There have been some interesting earnings reports since the market closed yesterday. Tesla (TSLA) missed on both the top and bottom lines for the first time in a long time, with Elon Musk sounding a warning about upcoming economic conditions. Meanwhile, Netflix (NFLX) went the other way, recording a beat of expectations for EPS while talking positively about subscribers’ acceptance of paid ads. Perhaps the most surprising in many ways was AT&T (T). That stock, which has been under consistent pressure all year, is popping nearly eight percent at the open after a solid beat and higher guidance for the all-important free cash flow. That is a huge move for a stock that has been grinding down for so long.
For all that, though, the most surprising thing about the stock market this morning is that the major indices are opening slightly higher, even though treasury yields are climbing, once again hitting multi-year highs. The psychologically important five percent level on the 10-year note is well in sight this morning, with a yield of 4.94% as I write. Investors have become used to stocks being very sensitive to treasury yields recently, with even quite minor increases resulting in markets dropping as traders anticipate a negative impact on the economy, but that isn’t happening this morning.
So, what is going on? Why are stocks climbing along with yields?
First, it should be pointed out that direct correlation between treasury yields and the stock market is, or at least was until quite recently, the norm. Most of the time, investors face a choice between bonds and stocks in their portfolio, selling one to buy the other. Bonds are preferred when the outlook is rough and stocks when it is good, with bonds being the neutral asset and thus the starting point of most moves. If the big money is selling bonds, which would push yields higher, they are usually doing so to buy stocks, which pushes stock prices higher, too.
Recently, however, that correlation has inverted. Traders and investors have been concerned that higher interest rates will slow the economy and thus have a negative impact on corporate profits and outlook, the ultimate drivers of equity pricing. So, higher yields have meant lower stock prices over the last year or so. The important question for investors this morning is why that isn’t the case today.
The most obvious explanation is that the market is looking at overall positive earnings so far and concluding that interest rates at around 5% are manageable, and that the economy and corporate profits can hold up well in that environment. If that is the case, and Occam’s razor tells us it probably is, then it is a very strong positive for stocks as we close out the year. Or should we be paying more attention to Elon Musk’s hesitancy? Is the consumer starting to feel the pinch?
On Monday, I wrote that while most of last quarter’s earnings would not really be indicators of overall conditions, Tesla was the exception. Above all, they sell high end cars that most people borrow money to buy, so disappointing results from them would be an indicator that consumers are feeling the pinch. That seems to be what is happening.
So, while it appears that the bulls are winning this morning, buying stocks even as bond yields hit new highs, I remain cautious because the positive earnings that are driving that sentiment are company specific. AT&T’s increases in subscribers is a competitive win in a very competitive market but not a sign of overall consumer strength, and Netflix’s ability to include advertising without putting off their customers is an internal thing, very positive for them but again without any broader implications. American corporations are famously adaptable and resilient and are demonstrating that once again this week. However, if consumers start to tighten their belts, as Tesla’s results suggest they are doing, the economy will slow, and the market will reflect that.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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