(Oct 24): Big tech climbed in late hours as Tesla Inc kicked off the “Magnificent Seven” earnings season with solid results. Bond yields rose on bets the Federal Reserve will take a measured approach on rate cuts.

Following a stock-market selloff on Wednesday, Wall Street pointed to a rebound led by its most-influential group. A US$300 billion (RM1.31 trillion) exchange-traded fund tracking the tech-heavy Nasdaq 100 gained after the close of regular trading. Tesla jumped 9% as Elon Musk’s electric-vehicle giant also indicated it expects another strong quarter of deliveries, saying it anticipates higher volumes for the full year.

“Earnings season is heating up. We believe there is continued upside ahead for stocks, especially now that we are entering a seasonally strong period of the year for markets,” said David Laut at Abound Financial.

After last week’s rally to fresh all-time highs, equities have taken a breather, with investors fretting over a number of near-term risks. The next three weeks capture big tech earnings, October’s payrolls report, and the US election, followed by the Fed meeting.

“Despite the possibility of more volatility as we get deeper into earnings season and close in on the November election, the market’s longer-term outlook remains solid,” said Daniel Skelly at Morgan Stanley’s Wealth Management. “And even though this week’s move is a reminder that even the strongest trends have setbacks, so far, this has been a run-of-the-mill pullback for the major indexes.”

The S&P 500 fell 0.9%. The Nasdaq 100 dropped 1.6%. The Dow Jones Industrial Average slipped 1%. International Business Machines Corp declined as its revenue underwhelmed. T-Mobile US Inc raised its forecast for subscribers after a strong quarter.

Treasury 10-year yields rose three basis points to 4.23%. The dollar rose. The yen hit the lowest in almost three months, reviving concern that Japan may intervene. The loonie slid after the Bank of Canada stepped up the pace of easing.

To Jonathan Krinsky at BTIG, equities are finally noticing the moves in bonds and the dollar. That’s a stark contrast to the action in the last couple of weeks, with the bullish narrative being that bonds were re-pricing to where they should be based on the stronger-than-anticipated economy, he noted. 

“While that might be fair in the big picture, markets are always concerned with the velocity of the move rather than the overall level, and the fact that stocks didn’t flinch in the face of those moves suggested complacency,” Krinsky said. “Whether this is the start of the pre-election jitters or not, we continue to see downside risk for equities broadly over the coming weeks, with an SPX pullback into the 5,500-5,650 zone a decent probability.”

The price of options that protect against an extended slump in treasuries has soared to the highest this year amid concerns that losses may deepen.

Meantime, swap prices reflect less than a 100% certainty that the central bank reduces rates at each of its two remaining policy meetings this year. The bond market is also trimming bets on the degree of Fed rate reductions over the next year.

“The price of options to hedge against treasury losses is soaring,” said Andrew Brenner at NatAlliance Securities. “In the US, it is about the election and potential sweep. That is what is being built into the rate structure, which is giving the vigilantes the green light. It will reverse, but it might take a severe employment number or a surprise in the election.”

“We would caution investors from reading too much into the recent rise in bond yields,” said Tiffany Wilding at Pacific Investment Management Co. “Over the past six major Fed rate-cutting cycles, the change in the 10-year treasury yield a month after the first cut has not provided a consistent signal about the magnitude of further cuts or whether the US economy falls into recession.”

In fact, yields rose in the month after the first cut more often than not, she noted.

“Equity market performance in the first month after the Fed starts cutting has been a similarly bad predictor of future economic performance (and market returns),” Wilding said. “Equities, more often than not, have tended to rise in the month after a cutting cycle begins, despite more significant divergence as time goes on.”

Looking at the same starkly different cycles of 1995 and 2007, equity returns (proxied by the rate-sensitive Russell 2000 of small caps) in the month after the first cut were positive in both cycles (at 4.6% and 6.9%, respectively), Wilding said. However, equity market performance was down 4.4% in the year after the 2007 cut, while it was up 21% in the year following the 1995 adjustment.

“Even with the recent move in 10-year treasury yields, we remain bullish on US large caps,” said Nicholas Colas at DataTrek Research. “History says to discount the idea that rates will blow out because of deficit worries, at least over the near term. Instead, we see higher yields as a sign that economic growth remains robust and corporate earnings growth should continue over the coming quarters.”

“All else equal, the more rate cuts that are removed for next year the less of an outlier reading it becomes for the market to achieve 15% earnings growth,” said Ryan Grabinski at Strategas. “However, additional rates cuts do not change the challenges the S&P faces with achieving that growth rate.” 

Sales growth continues to show signs of slowing, and if analysts were suggesting rate cuts would reduce interest expense, that argument is beginning to recede, Grabinski said. 

“Nearly 14% EPS margins continue to look more and more difficult to achieve,” he added. “The question is when does something give.”

To Jose Torres at Interactive Brokers, the equity market is extremely fragile considering the headwinds that are lurking right around the corner.

“Earnings expectations are buoyant for next year, which increases the importance of forward guidance rather than past results,” he said. “When considering that valuations are around 22 times next year’s profits, any disappointment in the outlook for the bottom line can significantly impact stock market performance.”