Market rates went up yesterday and stocks hit a few speed bumps as those higher rates created some valuation concerns for a market (i.e., S&P 500) trading at 22x forward twelve-month earnings that is a 21% premium to the 10-year historical average, according to FactSet data.
The other possibility is that stocks hit some speed bumps yesterday because the market had gone up six straight weeks and was due for a pullback. That idea can’t be discounted entirely considering that some pundits were suggesting the bump in rates was the result of U.S. growth being stronger than expected, which of course bodes well for earnings prospects.
This will be the narrative tug-of-war now. Are rates going up simply to adjust for the better economic growth or are they going up for other reasons like concerns about the deficit or inflation heating up again?
It could be all of the above, yet multiple expansion will be harder to achieve with higher rates clashing with high valuations that are a reflection of a lot of good earnings news that has been priced into the market already.
There was more good earnings news heard since yesterday’s close, too.
3M (MMM), General Motors (GM), GE Aerospace (GE), Verizon (VZ), Lockheed Martin (LMT), PulteGroup (PHM), and Kimberly-Clark (KMB) all topped consensus earnings estimates for the September quarter, yet only MMM and GM are trading higher in pre-market action.
The 2-yr note yield and 10-yr note yield traded higher overnight, hitting 4.05% and 4.22%, respectively. They have backed down to 4.03% and 4.19%, which has them little changed from yesterday’s settlement. The bigger point for the market, however, is that they are both up markedly since the Fed cut rates on September 18 and suggested more rate cuts are likely.
Since September 18, the 2-yr note yield is up 43 basis points and the 10-yr note yield is up 55 basis points. To be fair, since September 18 the Nasdaq Composite is up 5.5%, the S&P 500 is up 4.2%, the S&P Midcap 400 is up 2.9%, and the Russell 2000 is up 1.5%.
In other words, stocks have steered their way through the higher rates so far to higher highs — and record highs in the case of the S&P 500 and S&P 400 — but they are starting to turn more attention to the direction and pace of travel in Treasury yields given the multiple expansion that has occurred.
That attention is starting to slow their own pace of travel. The bigger question though is, will it change their direction of travel? It most certainly will if the earnings guidance doesn’t live up to the expectations priced into the market.
Currently, the S&P 500 futures are down 30 points and are trading 0.5% below fair value, the Nasdaq 100 futures are down 128 points and are trading 0.6% below fair value, and the Dow Jones Industrial Average futures are down 155 points and are trading 0.4% below fair value.
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Originally Posted October 22, 2024 – Higher rates and high valuations are clashing
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