Bond Yields And The Stock Market

During the week of January 6 to January 10, 2025, U.S. stock markets experienced notable declines, influenced by economic data and sector-specific developments.

Market Performance:

Dow Jones Industrial Average (DIA): Fell approximately 1.7% over the week, marking its worst start to a year since 2016. Source: MarketWatch.

S&P 500 (SPY): Declined about 1.5%, with significant losses in rate-sensitive sectors such as real estate and technology. Source: AP News.

Nasdaq Composite (QQQ): Dropped around 2.1%, reflecting substantial declines in the technology sector. Source: LPL Financial.

Key Influences:

• Employment Data: A stronger-than-expected jobs report revealed the addition of 256,000 jobs in December, reducing the unemployment rate to 4.1%. This robust labor market data led to concerns about sustained inflation and the Federal Reserve's potential delay in cutting interest rates, contributing to market declines. Source: WSJ.
• Sector Movements:
• Technology: Experienced declines due to rising Treasury yields and profit-taking after previous gains. Source: LPL Financial.
• Real Estate: Fell sharply, with the sector down 4% for the week, as higher interest rates impacted rate-sensitive industries. Source: LPL Financial.
• Energy: Contrarily, the energy sector saw gains, with a weekly increase of 0.82%, supported by rising oil and natural gas prices. Source: LPL Financial.

Notable Company Performances:

• Walgreens Boots Alliance (WBA): Shares surged 27.6% after reporting better-than-expected sales and profits. Source: Investopedia.
• Constellation Brands (STZ): Stock plummeted 17.1%, reflecting investor concerns despite positive earnings. Source: Investopedia.
• Delta Air Lines (DAL): Shares rose 9% following strong quarterly revenue reports, driven by high demand for premium travel. Source: WSJ.

Economic Indicators:

• Treasury Yields: The 10-year Treasury yield increased to 4.772%, the highest since November 2023, influencing borrowing costs and investor sentiment. Source: WSJ.
• Federal Reserve Outlook: The strong employment data has led traders to anticipate that the Federal Reserve may maintain its current interest rates longer than previously expected, affecting market expectations. Source: MarketWatch.

In summary, the first full trading week of 2025 was marked by declines across major U.S. stock indexes, driven by robust employment data that tempered expectations for near-term interest rate cuts, alongside sector-specific developments influencing individual stock performances.

Having delivered a percentage point of interest-rate cuts in the closing months of last year, Federal Reserve officials have entered 2025 with open minds. Policy has been “recalibrated” for the current economic backdrop, and incoming data on growth and inflation—plus the actions of the incoming Trump administration—will be the Fed’s guide from here.

December jobs data released on Friday made no case for urgency. The U.S. economy added 256,000 nonfarm payrolls last month, as unemployment ticked down by a tenth of a percentage point, to 4.1%.

Both figures were stronger than expected. Economists had been forecasting a slowdown after November’s rebound from a hurricane-wracked October. Instead, December hiring topped November’s total.

Markets had a decidedly good-news-is-bad-news reaction to the jobs data, with bonds and stocks dropping in unison on Friday. Growth and value stocks alike fell, as the small-cap Russell 2000 (RUT -2.22%) index entered correction territory, down 10% from its postelection peak.

Treasuries sold off across the maturity curve. On the short end, yields, which move inversely to prices, rose as investors further dialed back the odds of Fed easing, pushing the lone rate cut expected in 2025 to June from May. Further out on the curve, the 10-year Treasury note yield topped 4.75%, a level last seen in late 2023 and up by more than a percentage point since the Fed began cutting interest rates in September.

That rise has been driven by more than the economic and Fed outlooks. Few things are as bipartisan in Washington these days as deficit spending, and bond investors appear to be taking the view that heavy federal borrowing will persist through the new administration and beyond.

Further, President-elect Donald Trump has promised potential growth- and inflation-boosting policies, including tariffs, lower taxes, fewer regulations, and strict limits on immigration. But the still-uncertain extent and timing of these actions will determine their ultimate economic effects—and the appropriate Fed response.

In recent remarks, several members of the Federal Open Market Committee offered few firm predictions about inflation, jobs growth, and the economy in 2025—other than a continued expansion, which is decidedly the consensus view. The word “uncertainty” was used a dozen times in the minutes from the December FOMC meeting, published on Wednesday.

“Even when you know the direction you’re going, it’s hard to book a trip without knowing your final destination,” Federal Reserve Bank of Richmond President Tom Barkin said this past week.

The Fed is back to a data-dependent, wait-and-see approach to interest rates. It’s a similar stance to the one officials adopted in the second half of 2023 and for most of 2024, with interest rates at a two-decade high, inflation elevated but falling, and the labor market cooling. Recognizing progress on reducing inflation and seeking to keep the economic expansion going, policymakers moved to reduce the restrictiveness of policy in September.

Not much has changed since then: The unemployment rate has held at 4.1% or 4.2% for the past five months, while the core personal consumption expenditures price index—the Fed’s preferred inflation measure, without food and energy components—has been stuck at an annual rise of 2.7% or 2.8% through each month since August. That’s a historically healthy labor market, while inflation remains closer to 3% than the Fed’s 2% target.

In a speech on Thursday, Federal Reserve governor Michelle Bowman called the Fed’s December rate cut the “final step in the policy recalibration phase.” Investors should consider interest rates on hold for now—until the data and Washington policy break in one direction or the other.

