By David Uberti
Investors parsing the health of the U.S. economy encountered smooth sailing in financial markets in recent months. This week may have provided a warning shot.
America's credit downgrade earlier in the week sparked a selloff in bonds and stocks, arresting markets' summer climb and growing confidence that the country can get inflation under control while escaping a recession.
All three major indexes dropped Friday to finish the week in the red, with losses spanning big banks, big tech and major automakers. The Dow Jones Industrial Average fell by 1.1% this week, while the tech-heavy Nasdaq dropped 2.9% and the S&P 500 fell 2.3%.
The drop in bond prices after Fitch's downgrade of the U.S. credit rating left yields on longer-term government debt hovering near their highest levels since last November. That called into question the benefit of owning stocks, drawing traders away from higher-risk equities in recent days.
"This week's wobble in the fixed-income market kind of woke everyone up, " said Peter van Dooijeweert, head of multi-asset solutions at Man Solutions. "This isn't a free lunch."
The three major U.S. indexes are up considerably year to date. But investors are still analyzing if and how the Federal Reserve's interest-rate hikes to 22-year-highs will slow down the world's largest economy in the months ahead.
Many indicators about the country's inflation outlook continue to offer mixed messages. On Friday, the Labor Department said U.S. employers added 187,000 jobs in July, indicating that hiring has slowed from last summer. But wages continued to rise at a brisk pace.
The dueling narratives from such data have left investors like van Dooijeweert veering toward bonds that offer a healthy return without the risk of equities that could dive should the central bank nudge the economy into a recession.
"If the Fed's not cutting [interest rates], bonds need to sell off," he said, noting that yields would rise in such a scenario. "As we say in my house: party on."
Benchmark 10-year Treasury yields edged lower Friday, but were still higher at 4.060% this week, closing near their highest level in more than a decade. Those for 2-year Treasurys, which are more responsive to investors interest-rate expectations, dipped to 4.791%.
Those rates helped pull more investors away from stocks in most sectors of the S&P 500. Stocks in utilities, usually prized for their stability and dividend payouts, were the indexes' worst performers with a 4.7% drop this week.
Energy companies were one of the markets' few bright spots, pulled higher by oil prices that have reached their highest levels since April. Benchmark U.S. crude prices have risen for six straight weeks, closing this week at $82.82 a barrel.
On Friday, Amazon shares were a big winner, jumping 8.3% after the tech giant trounced expectations for quarterly profit.
Apple stock, meanwhile, fell 4.8% after the iPhone maker said revenue declined for a third straight quarter, marking the company's longest sales slump since 2016.
Friday's declines came despite corporate earnings largely beating Wall Street's expectations. Of 422 companies in the S&P 500 that have reported quarterly results, Refinitiv said 79% topped projections, up from the 66% average since 1994.
But some investors note that earnings expectations were fairly low. "It's hard to understand why the market prices [companies] at a premium in that scenario," said Jason Pride, chief of investment strategy and research at Glenmede.
Pride suspects that some investors have pointed to the stock market's performance this year as evidence that the Fed's rate increases won't eventually bite.
"The market's behavior is actually shifting people's beliefs about the economic impact of higher rates," Pride said. "I think that's feeding into itself to some degree."
Joe Wallace and Gunjan Banerji contributed to this article.
Write to David Uberti at david.uberti@wsj.com
(END) Dow Jones Newswires
August 04, 2023 16:24 ET (20:24 GMT)
Copyright (c) 2023 Dow Jones & Company, Inc.
