The stock market has a 'systemic problem'

Stocks are facing a known problem.

Even with better-than-expected first-quarter earnings, the market is struggling to move higher consistently as rising Treasury yields weigh on sentiment for stocks, reminding investors of the period in 2023 when higher yields drove stocks crash.

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

Kantrowitz pointed to the market action of the past month, which could be simplified to a basic formula: When Treasury yields have risen, stocks have fallen. And recently, revenues have soared. Ten-year government bond yields have risen more than 40 basis points since early April to 4.63%, the highest level since November 2023. During that time, the S&P 500 has fallen about 3%.

“Right now it's very difficult to see stocks rising without interest rates falling,” Kantrowitz said in a video overview of his research distributed to clients.

The same action could be seen in two-year government bond yields, with Evercore ISI's Julian Emanuel identifying 5% as the key technical level. That weighed on stocks during last year's bond-driven selloff. Notably, stocks' recent decline from their April highs came as the two-year index gained 5%. On Monday the two-year interest rate stood at 4.98%.

The rise in interest rates came about because investors have severely scaled back their bets on interest rate cuts by the Federal Reserve this year. According to Bloomberg data, market expectations have shifted from nearly seven cuts to about one by 2024. And Mike Wilson, Morgan Stanley's chief investment officer, wrote in a research note on Sunday that this upward pressure on rates is likely to continue unless Fed Chairman Jerome Powell was “mildly surprised” during his press conference on Wednesday.

Given recent high inflation rates, economists don't expect this to be the case when Powell speaks.

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

This would be a repeat of Powell's previous comments, 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 to date. S&P 500 companies beat their earnings estimates by an average of 9% this quarter, the highest level since 2021 according to Wilson, but stock price reactions have been “muted.”

“We believe this is due to pressure on valuations from higher interest rates,” Wilson wrote.

And strategists don't see this trend changing in the short term.

“While 'higher for longer' interest rates are not necessarily an insurmountable obstacle for stocks, parts of the stock market are more likely to lag if rates continue to rise,” said David Kostin, chief U.S. equity strategist at Goldman Sachs. “Most notably, stocks with weak balance sheets have generally struggled.”

U.S. Federal Reserve Chairman Jerome Powell attends a press conference in Washington, DC, the United States, on March 20, 2024. The U.S. Federal Reserve on Wednesday left interest rates unchanged at a 22-year high of 5.25 percent , up from 5.5 percent as recent consumer data indicate continued inflationary pressures.  (Photo by Liu Jie/Xinhua via Getty Images)U.S. Federal Reserve Chairman Jerome Powell attends a press conference in Washington, DC, the United States, on March 20, 2024. The U.S. Federal Reserve on Wednesday left interest rates unchanged at a 22-year high of 5.25 percent , up from 5.5 percent as recent consumer data indicate continued inflationary pressures.  (Photo by Liu Jie/Xinhua via Getty Images)

Federal Reserve Chairman Jerome Powell attends a press conference in Washington, DC, on March 20, 2024. (Liu Jie/Xinhua via Getty Images) (Xinhua News Agency via Getty Images)

Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.

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