Bond Yield Rise Pauses, Dow Futures Get A Bit of Help From Some Earnings

Equities futures were pointing to a higher opening for U.S. stocks Tuesday morning as the 10-year Treasury yield paused close to a level that apparently has concerned some market participants because of what it says about inflation expectations and the potential to dent corporate borrowing.

Earnings appear to be helping equities futures, if slightly, with six Dow Jones Industrial Average ($DJI) components reporting this morning. Leading the way was construction equipment maker Caterpillar Inc. CAT, which reported solid earnings of $2.82 a share versus analyst consensus of $2.11. CAT shares rose more than 4 percent in pre-market trading. Other Dow components advancing on this morning's earnings include Verizon Communications inc. VZ, Coca-Cola Company KO and United Technologies Corporation UTX. The $DJI’s advance appears to have been muted, however, on weaker earnings by 3M Co. MMM, which fell nearly 4 percent on lower company guidance, and insurance giant Travelers Companies Inc. TRV, which fell short of analyst estimates.

Eyeing 3% in the Ten-Year Treasury

The benchmark 10-year Treasury note yield came within a rounding error of 3 percent early Monday, drawing near that landmark level for the first time since early 2014 as concerns of possible inflation seemed to mount. At the same time, the financial sector, which often rallies when rates go up, came under pressure.

The mystery continues as financials can’t seem to get a lift from rising yields. It’s possible that some of the benefit from the yield rally might have gotten baked into the big bank stocks over the last two weeks, or we could be simply seeing some profit taking or even sector rotation. Whatever the case, banks had a rough day pretty much across the board Monday with some major names like Goldman Sachs Group Inc. GS and Morgan Stanley MS taking a hit. Maybe we’re in a “show-me” situation with the banks and direction might be clearer if the 10-year does hit 3 percent.

Yields have been climbing most of the year, and the positive spin would be that this is a vote of market confidence in the economy and perhaps easing concerns about geopolitics and trade. Rates have been historically low since 2008 but rose this year as the Fed removed accommodation and the economy grew near 3 percent. See figure 1 below.

At some point, the rising yields could inhibit corporate borrowing and spending, possibly helping to slow economic growth. Analysts are divided on what level yields would necessarily have to reach to really put fear into the stock market, but stocks have struggled ever since early February when inflation fears and rising yields sent major stock indices into a correction. A lot of eyes have been on 3 percent, but it remains to be seen if there’s anything besides psychology at play or if 3 percent really could be some sort of turning point.

On Monday, two of the three main U.S. indices were lower as investors appeared to worry about the prospect of higher inflation signaled by rising bond yields. The S&P gained a hair, but five of its 11 sectors were in the red with information technology the biggest loser.

The Heart of Earnings Season

Monday’s rally in yields comes in a week where about one-third of S&P 500 companies are scheduled to report earnings. Google parent Alphabet Inc. GOOGL GOOG kicked things off after the close by reporting better-than-expected earnings and revenue.

Two of the major companies in the telecom sector report earnings this week, as well. Joining Verizon Communications Inc. VZ, which reported strong earnings this morning, is AT&T Inc. T, which reports after market close on Wednesday. Telecom had a challenging 2017 and ended up being the worst performer for the year out of the S&P 500 (SPX) sectors. So far, 2018 hasn’t been any better for telecom companies and both T and VZ are down just over 10 percent as of yesterday's close, though VZ shares rose over 3 percent after Tuesday morning's release.

FIGURE 1: 10-YEAR FLIRTING WITH 3%. The Ten-Year Treasury Index (TNX), which equates to ten-times the 10-year Treasury rate, came within a stone's throw of 3 percent yesterday before retreating slightly. The 10-year began the year around 2.4 percent. Data source: Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

A Tale of Two Fears

As the 10-year Treasury yield nears 3 percent, some investors apparently are worrying about what that says about inflation and what the Fed might do with interest rates. After all, rising longer-term rates reflect expectations of a stronger economy, which the central bank might need to rein in, as inflation fears possibly emerge. As longer term rates rise, this can cause the yield curve to steepen. But some investors appear to be fretting about a flattening yield curve — where the spread between shorter and longer dated interest rates narrows. Keep in mind that you probably don’t need to be worried about both—not at the same time, anyway.

Durable Goods on Tap

We’re expecting a peek at forward-looking economic data later this week as the government reports durable goods orders from March. Because this number measures the level of orders for products meant to last three years or more, it can be seen as a vote of confidence (or lack thereof) on business conditions and growth several years into the future. A consensus provided by Briefing.com shows economists are expecting 1.9 percent growth in overall durable goods orders and 0.6 percent growth when stripping out transportation. Remember that big orders for aircraft and defense items can make one report look stronger than the overall economy might otherwise reflect.

Getting Defensive

Let’s step back and take a slightly longer term look at quarterly earnings, geopolitics, and inflation issues of the moment. It may be worth remembering that we have midterm elections coming up in November, and, according to investment research firm CFRA, the six months leading up to voting can be a challenging time for stocks, though past isn’t precedent. According to CFRA, since 1946, from April 30 to Oct. 31 in midterm election years, the S&P has fallen half the time, slipping an average of 1.1 percent and by double digits five of nine times. “Not surprisingly, investors have typically anticipated the uncertainty associated with this midterm mayhem by migrating toward defensive sectors, likely due to the more-static demand associated with their products and services, along with the above-market dividend yield that could serve as a cushion to a slump in prices,” CFRA said in a note.

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