Wall Street rounded out the week on a positive note on Friday, the first day of Q4. In the debt market, the 10-year U.S. Treasury bonds gained some ground as prices edged higher, driving yields below the psychological 1.50 percent mark. In the equity markets, all major indexes edged higher, led by small caps. In cryptocurrency markets, Bitcoin staged a strong rally. There was a weak spot, too—the foreign currency markets, where the dollar continued its slide against major currencies.
Will the positive tone of the first day of the new quarter carry through the end of the quarter? It’s hard to say. One day’s gains don’t signal an upward trend, especially if that day follows several days of losses. Instead, we can point to three factors that will drive markets in Q4: earnings, bond yields, and Washington politics.
Earnings
“Corporate earnings are the milk of Wall Street,” goes the adage in the circles of traders and investors who have been around for a long time. As a result, earnings are the critical variable in equity valuation models, which look beyond the short-term market gyrations fueled by emotions, to the fundamental value of listed companies.
So far this year, earnings have been strong for the broad market, and they will continue to be good, according to FactSet, which keeps a tally of corporate profits and analyst estimates.
“During the third quarter, analysts increased earnings estimates for companies in the S&P 500 for the quarter,” writes John Butters, VP and Senior Analyst of the company. “The Q3 bottom-up EPS estimate (which is an aggregation of the median EPS estimates for Q3 for all the companies in the index) increased by 2.9% (to $48.89 from $47.50) during this period.”
Butters points out that Q3 earnings marked the most extended period of consecutive quarterly increases since FactSet began tracking this metric in 2002.
In short, earnings will continue to be a tailwind for Wall Street.
Treasury Bond Yields
If corporate earnings are the “milk” of Wall Street, Treasury bond yields are the “alcohol” of Wall Street, one could say. They are also a key variable in equity valuation models. For example, bond yields are inputs in calculating the weighted cost of capital (WACC), which is used to discount future earnings and free cash values, to determine the intrinsic value of listed companies.
Lower bond yields make future earnings more valuable, pushing equity valuations higher. At the same time, higher bond yields make future earnings less valuable, pushing equity valuations lower.
For most of the year, the 10-year U.S. Treasury bond yields have stayed lower, flirting with the 1 percent mark. That has changed since early September, when bond yields turned north, flirting with the 1.50 percent mark. European bonds followed suit, with the 10-year German Treasury bond yields continuing to trade with negative yields, although they have risen from -0.45% to -0.2% over said period. Meanwhile, the 10-year Japanese Treasury bond yields edged higher over said period, to 0.07%.
In short, bond yields are beginning to turn from a tailwind to a headwind, as investors have to re-think equity valuations.
Washington Politics
There was a time when Washington politics were a big tailwind for markets. That was at the beginning of the pandemic in the winter of 2020, when politicians of all stripes united to pass unprecedented fiscal stimulus packages. The packages were designed to help the economy overcome the recession caused by the COVID-19 pandemic.
Now, this tailwind is turning into a headwind, as Washington must find ways to pay the stimulus bill and to deal with the looming debt limit, which threatens to push the nation into its first default. Politics have been interfering in the decision making on these matters, to say the least.
The Bottom Line
Markets are caught in the midst of the tailwinds of higher earnings, the headwinds of higher bond yields, and the headwinds of Washington politics. The combination makes it hard to predict where markets will be at the end of the quarter.
Disclaimer: The information contained in this article represents the views and opinion of the writer only, and not the views or opinion of TipRanks or its affiliates, and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices or performance.