Stocks plunge amid rising interest rates

Posted
Matt Phillips

The New York Times



Stocks suffered their steepest drop in six months Wednesday, as investors continued to digest rising interest rates and previously high-flying tech shares tumbled.

The Standard & Poor's 500-stock index dropped roughly 1.9 percent by midafternoon, bringing the broad equity bench mark down 3 percent for the month. The yield on the 10-year Treasury note, a key measure of borrowing costs, inched up to 3.24 percent.

The recent rise in bond yields — which are now at seven-year highs — has become a keen concern for stock market investors. It is something of a double-edged sword. Rising bond yields reflect the strength of the U.S. economy, where unemployment is at 49-year lows. But the yields also serve as a baseline for key borrowing costs, including those for home mortgages.

"Stock markets like rising interest rates because they tend to signal a strong economic backdrop," said Jonathan Golub, chief U.S. equity strategist for Credit Suisse. "That said, stock markets do not like very abrupt, large moves."

Some interest rate-sensitive areas of the market have suffered steep drops along with the upward move in borrowing costs. The rise in interest rates has pushed conventional 30-year mortgage rates toward 5 percent, hurting both home affordability and the share price of homebuilders.

Shares of homebuilders in the S&P 500 are down more than 4 percent this month, worse than the 3 percent drop for the overall index. So far this year, homebuilding stocks are down more than 25 percent.

But besides rising interest rates, other worries continue dog investors who have ridden the nearly decadelong bull market in stocks.

The tech-heavy Nasdaq Composite index, which was one of the best performing financial assets earlier this year, has already dropped more than 5.5 percent in October. Semiconductor stocks have been particularly hard hit, with the Philadelphia Semiconductor index down more than 7 percent in the month. With large global supply chains centering in Asia, semiconductor shares have been something of a bellwether for the ongoing trade tensions between the United States and China.

"It looks as though Trump is settling most of the trade skirmishes around the world that he started earlier this year with one important exception," said Ed Yardeni, president of stock market research firm Yardeni Research. "It looks like China is going to be a long-term issue."

Investors seem to be taking something of a cue from Vice President Mike Pence's hawkish speech on policy toward China last week. Separately, Bloomberg Businessweek published a story last week describing how Chinese spies used technology embedded on microchips to infiltrate U.S. companies.

"There's an increasing realization in the market that this is not just about the trade deficit. This is about security concerns, this is about geopolitical strength," said Evan Brown, director of asset allocation at UBS Asset Management. "It's about encouraging U.S. companies to move their supply chains out of China. And so there are questions about a broader disruption and potential legislation or scrutiny in these markets."

Many market observers expect strong third-quarter earnings will be enough to help stocks recover from the recent tumble. Those reports will start to flow in earnest this Friday, when large banks J.P. Morgan Chase, Wells Fargo and Citigroup are slated to post results.

Thanks to the strength of the economy and steep cuts in corporate tax rates, corporate earnings are expected to rise more than 20 percent from the third quarter of 2017, according to John Butters, an earnings analyst with FactSet. That would be the third consecutive quarter of earnings growth of more than 20 percent.

But there are some risks to that outlook. As the economy heats up, costs are climbing and starting to eat into relatively fat profit margins. On Wednesday, Fastenal, a company that makes products such as industrial bins used on factory floors, reported better-than-expected profit and sales numbers. But its profit margin fell short of expectations, and the stock fell more than 5 percent.

"We are starting to see some margin pressure from higher raw materials and energy and labor costs," said Savita Subramanian, equity strategist with Bank of America Merrill Lynch. Still, she stressed that strong economic demand should support corporate profits, even if margins start to contract.

That is one reason she thinks that the stock market remains an attractive place for investors, even with rising inflation and interest rates.

"I would stick with equities for the time being," she said.

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