Bond Yields Are Rising. Why That’s a Problem for Stocks

Is the stock market about to yield to reality?

That is yield as in the interest return on long-term debt securities. And the reality is that yields are headed higher as a result of real economic growth and inflation that continues to exceed most forecasters’ assumptions, which in turn suggests fewer, if any, short-term interest rate cuts by the Federal Reserve this year.

For stocks, higher bond yields imply no increase in price/earnings ratios and possibly some contraction from current levels. And those P/E multiples incorporate optimism about another year of double-digit earnings growth.

Add to those concerns the uncertainty of policies from the new Trump administration’s fiscal and trade policies, and you have the formula for sharp selloffs in bonds and stocks.

These forces came to a head on Friday after the Labor Department reported much-stronger-than-expected December job growth, which prompted a further recalibration in Fed policy expectations by traders and a further rise in medium- and long-term Treasury yields. Nonfarm payrolls jumped by 256,000 last month, about 100,000 more than economists’ guesses, while the unemployment rate dipped by 0.1 percentage point, to 4.1%. There were few nits to pick in the numbers, with only minor downward net revisions in the two previous months’ payrolls. (See this week’s Economy column for more details.)

After the employment report, markets further lowered the odds of Fed rate hikes this year. According to the CME FedWatch site, federal-funds futures are pricing in no cuts through June from the target range of 4.25% to 4.50% set at December’s meeting, and a single trim of 25 basis points (one-quarter percentage point) by December. A month ago, futures were pricing in two 25-basis-point cuts by midyear and possibly a third by year end.

“With the December jobs report, the only mystery is why the market is still forecasting cuts in the funds rate in 2025 and 2026,” Steven Blitz, chief U.S. economist at TS Lombard, wrote in a research note on Friday. Expectations of monetary easing are based on the assumption of a return to 2% inflation, which won’t happen absent a recession. That’s unlikely given the incoming administration’s and the Fed’s shared inclinations to promote growth, he added.

Instead, Blitz sees 3% real gross-domestic-product growth and 3% inflation. With no anticipated Fed rate cuts in 2025 and 100 basis points of potential hikes in 2026, getting to a 6% 10-year Treasury yield is “far from a stretch given history and the volatility that the Trump administration is bound to usher in.”

Treasuries are actually entering the sixth year of the third “great bond bear market of the past 240 years,” notes BofA Global Research’s strategy team led by Michael Hartnett. Previous secular trends of rising bond yields spanned 1899 to 1920 and 1946 to 1981. They count the current bear market (in lower prices and higher yields) from the summer of 2020, when the 10-year bottomed at 0.56%. On Friday the 10-year yield reached 4.77%, the highest since Nov. 1, 2023, and just above the 4.75% average since 1790, as calculated by BofA.

Corporations have responded by bringing to market a heavy slate of $80 billion of investment-grade securities since the start of the year through Wednesday (before most markets were closed on Thursday for former President Jimmy Carter), compared with the average of $66 billion in corresponding periods in 2022-24, says BofA. Corporate treasurers appear to be taking advantage of current financing terms before yields rise further.

Rising bond yields are also an international phenomenon. Government yields are moving up in Europe, where growth is tepid and budget strains prevail, especially in France and the U.K. Interest rates in Brazil have also been forced higher by debt concerns.

In the U.S., higher yields present a tough hurdle for equities. The S&P 500 index (SPX -1.54%) trades at 22 times expected forward earnings, wrote Jason De Sena Trennert, head of Strategas Research. That heady valuation also presumes another year of double-digit earnings growth on top of yet-to-be-reported final 2024 numbers.

Further, it’s difficult to justify P/E expansion without a meaningful decline in long-term interest rates and another period of “irrational exuberance” as seen in the 1990s. Trennert adds that odds of the latter might be greater than presumed given the incoming administration’s anticipated deregulation and more pro-business stance. (It should be noted he has said he is open to accepting a position in the Trump administration.) But given the struggles stocks have shown when the 10-year Treasury tops 4.50%, “discretion may be the better part of valor in 2025,” he concludes.

With increased pressure on P/E multiples from rising bond yields, the fourth-quarter earnings season about to start takes on even greater importance. As always, the outlooks for future quarters presented in earnings calls count more than the numbers for the quarter just ended. Along with weak growth abroad, higher-for-longer U.S. rates present risks for growth and equity valuations.

A large part of the near-term direction of a shaky stock market will be determined this week. Fourth quarter earnings season starts on Wednesday January 15. I intend to tread very carefully.

Factors this week I'm focusing on this week:

1) Earnings season kicks off with big banks and brokerages announcing results.

2) CPI on Wednesday

3) Thursday earnings continue with TSM and UNH set to report

4) Thursday the Census Bureau reports retail and food services sales for December

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DATA: Barron’s print edition page 34 1/13/25 Market Week Avi Salzman

Paragraph: one ChatGPT market recap for the week of 1/6/25-1/10/25 As stated above

Paragraph: two Barron’s print edition page 33 1/13/25 Fed Uncertainty Nicholas Jasinski

Paragraph: three Barron’s print edition page 6 1/13/25 Bond Yields Randall W. Forsyth

Paragraph: five Closing remarks Richie Naso opinion