The Daily Prophet: Can't Blame 3% Bond Yield for This Stock Rout

There's been a lot of handwringing lately over what would happen to stocks once benchmark 10-year Treasury note yields reached 3 percent. Well, yields breached that level on Tuesday for the first time since January 2014, but that wasn't really why the S&p 500 Index fell the most since April 6. The reason is more disturbing than the prospect for higher borrowing costs.

Although equities started out the day in the black, and they did wobble once 10-year yields reached 3.001 percent, it was an unexpected announcement from Caterpillar, the world’s biggest maker of construction and mining equipment and often viewed as a bellwether of the global economy, that caused the rally to reverse. Caterpillar's first-quarter earnings released early in the morning beat estimates, but company executives later said on a call with analysts and investors that those results “will be the high watermark for the year.” Therein lies the problem for the stock market. Everybody knew coming into earnings season that profits would be strong, but to justify the lofty price-to-earnings levels that stocks were trading at early in the year, companies would need to be equally bullish in their outlooks. But that is not happening. Based on the companies that have reported so far, earnings-per-share rose by 17.8 percent from a year earlier, above early-season targets of 16.5 percent. But, strategists at Bloomberg Intelligence note, estimates for the next four quarters have declined.

"S&P 500 stocks have offered a lukewarm greeting to red-hot earnings, with outlooks somewhat chillier," the BI strategists wrote in a research note. "A turnaround in analyst-estimate revisions is likely necessary to get stocks moving in a positive direction again."

IT'S BOND ARMAGEDDON -- OR MAYBE NOT
Although it remains to be seen whether 10-year Treasury yields at 3 percent will have a punitive impact on the global economy and markets, they do serve to underscore how borrowing costs for governments, companies and consumers have risen quite substantially, and not just this year. The yield on the Bloomberg Barclays U.S. Aggregate Bond Index rose to 3.31 percent on Monday, up from the post-crisis low of 1.56 percent in 2012 and the highest since mid-2010. The U.S. government's interest expense so far in fiscal 2018 ending in October is $241.7 billion, up from $223 billion at the same point in fiscal 2017 and from $191.8 billion in 2016. The big question for investors is whether the economy is strong enough to withstand these higher rates. After all, the Federal Reserve Bank of Atlanta's widely-followed GDPNow, which aims to track growth in real time, shows the economy is likely expanding at 2 percent rate, which marks a big deceleration from the past three quarters. Although government data released Tuesday show that new-home sales increased in March to a four-month high in the face of the highest mortgage rates in four years, some economists say that was mainly a reflection of the dearth in supply of existing homes, forcing homeowners to buy newly built houses. If the economy is more a reflection of Caterpillar than home sales, then maybe yields might be near a peak for the year.