Yields in Focus After Big Dip Boosts Non-AI Stocks

Colette Eau Claire (0:05)

Welcome to the Schwab Market Update Podcast, where we prepare you for each trading day with a recap of recent news and a look at what's ahead.

I'm Colette Eau Claire, and here is Schwab's Early Look at the Markets for Friday, October 16th. Treasury yields declined dramatically late this week, despite mounting inflation. The decline from 24-year highs in the 10-year note yield fueled a comeback Thursday on Wall Street powered by rate-sensitive cyclical sectors like financials and industrials, though defensive healthcare-led AI continued to struggle. Today lacks the data and earnings punch of the last few sessions, and Monday is also quiet giving investors a chance to contemplate an eventful week and watch geopolitical developments. Prude oil remains near recent highs amid clashes overseas, a major factor behind the inflation worries. Typically, the type of inflation in this week's September Consumer Price Index or CPI and Producer Price Index or PPI would kick yields into higher gear on worries of Federal Reserve rate hikes and overheating economic growth. This time around, though, investors seem to gravitate toward perceived safety, buying Treasuries and stocks in more defensive sectors amid market and geopolitical turmoil. AI and chip-related stocks continue to struggle late this week, however, as investors reassessed whether heavily indebted data center, software and semiconductor companies can turn today's enormous capital spending into tomorrow's profits. Last week's report of slower revenue growth at OpenAI and worries about cheaper memory chip competition from China dogged the chip market recently. PPI show troubling signs of higher energy costs seeping into the broader economy, something that might trouble the Fed as it tries to keep inflation expectations anchored amid the gas price blowout. Core PPI surged 0.7% monthly, excluding food and energy, well above expectations of 0.3% and the most dramatic rise in four years. Monthly headline PPI, which includes energy, soared 1.3%, a sizzling 6.3% annual rise in the headline number compared with expectations of 5.3%, or annual PPI of 5% compared with expectations of 4.4%, and is running at a 5.11% annual pace over the last three months. Energy continues to be the main culprit, said Cooper Howard, Director of Fixed Income Research and Strategy at the Schwab Center for Financial Research, or SCIFR. A risk is that higher diesel and energy prices begin to bleed into other categories, and PPI suggests that's the case. For the Fed, this report, combined with CPI, raises the odds of a rate hike in October. We expect two more hikes this cycle, depending on the pace and breadth of inflation.

As of late Thursday, however, chances of a Fed rate hike later this month fell to 27% from 33% a day earlier, according to the CME FedWatch tool. For the full year, odds of at least one more rate hike were 89%.

Both CPI and PPI could factor into the September Personal Consumption Expenditures, or PCE, prices report, the Fed's favorite inflation meter, due later this month. For PPI metrics that map over to PCE, airfares were the standout, increasing 5% month over month. The Fed got more news of a hot economy Thursday, as September retail sales growth of 0.8% easily outpaced expectations of 0.3%. This backed what bank executives said on earnings calls earlier this week about a strong business and consumer climate, plentiful loan demand, and little in the way of credit worries. Several Fed speakers said this week they support more rate hikes, but the question is whether that happens at the October 28th meeting or in December. All of which raises the question why Treasury yields suffered their biggest decline since June on Thursday, falling to the lowest level since September 23rd for the 10-year note. This could reflect investors seeking perceived safety in Treasuries amid rising geopolitical tension between Russia and Ukraine and in the Middle East. The coming US midterm election might also be a factor. However, the dive in yields is only a little more than 24 hours old, so it's early to draw conclusions or state that the long yield rally is over. The swing from a peak 10-year yield near 5.33 percent to a low of 5.05 percent over 24 hours also suggests investors are balancing renewed bed risk against concern that tighter financial conditions and an AI credit unwind could eventually weaken growth. The latest Atlanta Fed GDP Now estimate for third quarter gross domestic product or GDP growth is 3.6 percent. That's unchanged from earlier this month.

The defensive rotation in stocks is clear. Healthcare gained more than 1.8 percent Thursday as technology fell 0.5 percent. Broader participation hasn't collapsed, but make-it-kept technology weakness has an outsized index impact. Investors might want to watch credit conditions, treasury yields, Fed guidance, and semiconductor stabilization rather than chasing either the selloff or the defensive trade. It's unclear if this week's dramatic selloff in ships that sent the Philadelphia Semiconductor Index into correction down 10% from recent highs is part of a longer-term trend or simply short-term anxiety. It's clear either way that chipstots have gained no ground since their June peak, though the Philadelphia Semiconductor Index, or SOX, remains up for the year. Outlooks recently from chipmakers looked robust, and Deutsche Bank maintained its buy rating on data center builder CoreWeave Thursday, saying there is no company-specific reason to justify the sell-off that sent CoreWeave shares down 15% Wednesday. Anthrobic, the AI giant gearing for its expected initial public offering, saw quarterly revenue jump 45% sequentially to nearly $17 billion, the Wall Street Journal reported. Earnings accelerate next week with Tesla, Meta and Netflix. The last of those is down 40% so far this year and announced 1,000 job cuts earlier this week. Items to watch today include importing export prices, industrial production and treasury international capital flows that track foreign investment in US assets.