Wall Street is heading for a high-stakes showdown, as booming corporate earnings for technology and energy firms collide with a relentless rise in bond yields.
Professional analysts expect corporate earnings will continue to soar, driven by the ongoing build-out of the data centers needed to power artificial-intelligence technology.
These great expectations have helped major indexes like the S&P 500 surmount a number of obstacles this year. The war with Iran has pushed oil prices into triple-digit territory, putting even more pressure on consumers already struggling with high prices. Meanwhile, yields on 10-year and 30-year Treasury notes and bonds have risen to their highest levels in decades, adding yet another headwind.
Rising yields have helped to accentuate a growing divide in the U.S. equity market. Apollo Chief Economist Torsten Slok recently pointed out that the market has fractured into two camps: AI stocks, and non-AI stocks. Beginning in August, the rally started to narrow. Major indexes appeared to hold up, even as a majority of stocks struggled.
Things seemed mostly contained until this past week, when stocks tied to the AI trade suddenly hit the skids. Helping to underscore the sense of panic, Treasury yields dropped, even as oil prices continued higher. Investors responded by shifting back into stocks and sectors that had struggled in the face of rising interest rates.
For months, investors remained so fixated on earnings that AI stocks mostly sidestepped the pain felt by shares of small-capitalization companies and other more interest-rate-sensitive names. But with investors now increasingly willing to question the AI-driven growth story, the bar for these stocks to continue higher has been raised.
After a flurry of early reports from major banks and consumer-focused companies like PepsiCo failed to impress, the onus is falling on the major AI beneficiaries to restore investor confidence with this next batch of guidance and results.
“Skepticism is on the rise,” said Mark Hackett, chief market strategist at Nationwide.
As bond yields continued higher on Friday, the market appeared headed for a tug-of-war between two powerful opposing forces. On the one hand, earnings growth has reached a blistering pace typically only seen during the early stages of an economic recovery. On the other, the forces pushing bond yields higher appear unlikely to abate any time soon, said Michael Monaghan, a portfolio manager of the Founders 100 ETF.
“There’s a tension in the marketplace in that, even though the market is up year to date, it’s considerably cheaper versus forecasts for next year’s earnings,” Monaghan told MarketWatch on Friday.
Although prices have held up, valuations — that is, how much investors are willing to pay for each dollar of expected earnings — have slumped. As of Friday, the S&P 500 was trading at 19 times expected consensus earnings, below its five-year and 10-year averages, according to FactSet data.
Jurrien Timmer, director of global macro at Fidelity Investments, told MarketWatch that the idea that tech stocks are immune to the growing macro pressures isn’t quite right.
“Think of it as a dynamic where earnings growth goes in the numerator and the cost of capital goes in the denominator. Right now, earnings are growing by leaps and bounds, but the cost of capital is rising as well,” Timmer said during an interview with MarketWatch. “It becomes a race between the two over which one affects stock prices more.”
Comments