Fed to Present Update at Jackson Hole on Friday
In the year since Federal Reserve Chairman Jerome Powell’s last speech at the Jackson Hole Economic Symposium, the Fed has been hard at work, raising interest rates and talking tough about inflation. A year on, the Fed has made plenty of progress on inflation, which is down by two-thirds since then, while also avoiding pummeling the economy. So far, economic growth has been resilient, and the labor market has stayed strong. The Fed has put a lot of tightening into the system in the last fifteen months, so the question is: how much more to squeeze to get inflation down to the Fed’s declared 2% target?
Bonds Posing Challenge for Stocks
In much of the last decade, a common Wall Street refrain was T-I-N-A. (There Is No Alternative) . . . to stocks. As bond yields bumped along the bottom in the years following the 2008-2009 financial crisis, investors were pretty much pushed into stocks because
- low yields made bonds a high-risk, low potential return proposition,
- low interest rates reduced companies’ cost of capital, making it easier for them to grow their earnings and
- low interest rates allowed price-to-earnings multiples for stocks to expand.
We are now leaving that era behind. This week, the yield on the benchmark 10-year Treasury note hit its highest level since 2007: 4.35%. Many analysts see yields continuing to climb as our resilient economy offers the Fed more cover to continue to raise interest rates, or at least to keep them higher for longer. Higher bond yields pose a challenge for stocks for two reasons.
- First, bonds, if they offer attractive enough yields, are a competitor to stocks for investors’ capital.
- Second, higher bond yields (and higher interest rates in general) make it more expensive for companies to access capital and therefore have a dampening effect on corporate earnings growth.
So far this year, the rise in bond yields has not seemed to bother stocks too much, but that could change.
Earnings Season Finishing Up
We are now in the tail end of companies reporting their earnings for the second quarter. With much of the rally in stocks so far this year driven by excitement over artificial intelligence, the technology sector is responsible for most of the gains in the S&P 500 Index. Companies have acquitted themselves well so far this earnings season, with nearly 80% of them reporting earnings ahead of analysts’ estimates. However, to be fair, many had lowered their earnings forecasts earlier in the year, when a recession seemed to be a foregone conclusion. Despite topping estimates, earnings have continued to trend lower on a year-over-year basis, and the second quarter marks the third straight quarter of an overall decline for earnings. Stock investors seem to be anticipating both tougher economic times to come in the following quarters, but also a more accommodative Federal Reserve.
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