Bonds Give Stocks a Fright

By Crest Capital Advisors on January 13, 2025

Dow: (1.86%) to 41,938.45
S&P 500: (1.94%) to 5,827.04
Nasdaq: (2.34%) to 19,161.63
Russell 2000: (3.49%) to 2,189.62
Bitcoin: 95,235
10 Year Yield: 4.76%
Outperformers: Energy 0.90%, Healthcare 0.52%, Materials 0.14%
Underperformers: Real Estate (4.10%), Technology (3.10%), Financials (2.71%)

US stocks were lower this week, with the S&P 500 and Nasdaq both down for a second-straight week (and the S&P 500 now off for the fourth week in the past five). The small-cap Russell 2000 also broke two-straight weekly gains, and is now back to pre-election levels. So much for the election enthusiasm.

The main catalyst for the market weakness was the upward pressure on US Treasury yields. Notably, the 10-year Treasury yield hit the highest levels since Q4-2023. Friday’s December payrolls was the big data event of the week which reinforced this upward trend in Treasury rates. Headline payroll growth of 256k net new jobs was well ahead of consensus for 150-160K, while the unemployment rate ticked down to 4.1%. Traders concluded the strong jobs report will lead to fewer rate cuts by the Fed, and therefore tighter financial conditions for a US economy which continues to exceed growth expectations.

Even before Treasuries sold off further on Friday, Bloomberg noted traders have increasingly been positioning for the 10-year to spike back up to 5%, a level not seen since October 2023. Beyond the upside surprises in data, the backup in yields was also attributed to factors including ongoing concerns around debt/deficits and new policy initiatives that could exacerbate these trends. All of the ‘easing of conditions’ priced in ahead of the actual Fed rate cuts has now been completely wrung out of the market. Stocks, especially smaller stocks, aren’t liking it one bit. Some pundits are blaming it on the aforementioned deficit hawks, also referred to as “bond vigilantes”.

Speaking of vigilantes…

Market Disconnect

The Fed has cut interest rates by 100 basis points since September, and over the same period, 10-year interest rates are up 100 basis points. This is highly unusual, see charts below. Is it fiscal worries? Is it less demand from abroad? Or maybe Fed cuts were not justified? The market is telling us something, and it is very important for investors to have a view on why long rates are going up when the Fed is cutting.

And taking the current period and overlaying it to prior periods.

Our Interest Rate Crystal Ball

We’d like to suggest the direction of economic data surprises (recent payroll report excluded) does not justify the current trajectory of interest rates (see the chart below). We expect yields to close the gap with the economic surprise index (red line) by moving lower in the months ahead. This should finally give stocks some reprieve and potentially catalyze the next move higher in the stock market. Time will tell.

Put simply, higher bond yields are holding back stocks. We’ve reached the red line for risk and in order for this to be a “buy-the-dip” moment, we need to see some yield relief. Otherwise, we risk seeing a slightly deeper correction than what we’ve already seen. But, in either scenario, we see the recent moves as buyable because fundamentally, the US economy and therefore corporate profit outlook are in sound shape.

Earnings Season Preview

Before we dive into the quarterly reporting season on deck, let’s first take a look at consensus forecasts for the full year of 2025 earnings-per-share growth (EPS). The bottom-up fundamentals continue to point to a robust growth outlook for earnings in 2025, with the consensus expecting a very robust 13% earnings growth for the year.

Turning to Q4 earnings and the reports we will be getting in the coming weeks, EPS growth is expected to have another strong showing with expectations set at 9.6%. This figure is slightly lower than where it was 3 months ago for the fourth quarter, as the strong Q3 reporting season appeared to have borrowed some from the upcoming reporting season. The sectors expected to have the strongest showing are Communications and Financials with Energy expected to be the biggest detractor. The resilience of the consumer is expected to show once again with discretionary trouncing staples growth.

And last, turning to revenue growth, here we see a bit more muted expectations with economist estimates at 4.1%. Still solid and certainly gives room to exceed expectations. This may also support the thesis that the future direction of the US economy is likely slower growth, rather than a re-acceleration. From a sector standpoint, Technology is expected to have the strongest showing followed by defensive sectors like Utilities, Health Care, and Real Estate. Energy and Industrials are expected to be the laggards.

