Interest Rates are the Market’s New Boss

Interest rates are now more important than profits for stock performance, according to a recent article in The Wall Street Journal.

“The first quarter was very good for U.S. companies, as a brew of corporate tax cuts, solid global economic growth and a weaker dollar pushed profits higher,” the article says, adding that while profits will be strong all year, the first quarter will likely be “as good as it gets.” But as growth slows, it says, bond yields have seen an uptick, with the 10-year yielding 3.09% versus 2.41% at the beginning of the year.

With low unemployment and inflation “warming up,” the article notes that the Fed is set to keep hiking rates. “Yields,” it adds, “will face more upward pressure because the supply of Treasurys on the market is increasing, as the Treasury steps up issuance and the Fed continues to run off its holdings.”

In this type of environment, says WSJ, the stocks that perform well are those that can sustain strong earnings growth—”Those will likely be cyclical companies, but only those where sales stay ahead of rising costs.” Home builders, it says, are “growing but suffering from rising costs for labor and materials” and consumer staples companies could face challenges as Treasury yields climb.

“If rates keep rising,” the article concludes, “the number of stocks that can generate strong growth will dwindle. That makes for crowded trades that inevitably end in nasty selloffs. We’ve got a way to go but the path has been laid.”