Disconnect Forms Between Earnings & Stocks; "Conflicting Narratives" in AI & Yields

Sam (0:00)

Welcome back to Morning Trade Live. It's time now for the big picture. Let's welcome in the team from Charles Schwab, Cooper Howard, Director of Fixed Income Research and Strategy, Schwab Center for Financial Research, and Alexandra Semenova, Financial Insight Strategist over at Charles Schwab. Good morning to both of you. Thank you so much for your time. Happy Friday. All right, let's start with the earnings because it's been interesting hearing from some of these companies now that we're really in the thick of it. Obviously tech, regional banks, but also the big ones. What have you made of what they've said and the reaction we've seen so far?

Alexandra Semenova (0:28)

Yeah, Sam, well, the reaction is kind of telling us everything. The thing that I've been watching most closely is the disconnect between what companies are reporting and generally muted to negative stock reaction to solid results, which tells us that the bar is much higher for companies to deliver. We have all seen the parabolic charts for earnings expectations. And so the onus is really on guidance, this reporting cycle and investors will want to hear from management that companies can deliver on those expectations.

Historically, the earnings season has been a bullish catalyst for markets. From the unofficial start of the reporting cycle marked by JP Morgan to the unofficial end marked by Walmart, the S&P 500 has climbed roughly 70 percent of the time historically. But the beats are no longer going to be enough. We're going to want to hear from management that they have an optimistic outlook about how they can deliver on strong fundamentals.

Sam (1:21)

And we got that from ASML and TSMC.

Yet, look at the state of this AI trade. It's been incredible what has offset what have been undoubtedly amazing numbers from some of these companies. So you raise a really good interesting point around raising the bar right now. Cooper, I want to get to you because in a bid to seek shelter this week, investors went to bonds. I mean, this bond buying has really been the story of the week here. I was looking at some of the fund flows. Treasury's had the 16th week of inflows. That's the longest streak since August 2024 What has that told you about fixed income?

Cooper Howard (1:56)

Yeah, definitely. Thank you for having me on this morning. I think it's a very interesting week. If you came in on Monday and you told me that we were going to see a hotter than expected PPI, hotter than expected CPI and yields would be lower on the week, I'd put a low probability on that. But here's where we are right now. I think really what we're seeing is too conflicting narrative that's happening in the Treasury market right now.

One is potential that the AI build out is a little bit stretched and might have a little bit of a concern weighing on overall economic growth. So that's pulled yields a little bit lower. But then also, like I'd mentioned earlier, we're just seeing elevated levels of inflation through PPI, through CPI. So that's putting a little bit of upward pressure on yield. So going forward, Sam, our expectation is that we have a fair value top of the fair value range is about 5%.

Now, that's not to say that it can't trade outside of that fair value range for an extended period of time. That's actually kind of what we're seeing right now. But I wouldn't be surprised if we continue to see a lot of that volatility in the fixed income markets, especially with treasury rates, as we balance between this push-pull narrative of is there going to be a potential slowdown in economic growth due to the AI build-out or is inflation going to continue to remain elevated for an extended period of time and put upward pressure on yields going forward?

Sam (3:17)

All right. Obviously, I don't think north of 5% was really on anyone's bingo card coming into the week. We certainly have seen those credit spreads widening, a few concerns around what's happening over the corporates.

We've seen a flattening of the curve. I know that this is something you've been watching, Alex, very closely, particularly that 5% on the 10-year. I mean, what does that mean for corporate America in light of the earnings you just mentioned?

Alexandra Semenova (3:41)

Yeah, again, it means that the bar is even higher for earnings to deliver when you are now competing with the income that you're getting from bonds, right?

And also one interesting thing, Sam, of course, has been the disconnect in breadth in the market. So for September, the S&P 500, the cap-weighted version was down about, I think, 0.3% and the equal-weighted version down more than 5%. So it's a tale of two markets where at the index level they're still not that far off from all-time highs, but the majority of stocks are in a bear market. And one thing that we will want to see is a broadening out and whether the earnings season can provide that to give us a more solid foundation going into year end. Yesterday was actually one of the best days for breadth since June. So it is pretty reassuring to see that investors are kind of rotating into other pockets of the market as kind of a defensive play. So we'll see if that continues to play out, especially against this backdrop of higher yields, continued uncertainty around the Fed and of course, the midterm election coming up.