Politics in the Data!

Before you run off and jump to conclusions on economic survey data (such as this week’s ISM survey or in particular, Friday’s Consumer Sentiment poll, consider that politics, yes politics, plays a central role in how people see things. Not only must we now question political polls when it comes to which candidate is actually ahead (See Iowa poll in the 2024 election cycle), but now we must think about the political make-up of the surveyed respondents of economic outlooks as well in order to determine the true validity of the data! 

Take for example Friday’s University of Michigan Consumer Sentiment poll. Here we see the political divide is stark.

The headline report concluded that consumer’s collective year-ahead inflation expectations jumped to 3.3%, compared to just 2.8% in December. In isolation a scary assessment for the inflation outlook.

But, when we parse the data for political affiliation, take a look at this craziness!!!

Democratic respondents in isolation suddenly see inflation expectations exploding from 1.5% in October to 4.2% this month!

And yet, Republican respondents suddenly see inflation collapsing from 3.6% in October to 0.1% this month!

It’s Black, It’s White. These sides are very far apart from the likely reality.

And of course, stocks pulled back further on Friday when this headline news was released. But once you read into the details, we say it’s all garbage.

Private Market Corner

US Private Equity Markets look to find exit relief in 2025 after experiencing four consecutive years of decreasing M&A activity. As of Q3 2024, the investment (dollars in) to exit (dollars back out) was nearly 3:1. Exit doors re-opening will be a welcomed sign for both institutional PE investors, high net worth PE allocators, and the greater capital markets.

Economic Funnies

Crazy Stat(s) of the Week

• The S&P 500 ended 2024 on a four-day losing streak and in the process saw its biggest decline from Christmas through year end since at least 1952. (Even worse than the lump of coal Powell gave us in 2018!!)

• According to the Wall Street Journal’s analysis of the Los Angeles fires, the damage incurred is likely to be the costliest blaze in US history. Insured losses could be more than $20 billion, or even higher if the fires spread further.

Quote of the Week

“A 10% decline in the market is fairly common – it happens about once a year. Investors who realized this are less likely to sell in a panic, and more likely to remain invested, benefitting from the wealth-building power of stocks.”                            

 –         Christopher Davis

Calendar of Events to Watch for the Week of January 13th

Next week kicks the markets into full gear in the new year with the start of Q4 earnings season. Big banks give us a first look at the initial state of earnings on Wednesday and ramps from there. On the conference calendar, one of the most influential…the JP Morgan Healthcare Conference…kicks off on Monday and typically includes a plethora of earnings pre-announcements. A big slate of economic data is on deck as well with CPI/PPI front and center. After Friday’s payroll induced sell-off, it will be important for stock market investors to see these reports come in “cooler” than expected.  

Monday 1/13 – No major US economic reports on deck today. The US Treasury monthly budget deficit/surplus data will be released with economists expecting a -$43 billion deficit for the latest month.  

Tuesday 1/14 – US Producer Price Index (PPI) headline is expected to come in at 3.4% year-over-year (0.3% month-over-month), up from 3.0% last month. The Core PPI (Ex-Food/Energy) is expected to come in at 3.7% year-over-year, up 0.2% month-over-month.  

Wednesday 1/15 – The main event of the week will be today’s Consumer Price Index (CPI) report. Economists are expecting headline CPI to print at 2.8%, up from 2.7% last month. The monthly change is anticipated to be 0.3%. The Core CPI (Ex-Food/Energy) is projected unchanged at 3.3%, and increasing at a 0.2% monthly pace.

Thursday 1/16 – US Retail Sales for December are expected to come in up 0.6%. On the trade front, the Export Price Index is expected to decline by -0.4% while the Import Price Index is expected to post a -0.3% decline.  

Friday 1/17 – December Industrial Production is expected to come in at 0.4% month-over-month, December Housing Starts, despite higher interest rates, are expected to post a 3.2% month-over-month increase.

Source: MarketWatch / FactSet (January 2025)