Laverne & Shirley; Jordan & Pippen; Earnings & Interest Rates
The stock market's direction is primarily driven by the duo of earnings and interest rates, where currently low US 10-Year Note yields at 1.35% combined with expected S&P 500 earnings growth of over 35% create a favorable environment despite potential challenges from new COVID variants, slowing global growth, and tightening fiscal and monetary policies.
History is full of great duos, both fictional – Cagney & Lacey, Holmes & Watson – and real – Venus & Serena, Sonny & Cher. When it comes to investing, we have our own great duo, a pairing that more than any other determines the direction of the stock market: earnings & interest rates.
When one owns a stock they have a claim on a share of a company’s earnings – and growing earnings should, on balance, reflect a company and a business model that is performing well, and importantly, generating capital that can be reinvested back into the business and/or distributed to shareholders. Stating the obvious, growing earnings are a good thing, and declining earnings are a bad thing.
Interest rates (and here we can think of interest rates broadly, from the Federal Funds Rate to yields on high quality, traditional fixed income, including the yield on the US 10-Year Note, which is the global risk-free rate) are important in that high rates make a company’s future earnings worth less and low rates make a company’s future earnings worth more. Again, stating the obvious, low rates are good for the market and high rates are bad for the market.
Well, the yield on the US 10-Year Note sits at a very low 1.35% and S&P 500 earnings are expected to grow 35%+ this year. Said plainly, rates are low and earnings growth is high – something to keep in mind as we navigate a summer likely to be marked by concerns and questions over new variants of the coronavirus, slowing global growth, and less supportive fiscal and monetary policy.