Strong Earnings Season Pushes Stocks Higher

The stock market rebounded from its longest downward streak in 2023, thanks to a slew of corporate earnings reports. Notably, Microsoft Corp. and Google's parent company, Alphabet Inc., released their financial results after the close of trading.

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The S&P 500 put a stop to its five-day decline. Positive data indicating an increase in U.S. business activity amid moderating inflation provided a boost to investor sentiment. Verizon Communications Inc. exceeded expectations with its results, and companies such as 3M Co., Coca-Cola Co., and General Electric Co. saw gains due to optimistic forecasts. Concurrently, shares of businesses associated with cryptocurrencies saw an uptick as the price of Bitcoin briefly surpassed $35,000. Meanwhile, the yield on the 10-year Treasury hovered around 4.9%, following a day of significant volatility in the bond market. In contrast, the price of oil dipped below $85 per barrel.

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Investors seeking a ray of hope during the earnings season are pinning their expectations on the tech giants. The five largest companies in the S&P 500—Apple Inc., Microsoft, Alphabet, Amazon.com Inc., and Nvidia Corp.—account for approximately one-quarter of the benchmark's total market capitalization. Analyst estimates compiled by Bloomberg Intelligence suggest that their earnings are projected to increase by an average of 34% compared to the previous year.

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According to David Trainer, the CEO of New Constructs, the performance of these major tech companies tends to have a significant impact on the broader market. He states, "Strong big tech earnings may just be what's needed to end the stock market correction that started in late July. If big tech companies exceed expectations and provide robust guidance for future earnings, we could witness a strong rally in the stock market through the year's end."

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The rise in interest rates has made already lofty valuations in the big tech sector appear even pricier, with this group remaining the most crowded trade among fund managers, according to Bank of America Corp. Consequently, investors are willing to pay extra for insurance against a potential downturn in companies like Alphabet and Microsoft, both of which have been instrumental in driving the S&P 500's gains this year. Investors are banking on these companies to deliver substantial earnings growth that can propel their stocks higher or, at the very least, justify this year's price increases.

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The pain experienced by long-term growth stocks, exacerbated by the recent surge in Treasury yields, may soon begin to subside. This shift is suggested by the Taylor Rule, an equation developed by economist John Taylor in 1993. It is used to gauge how the Federal Reserve can utilize its overnight bank lending rate to manage inflation or stimulate the U.S. economy. The Taylor Rule is now approaching a pivotal point for the U.S. equity market, indicating that the central bank has at last normalized interest rates.

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Vanguard Group Inc. has a message for investors awaiting a clear signal before reentering the fixed-income market following a challenging period this summer: "Shake it off." The world's second-largest asset manager, overseeing $7.8 trillion globally, expects interest rates to remain elevated for an extended period and foresees a mild recession around mid-2024, with limited potential for high-grade spreads to tighten.

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In other parts of the world, Chinese President Xi Jinping has increased support for the world's second-largest economy by issuing more sovereign debt, raising the budget deficit ratio, and making an unprecedented visit to the central bank. Bank of Japan officials are likely to closely monitor bond yield movements until the last minute before deciding whether to adjust the yield curve control program at a policy meeting next week, according to sources familiar with the matter.

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European Central Bank chief Christine Lagarde believes the fight against inflation is progressing well, but the lack of a regional agreement on fiscal rules is becoming a source of concern, according to insiders.

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