for some additional context. After consolidating for most of the year, yields are attempting another breakout above that 3% level. Is it an important psychological level? Maybe, maybe not. We care about it because it's the 2013 highs and the 161.8% extension of the December 2016 through September 2017 decline. If we're above that level, 3.6% is our next upside objective.
The Bottom Line
This relationship between regional banks and REITs is one piece of a complicated interest rate picture, but it's a very important one that we want to keep on our radar. If you're in the camp that interest rates are headed higher, you want to see this divergence resolve itself with the ratio quickly recovering support and pushing to new highs.
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Thanks for reading, and let us know if you have any questions!