Fourth-quarter earnings season is underway, and while expectations are high at an estimated 11.7% average year-over-year growth among S&P 500 companies, the actual number probably won’t matter much to the market’s short- and intermediate-term direction.
Ignore inflation numbers too. CPI, PPI – this week’s dual reports of the December results were encouragingly cooler than expected. But in the end, what really matters is how they impact the Fed’s decision-making, which we probably won’t know until at least the end of the month.
Until then, and frankly, regardless of what Jerome Powell says later this month and beyond, there’s only one number that will truly determine which way the market goes next: the 10-year Treasury yield. In September, around the time the Fed made its first, deceptively aggressive 50-basis point rate cut, the yield dipped to 3.6%, and stocks took off. Since then, Treasury yields have been on a steady climb, topping 4.8% this week for the first time in 14 months.
It’s no coincidence that as the 10-year yield has accelerated in the last six weeks as the Fed has become more hawkish that stocks have fallen off, considerably in some cases. On December 6, the 10-year note yielded 4.15%, neatly coinciding with an all-time market top. Since then, yields have ballooned by more than 15%, while the S&P has retreated more than 4% while under-the-surface measurements like the Russell 2000 and the Equal-Weight Index have fallen 11% and 8%, respectively.
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This chart, courtesy of Stockcharts.com, demonstrates the inverse relationship between Treasury yields (purple line) and stocks (red line) in the last year:
And the magic number is 4.5%.
Treasury Yields’ Green-Light Number for Stocks
When the Treasury yield is below 4.5%, stocks mostly flourish. When it’s above 4.5%, they flounder.
To wit: from the beginning of June through mid-December, the yield was below 4.5% virtually the entire time, and the S&P was up 15%. Last April and May, when the yield was mostly above 4.5%, the S&P was flat; and in the past month, it’s down 2.5%.
Granted, there have been exceptions, like when the market cratered last July and early August when yields were mostly in the 4.1%-4.2% range. But as you can see from the chart above, once rates dipped below 4%, stocks took off again.
So while the market isn’t immune to pullbacks while Treasury yields are below 4.5%, it’s all but incapable of rallying, at least for more than a few days, when yields are above 4.5%. And that made Wednesday’s dip to 4.65% – fueled by the better-than-anticipated CPI print – encouraging. Investors certainly ate it up, with every index, including the Russell, up more than 1.5%. For the rally to last, yields will need to pull in a little more in the coming days.
This has been one of the stranger bull markets in history, with high interest rates limiting investor enthusiasm for most stocks outside the sure bets that comprise the Magnificent Seven or a select few artificial intelligence leaders. It’s why money market funds have risen to a record $7 trillion and the majority of sectors remain undervalued. Eventually, rates will come down, and perhaps more widespread buying will ensue. But for now, the Fed is king, and Treasury yields matter.
If they reverse course and fall back below 4.5% in the coming days, then there’s a good chance the worst of the December/January selloff is behind us.
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