S&P 500 Wipes Out Losses as Bonds Find Footing: Markets Wrap

(Bloomberg) — Stocks wiped out losses as the bond market stabilized after a selloff driven by prospects of a slower pace of Federal Reserve rate cuts.

Equities edged up in afternoon New York trading as traders tried to shrug off concern about Fed policy to focus on prospects for strong corporate profits amid a resilient economy. While an over 20% rally this year has made prices a bit harder to justify when plotted against earnings  — and many strategists say valuations will eventually need to go down — they anticipate that solid fundamentals will likely compensate for that.

“Stocks will likely move on incoming data around employment, inflation, and corporate earnings, which should remain favorable for stock prices through year-end,” said Anthony Saglimbene at Ameriprise. “As long as fundamental conditions remain firm, the bull market should continue to ride the near-term ups and downs in sentiment while continuing its grind higher.”

Meantime, exposure to the S&P 500 has reached levels that were followed by a 10% slump in the past, according to Citigroup Inc. strategists. Long positions on futures linked to the benchmark index are at the highest since mid-2023 and are looking “particularly extended,” the team led by Chris Montagu wrote in a note.

“We’re not suggesting investors should start to reduce exposure, but the positioning risks do rise when markets get extended like this,” they said.

The S&P 500 was little changed. The Nasdaq 100 added 0.2%. The Dow Jones Industrial Average gained 0.1%. The Russell 2000 of smaller firms slipped 0.2%. Texas Instruments Inc., which gets almost three-quarters of its revenue from industrial and automotive chips, reports results after the market close.

Treasury 10-year yields were little changed at 4.20%. The euro hit the lowest since early August amid bets the European Central Bank will keep lowering rates. Options traders are increasing bets that Bitcoin will reach $80,000 by the end of November no matter who wins the US election.

Oil advanced as traders tracked tensions between Israel and Iran. Gold climbed to a fresh record.

Equities rebounded as the Treasury market halted a selloff that drove the 10-year yield up 10 basis points in the prior session.

At the heart of the rout was a reassessment of the outlook for US monetary policy. Traders are paring back bets on aggressive easing given the US economy remains robust and and Fed officials have sounded a cautious tone over the pace of future rate decreases. Rising oil prices and the prospect of bigger fiscal deficits after the upcoming presidential election are only compounding the market’s concerns.

“Of course, higher yields do not have to be negative for stocks. Let’s face it, the stock market has been advancing as these bond yields have bee rising for a full month now,” said Matt Maley at Miller Tabak Co. “However, given how expensive the market is today, these higher yields could cause some problems for the equity market before too long.”

To Solita Marcelli at UBS Global Wealth Management, while recent data indicate a more resilient US economy than previously thought, the broad disinflation trend is still intact, and downside risks — albeit lower — to the labor market remain. She continues to expect a further 50 basis points of rate cuts in 2024 and 100 basis points of cuts in 2025.

A string of stronger-than-estimated data points sent the US version of Citigroup’s Economic Surprise Index to the highest since April. The gauge measures the difference between actual releases and analyst expectations.

“On the back of September’s strong economic data, markets have already priced a slower pace of cuts,” said Lauren Goodwin at New York Life Investments. “If the Fed is able to move towards a 4% policy rate — still above the levels most believe represent the ‘neutral’ rate — then the equity market rally can continue. Disruptions to that view make equity market volatility more likely.”

The last time US government bonds sold off this much as the Fed started cutting interest rates, Alan Greenspan was orchestrating a rare soft landing.

Two-year yields have climbed 34 basis points since the Fed reduced rates on Sept. 18 for the first time since 2020. Yields rose similarly in 1995, when the Fed — led by Greenspan — managed to cool the economy without causing a recession. 

In prior rate cutting cycles going back to 1989, two-year yields on average fell 15 basis points one month after the Fed started slashing rates.

Meantime, the International Monetary Fund said the US election is creating “high uncertainty” for markets and policymakers, given the sharply divergent trade priorities of the candidates. That gap creates the risk of another potential round of volatility on global markets similar to the rattling August selloff.

“Presidents don’t control markets,” said Callie Cox at Ritholtz Wealth Management. “Over time, the stock market’s common thread has been the economy and earnings, not who’s in the Oval Office. Be prepared for mood swings in markets as we get closer to Election Day. But remember that election-fueled storms often dissipate quickly.”

As the earnings season rolls in, US companies are reaping the best stock-market reward in five years for beating profit expectations that were lowered in the run-up to the reporting season.

S&P 500 firms that posted better-than-estimated third-quarter earnings have outperformed the benchmark by a median of 1.74% on the day of reporting results, according to data compiled by Bloomberg Intelligence. That’s the strongest rate in BI’s records going back to 2019.

At the same time, companies missing estimates trailed the S&P 500 by a median of 1.5%, a less severe underperformance than the 1.7% experienced in the second quarter, the data showed.

“This earnings season we are watching what companies are saying about inflation and the economy,” said Megan Horneman at Verdence Capital Advisors. “In addition, their view on interest rates, especially if the Fed cannot be as aggressive as the market is pricing in at this point. It is good to see analysts getting realistic about 2025 earnings growth. However, at 15% earnings growth, we believe it is still too optimistic given the expectation for slower economic growth in 2025.” 

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