Talk of an earnings recession is so last-week. With numbers in for just over 20% of S&P 500 (.SPX) members, the latest growth prediction stands at negative 3.3%. That’s as good as a gain, and it pushed market indexes to new highs on Tuesday.
Two things we knew going into reporting season were that the earnings growth consensus stood at negative 4.3%, and that companies would surely surprise to the upside. They almost always do. The only question was whether it would be a big surprise or a small one.
It’s a big one so far. According to FactSet, earnings have come in 6.3% ahead of expectations. The five-year average is 4.8%. At this rate, better-than-expected results might be enough to pull earnings just above break even versus a year ago, averting an earnings recession.
Coca-Cola (KO), United Technologies (UTX), and Twitter (TWTR) were among the companies driving the market higher on Tuesday following well-received financial reports. They helped the S&P 500 close up 0.9% at a new record high of 2933.68. The Dow Jones Industrial Average (.DJI) also gained 0.5%. The Nasdaq Composite (.IXIC) also reached a new high, adding 1.3%.
The prospect of a slight earnings gain for the first quarter might not sound especially positive compared with last year’s 22% earnings growth, but it’s bullish enough to send the stock market still higher from here.
That’s because interest rates are still the most powerful force in the financial universe. In recent years, the Federal Reserve has hiked its core federal-funds rate from near zero to a target range of 2.25% to 2.50%. That had a muted effect on long-term bond rates, but it had threatened to raise short rates high enough to compete with stocks for investor affection.
This year, however, the Fed has signaled that it will stay put on rates for now. The 10-year Treasury recently yielded 2.6%, while the S&P 500 index traded at 18 times last year’s earnings. That’s equivalent to an earnings “yield”—earnings divided by price—of about 5.5%.
That’s quite a spread. The 10-year Treasury normally has a lower yield than the stock market, because of its higher relative safety. But the historical average yield for the 10-year Treasury is between 5% and 6%, and for the stock market, the long-term average earnings yield is between 6% and 7%.
The alternatives to stocks are so stingily priced at the moment that the market doesn’t need much of an excuse to rise. As it hits new highs in coming days, give 25% of the credit to the realization that we’re dodging an earnings recession, and the remaining 75% to a foreseeable future of still-low rates.
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