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Earnings Can’t Clear Bar for Stock Gains

By John Persinos on April 30, 2018

Covering the stock market’s daily movements lately is like watching a financial version of the movie Groundhog Day. The same dreary events repeat themselves.

At the opening bell today, stocks burst into the green on a wave of strong earnings reports. But by midday trading, gains evaporated as investors started to fret about economic storm clouds. The three main indices all ended in the red.

We’ve seen this plot before. The trading day started on an auspicious note, in the wake of solid corporate operating results. Before markets opened today, McDonald’s (NYSE: MCD) posted first-quarter earnings per share of $1.79, easily beating consensus expectations of $1.67. Revenue came in at $5.14 billion versus the expected $4.98 billion. MCD shares today rose 5.75%.

Investors are still trying to digest the big news that broke on Sunday, when Sprint (NYSE: S) and T-Mobile US (NSDQ: TMUS) announced that they had reached a deal to merge to create a new telecommunications giant. The two firms had tried unsuccessfully to merge before. Both stocks fell today, as analysts cast shade on the merger’s prospects.

The new telecom colossus would provide tougher competition against industry leaders Comcast (NSDQ: CMCSA) and AT&T (NYSE: T). The matter now rests with regulators, who must decide if the merged entity would result in less choice and higher prices for consumers.

The 10-year Treasury bond yield dipped slightly to 2.94% and continues to flirt with the 3% threshold that investors find so troubling. Investors are anxious about inflation and whether the U.S. and global economies can withstand rising interest rates. They’re awaiting clarity from key economic reports this week.

On the docket in coming days: Motor Vehicle Sales, PMI Manufacturing Index, ISM Manufacturing Index, Construction Spending (Tuesday); MBA Mortgage Applications, ADP Employment Report (Wednesday); Jobless Claims, PMI Services Index, Factory Orders (Thursday); and Employment Situation (Friday).

Also scheduled this week is a two-day meeting of Federal Reserve’s Federal Open Market Committee (FOMC), on Tuesday and Wednesday. Input costs for energy and raw materials are rising. Wage growth adds to the inflationary fuel. It’s the perfect recipe for rising interest rates.

When the stuff hits the fan…

In the wake of the great financial crisis of 2008-2009, central banks embarked on a loose money policy to shore up battered economies, pushing the 10-year Treasury bond yield to historic lows. Now that central bankers are tightening the money spigot, the 10-year yield has been steadily rising (see the chart below, compiled with data from Bloomberg).

When the 10-year Treasury yield recently breached the 3% level, Wall Street got rattled. The last time the yield surpassed 3% was in 2014. The main worry is that a rising yield on the benchmark bond would boost borrowing costs.

Global growth is synchronized, which means all regions are growing in tandem. The world economic picture hasn’t been this bright since 2010, a backdrop that has fueled the bull market in equities.

But investors are starting to worry that global growth will sputter. It’s not just the Federal Reserve that’s hiking interest rates. Britain boosted interest rates in November and the European Central Bank is expected to end its quantitative easing this year.

Then there are President Trump’s $1.5 trillion in tax cuts, which increasingly appear to be a mixed blessing. The sharp reduction of the corporate tax rate is a windfall for corporate bottom lines, especially banks. But at what cost?

The Congressional Budget Office recently projected federal deficits greater than 4% of U.S. gross domestic product every year for the next decade, to the tune of at least $1 trillion a year. That’s the result of tax cuts combined with legislative increases in spending. By 2028, America’s government debt burden could balloon from this year’s $15.5 trillion to a mind-boggling $33 trillion.

Government bond issuances are projected to nearly double this year, to more than $1 trillion, as the federal government finances a growing deficit, just as key buyers, including the Federal Reserve, are withdrawing.

Net Treasury issuance to the public is expected to average $1.27 trillion per year over the next five years, compared to an average of $658 billion over the past five years. The upshot: ever-higher Treasury yields.

We’re overdue for a recession. When the downturn inevitably occurs, the proverbial stuff will hit the fan. Government and corporate leaders will have precious few tools at their disposal to deal with recessionary conditions.

In this environment, it’s difficult to imagine that the stock market can continue to rack up the healthy gains we’ve enjoyed in recent years, as less risky bonds provide decent returns and an alternative to stocks.

When the tax cut bill passed in December, corporate leaders popped the champagne. They’re now bracing for a big hangover. Welcome to the not-good-enough earnings season. The bar has been set impossibly high.

Monday Market Wrap

  • DJIA: -0.61% or -148.04 points to close at 24,163.15
  • S&P 500: -0.82% or -21.86 points to close at 2,648.05
  • Nasdaq: -0.75% or -53.53 points to close at 7,066.27

Monday’s Big Gainers

E-commerce platform beats on earnings.

Refiner plans to merge with peer Marathon Petroleum (NYSE: MPC).

Logistics firm targeted for merger.

Monday’s Big Decliners

Pharmacy chain’s CEO steps down.

Telecoms planned merger with TMUS raises doubts.

Proposed merger with Sprint faces regulatory hurdles.

Letters to the Editor

“Why do most economists say Brexit is bad for the British economy?” — Jason G.

Britain’s exit from the European Union would weigh on the country’s £229 billion annual trade with the EU, because Brexit would result in new trade barriers and tariffs.

A primary advantage of EU membership is free trade among member nations, which makes exporting goods to other EU countries cheaper and easier for British companies.

Got questions about rising bond yields and how they affect your investments? Drop me a line:

John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.

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