Do interest rates really matter for stocks?

Stocks rallied yesterday on continued strong earnings and investors shook off their rate hike fears. Treasury yields continued to climb but tech stock buyers were unphased…yesterday, at least.

What’s all this fuss about?  I got my start on Wall Street on a Treasury Bond trading desk.  Back in those days, bond trading was a big deal… at least in the minds of bond traders. I would go out with college friends, and they would spend hours asking me questions about stocks. Stocks?  “I AM A BOND TRADER, do you want to know what a basis point is worth on the Long Bond,” I would say. “How about the overnight repo rate on the double-old-5-year?” At that point most of my fellow revelers would cock their heads askew, take a pause, and then finally change the topic to something other than Wall Street. It was all fine and good for me, though. I am math guy, and bonds are mostly all about the math. Sure, there are stories behind certain bonds, especially if you move into corporates, munis, or high yields, but for the most part those too were somewhat tethered to math at the end of the day. That is a nice way of saying that bonds were just not viewed as being… well, sexy for a complete lack of a better adjective. Back then, there were plenty of good stories about Apple, Microsoft, Oracle, and even Pfizer. For reference, those stocks were trading around $0.33, $0.64, $0.48, and $2.83 respectively (adjusted for splits, etc.). Those companies had great prospects, which at the time, were just colorful stories. Apple was still selling its Macintosh computer…its fancy, game changing colored iMac did not come out until 1998, but Steve Jobs could sure captivate an audience.  Microsoft was on Windows 2.0, which looked nothing like the current version. In fact, at the time, most PC users didn’t even use Windows, launching programs from DOS or directly from floppy disks. At that point, mobile phones were reserved for Wall Street, Gordon Gecko-like hotshots or drug dealers. Motorola replaced its iconic DynaTAC brick phone with the first flip phone in 1989 (MicroTac). Coming back to you, yet? Great ideas, great stories, and great hopes for not only those tech upstarts, but also biotechs, and yes, big pharma. That is what people wanted to talk about at parties or on line at the grocery store (yes back then “online”, was two words). Ok, so turn the clock forward, and we know that all those companies made good on those great hopes, creating new stories and more hope along the way. Sure, the numbers were important, but the stories are what got all the attention. Back to bonds…

No stories, no great hopes, just the Treasury yield curve at the base of everything. It moved up and down, and it flattened and steepened with Fed moves, and economic releases. Bond traders had screens without keyboards…lots of screens, and they communicated via telephone. Stock traders were always dressed more fashionably, and they used fancy PCs to do their trading. I remember that the Nasdaq market makers at my firm had their own glass enclosed trading floor. The stock traders barely even noticed us even though we were doing trades that eclipsed theirs by orders of magnitude. Wall Street bond traders even had their own bars, which were rarely, if ever frequented by the more colorful equity traders.  Then came The Global Financial Crisis and suddenly everyone, even equity traders, wanted to know about interest rates and fancy bond derivatives…shocker. Fed Funds rates, for the first time ever, were at 0% in the wake of the disaster.  Now THAT was a story that got attention. Zero interest rate policy, or ZIRP, was recognized as the aggressive monetary stimulus that it was, and stock traders viewed that as a good thing, which it…well, was. If bond traders could promise low rates, stock traders could hope for great gains, and vice versa, rising rates and yields began to be perceived as being bad. The good news was that at least, equity traders began to look to the bond market to interpret economic numbers and Fed policy, which along with stock fundamentals…and stories gave an investor a more complete picture.  Turn the clock forward once again to 2018 where the economy was losing steam and earnings growth slowed causing stocks to sell off. The Fed stepped in with kind words and promises of lower rates, causing stocks to rally. This further served to bolster the stock market’s fascination with low rates. This fascination got its own term: the Fed put. If the Fed could keep rates low or lower them every time stocks were on the rocks, stock traders could almost always guarantee success. Then came the pandemic and an unprecedented stimulus package from the Fed, which included 0% Fed Funds once again. Tech and growth stocks began to rally even as the economy entered a recession. The March dip was a huge buying opportunity and investors were investing in prospects beyond the pandemic. As the economy recovered and inflation picked up, the Fed had to jump into action once again, this time to tackle inflation. Suddenly all eyes are back on the non-sexy, very practical bond market. Now, stock traders have learned that higher yields on bonds, when plugged into a discounted cash flow model, make the present value of a stock lower. Now, that is math, but at the end of the day it only underscores the belief that more stimulus is good and less is bad. We are now moving through earnings season and investors will have a chance to get further insight into their portfolio holdings and wish lists. One would hope that, in those, investors will find justification to buy or sell…along with stories and great hopes. The bond market is still the best indicator of Fed policy and economic health today and in the future, and by the way, higher yields indicate a strong economy in the future. I still have lots of monitors on my desk. I am now trusted with keyboards and even a mobile phone. Though I spend most of my time talking about stocks, I still have at least half of my screens dedicated to the bond markets. 

WHAT’S SHAKIN’

CVS Health Corp (CVS) shares are lower by -0.75% in the pre-market after it announced EPS and Revenues that beat estimates by +10.59% and +1.39% respectively. Sales were stronger in the 4^th quarter as a result of increased demand for testing and vaccines, but the company gave a weaker forward guidance for cash flow, which caused shares to decline.   Dividend yield: 1.98%.  Potential average analyst target upside: +3.5%.

Enphase Energy Inc (ENPH) is trading higher by +20.75% in the pre-market after it announced that it beat EPS and Revenue estimates by +23.38% and +2.53% respectively. The companies forward guidance revenue range is far above analysts’ estimates.  Potential average analyst target upside: +51.1%.

Chipotle Mexican Grill Inc (CMG) is higher by +6.48% in the pre-market after it announced an EPS and Revenue beat after last nights close.  The company managed to grow same store sales by +15.2% beating analysts’ +14.8% expected gain. The company has a forward PE multiple of 29.53 which is higher than the median of its peers, but it is still lower than those of hotshot competitors Wingstop (WING) and Shake Shack (SHAK).  Potential average analyst target upside: +32.2%.

ALSO, this morning: Lithia Motors (LADD), Bunge Ltd (BG), Ares Capital (ARCC) all beat on EPS and Revenues. Trimble (TRMB) and Yum! Brands (YUM) missed on EPS but beat on Revenues.

YESTERDAY’S MARKETS

Stocks closed higher yesterday on positive earnings announcements and contrary to rising bond yields, which have lately been foiling rallies.  The S&P500 added +0.84%, the Dow Jones Industrial Average gained +1.06%, the Nasdaq Composite Index rose by +1.28%, the Russell 2000 advanced by +1.53%, and the S&P500 ESG Index traded higher by +0.87%. Bonds declined and 10-year Treasury Note yields gained +5 basis points 1.96%. Cryptos climbed by +5.26% and Bitcoin rose by +0.29%.

NXT UP

• Fed speakers: Bowman and Mester.
• The Treasury will auction $37 billion 10-year Notes.
• After bell earnings: MGM Resorts, Lumen, Twilio, Walt Disney, Sonos, Vimeo, Ceridian, Uber, Motorola Solutions, Annaly Capital, Equifax, Fluence Energy, Mattel, and O’Reilly Automotive.