Credit: Shutterstock photoThis will be a week packed with earnings releases, many of which, such as Alphabet (GOOG, GOOGL) this evening and Caterpillar (CAT) tomorrow, have been eagerly awaited. These also have the potential for significance beyond the companies themselves, reflecting larger trends or themes.
However, it is quite possible that the focus of the financial media will not be on those earnings this week, but rather on a market that is usually considered staid and boring and is therefore usually given much less attention than it deserves: Treasuries.
Or, more specifically, the 10-Year T-Note, and its flirtation with a three percent yield.
Media coverage is not always correlated with significance, so should investors care where 10-Year yields trade? The answer is yes, but with a couple of provisos.
One of the things that I was taught early in my dealing room career was not to underestimate the bond market. Financial news is usually focused on stocks which, given that is where most investors have most of their money, makes sense. Traders however, understand that more often than not, the price of equities is a function of the price and yield of bonds, not, as the media coverage would suggest, the other way around.
Usually, yields and stock prices tend to move in unison. Treasury yields rise when the price of the bonds falls, so a jump in yields is generally seen as a sign that investors are moving from the “safe” bond market to the riskier stock market. That in turn indicates confidence in the economy.
This week, though, a break above 3% will send a different message and could easily spark a big selloff in stocks.
That is because this jump in yields is a product of the Fed raising rates, rather than a move driven by market sentiment. Obviously, the Fed wouldn’t be doing that if they weren’t confident the economy could withstand it, but most would say that it is low interest rates are what have stimulated the recovery and driven stock prices higher over the last decade or so.
Investors, faced with a paltry 2.5% return on Treasuries, have been forced into the stock market, thus pushing stocks ever higher. The fear is that that is an artificial move up prompted by the Fed’s actions, and that when rising yields make bonds more attractive and discourage borrowing and investment, stocks will collapse.
Investors, it seems have settled on the 3% level as significant in that regard. The last time we threatened that level back in February the well-respected veteran trader and CNBC contributor Art Cashin said that if it was hit, "all hell" would break loose. However, that doesn’t mean that if yields hit 3.01% you should immediately sell everything.
In trading, round numbers are psychologically important, but a break of them can be misleading, and it is better to wait for confirmation of the break before reading too much into a few trades. Certain levels gain significance in real terms when they attract a lot of orders. There will be those looking to buy the 10-Year Note just below the 3% yield as it represents the top of a long-standing range, and some, often the same people, looking to sell as a stop loss on a breakout above that level.
The tendency of traders to squeeze those orders means that a breakout isn’t confirmed immediately a trade takes place above 3%. That would only be the case if yields move higher and stay there for long enough to account for the fast money trades.
It is possible that that will happen this week, but a quick visit to a three handle then a drop back looks more likely at this point, at least initially. As you can see from the chart, this is the second try at 3%. Traders’ conventional wisdom is that the third attempt at any significant point of support or resistance is far more likely to succeed than the second, so a break just above three will attract a lot of bond buyers, pushing yields back down before a breakout is established.
At some point, though, the 10-Year will break clear, and when that happens Cashin’s February prediction could easily come true.
Usually during earnings season, my advice is to look away from distractions and to focus on what counts: corporate profits. This week is different. A clean, sustained break of 3% in the 10-Year yield would not be a distraction. It would be a real indicator of a new, higher range for rates across the board, and that would be bad news for a stock market fueled by easy money. So, as important as earnings are, pay attention to the 10-Year!
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
