We’re in the final innings of earnings season, and it’s been a remarkably strong quarter.
Per FactSet:
For Q4 2024, the blended (year-over-year) earnings growth rate for the S&P 500 is 16.9%. If 16.9% is the actual growth rate for the quarter, it will mark the highest (year-over-year) earnings growth rate reported by the index since Q4 2021.
But, despite that earnings strength, the broader markets have been relatively flat for the last ten weeks or so.
Of course, there have been plenty of negative headlines that have (temporarily) threatened the market, like DeepSeek last month, higher inflation, the threat of tariffs, etc.
So, is the market underweighting the impressive earnings season, or is it allowing the negative headlines to constrain it?
It may be a bit of both acting as counterweights, but there’s actually 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 that cut, Treasury yields went on a steady climb, topping 4.8% in January for the first time in 14 months.
As the 10-year yield accelerated with a more hawkish Fed, stocks weakened, considerably in some cases.
On December 6, the 10-year note yielded 4.15%, neatly coinciding with an all-time market top.
Then, yields ballooned by more than 15% and the S&P retreated more than 4% while under-the-surface measurements like the Russell 2000 and the Equal-Weight Index fell 11% and 8%, respectively.
This chart, courtesy of Stockcharts.com, demonstrates the inverse relationship between Treasury yields (purple line) and stocks (red line) last year:
For investors, the magic number is 4.5%.
The Treasury Yield to Watch
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, it’s no coincidence that stocks are pinned near their all-time highs today, as the 10-year Treasury is trading at almost exactly 4.5%.
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%.
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 market’s malaise is behind us.
