Its been a fun parlor game since the start of the Fed’s unprecedented policy of QE and ZIRP to predict what will happen to risk assets here in the U.S. once the central bank moves back to traditional monetary policies. While most investors were fairly certain that the end of QE and ZIRP would cause a massive correction in bonds, the timing, until very recently has been less than certain. Today the yield on the 10 year Treasury bond is reaching new highs for 2015, and quickly approaching key support at 2.4%, which was also a key technical breakdown level from last year:
I have no clue whether or not the yield hits resistance, but one thing that has been certain is that high yielding defensive stocks like consumer staples and utilities are some of the first equity related casualties of the unwind of ZIRP as their yields are far less attractive in a rising rate environment, finally making valuation relative to expected growth look a tad silly when you strip out the premium dividend yield to that of Treasuries. And it’s not just the yield differential. Another side effect of the Fed unwind of QE is the adverse effect to U.S. multinationals’ earnings from the massive reversal in the U.S. Dollar. We have been over all of this before and while there were some who thought the collapse in commodity prices would help (a massive input cost for most U.S. companies) the recent bounce there has marginalized this perceived benefit.
The poster child for this conundrum of U.S. multinationals is Proctor & Gamble (PG). The stock’s 3.38% dividend yield seems fairly attractive relative to the 10 year yield about 1% lower. In fact, there was a time in late 2014 when the stock was almost 17% higher but since then earnings prospects have declined in a big way as 60% of their sales come from outside North America. And while the Dollar Index (DXY) is well off the recent highs it is up almost 11% in March and the year to date gains of 6% are wreaking havoc on overseas sales and profitability.
The one year chart of PG reflects this sentiment change, now approaching 52 week lows:
Looking out a couple years there is obvious long term support near $75:
Sentiment in PG has gone from euphoric at year end to downright nasty less than 6 months after since the stock made new all time highs in December. While analysts have been aggressively cutting estimates, in line with two consecutive downgrades to guidance in 2015, at some point soon analysts could be caught off sides with 9 buy ratings, 18 holds and 2 sells.
Much like the Walmart (WMT) trade from earlier, PG could be setting up for a short premium range trade as $75 looks like very well defined technical support, and $85 should serve as very staunch near term technical resistance, which also corresponds with the stock’s 200 day moving average (yellow line below):
We like the idea of a long delta entry closer to $76 with the idea that any moves higher from there are likely to be muted. Short premium trades with targets around 80 or even slightly higher are the trades we’d want to do at that point. We’ll update on the site if we decide to step in.