The stock market has a ‘systemic problem’

Stocks are facing a familiar problem.

Even as earnings for the first quarter come in better than expected, the market has struggled to climb higher consistently as rising Treasury yields weigh on sentiment for equities, reminding investors of the period in 2023 when higher yields sent stocks crashing.

“Higher rates are now a systemic problem for equities,” Piper Sandler chief investment strategist Michael Kantrowitz wrote in a weekly note to clients on Friday.

Kantrowitz pointed to the market action over the last month, which could be simplified to a basic formula: When Treasury yields have risen, stocks have fallen. And recently, yields have soared. The 10-year Treasury yield is up more than 40 basis points to 4.63% since the start of April, its highest level since November 2023. In that time, the S&P 500 has fallen about 3%.

“At this point it’s really hard to see equities going up without rates going down,” Kantrowitz said in a video breakdown of his research distributed to clients.

The same action could be seen in the two-year Treasury yield, where Evercore ISI’s Julian Emanuel has flagged 5% as the key technical level that weighed on stocks during last year’s bond-driven sell-off. Notably, stocks’ recent decline from their highs throughout April came as the two-year hit 5%. On Monday, the two-year sat at 4.98%.

The rise in yields has come as investors have heavily scaled back their bets on Federal Reserve interest rate cuts this year. Market expectations have shifted from nearly seven cuts to around just one in 2024, per Bloomberg data. And Morgan Stanley’s chief investment officer Mike Wilson wrote in a research note on Sunday this upside pressure in yields is likely to remain unless Fed Chair Jerome Powell “surprises on the dovish side” during his press conference on Wednesday.

Given recent hot inflation readings, economists don’t expect that to be the case when Powell speaks.

“We expect the main message from the press conference to be that policy needs more time to work,” Bank of America US economist Michael Gapen wrote in a research note previewing the event. “Powell should indicate the next move is still likely to be a rate cut, but the Fed will be in wait-and-see mode until it achieves confidence it desires on inflation.”

This would be a reiteration of prior comments from Powell, which brought little relief to the bond market.

Rising yields have also helped explain why the S&P is down nearly 3% this month despite a better-than-expected first quarter earnings season thus far. S&P 500 companies have topped earnings estimates by an average of 9% this quarter, the highest since 2021 per Wilson, but stock price reactions have been “muted.”

“We think this is attributable to the pressure on valuations from higher rates,” Wilson wrote.

And strategists don’t see this trend changing in the near term.

“While ‘higher for longer’ rates are not necessarily an insurmountable obstacle for stocks, certain parts of the equity market are more likely to lag if rates keep climbing,” Goldman Sachs chief US equity strategist David Kostin said. “Most notably, stocks with weak balance sheets have generally struggled.”