Coke’s original formula keeps delivering

Stocks took a beating on Friday as bond yields spiked higher, spurred by comments by Treasury Chair Yellen and Powell’s comments, a day earlier. Two-year Treasury Note yields are reflecting a very aggressive Fed and stock markets are concerned.

Let it be.  Wow, there are so many things I could write about those three words, which have impacted my life, as well as millions of others, in so many ways. But today, I am not going to get too deep with the phrase. My regular readers know that I like to fall back on basic economic theory as much as possible. Why? Because, though the theories sometimes seem too basic to be realistic, they have stood the test of time, and because at the end of the day, it is basic behavior which is at the heart of everything we do. When your neighbor or even an extreme stranger is making a decision whether or not to buy a car, whether to purchase brand-name or store-brand peanut butter, or even whether to keep their Netflix subscription after the price rose, do you think that they apply different logic than you? Of course, not. Clearly everyone’s financial situation is different, and some folks are more “financially aggressive” than others, but for the most part, if prices are going higher and the economic future is looking cloudy, most folks are likely to hold back or lighten up on their buying. The same logic applies to companies. In fact, companies are even more predictable. They spend and borrow money in order to finance new projects and expansion. When the costs of borrowing that capital goes up or if the economic future appears to be slowing, companies will pull back on their investment. It is very difficult to argue with those very basic, economic tenets. It is those basic economic tenets which underpin the Fed’s monetary policy strategy. Lowering rates make credit-based purchases by consumers and companies cheaper. They will consume and invest more in that environment. In contrast, when rates are higher, big credit-based purchases and capital improvements will cost more and consumers along with companies will consume, well…less stuff… and services. In the low-interest rate example, more purchases cause economic expansion and greater demand causes faster inflation, while in the high-interest rate example, the exact opposite occurs with a slowing of economic growth and moderate inflation. So here we are with the economy expanding rapidly and inflation on the rise due to higher demand, spurred by a period of low interest rates. The Fed has begun to raise those rates and is likely to continue. So, does that make the Fed the enemy? Well, not quite.

Last Friday, 2-year Treasury Note yields got as high as 2.78% during the session. For some reference, 2-year yields have not been that high since 2018. At that point, the Fed Funds rate was around 2.40%. Right now, the Fed Funds rate is at 0.25%, far lower than back in 2018. That just means that the market is anticipating a similar Fed Funds rate within the next 2 years. We know that the market attempts to anticipate where things may be in the future, which is great, but there are some more important implications to recognize, especially when it comes to the bond markets and yields. Everyone these days, rightly so, is obsessed with what the Fed is doing and saying, but the reality is that the Fed’s actions alone have very little direct impact on what you, me, or companies do. Remember that the Fed Funds rates is the overnight lending rate between banks, who borrow and lend between themselves to ensure that they meet reserve requirements. Treasury bond yields, on the other hand, have a direct impact on the interest rates that you and I, and even companies pay to borrow money. Don’t believe me? Thirty-year fixed mortgage rates were just above 3% a year ago, while today, the average national is around 5.25%. Let’s call that 2% more, while the Fed has only raised Fed Funds by ¼ of a percent. Your monthly payment on the same size mortgage will cost you more than it did a year ago. That is likely to affect home buying decisions. Perhaps consumers will hold off on purchases, attempt to pay less, or even seek to buy cheaper homes because of that. Dictated by the markets…and not the Fed’s rates. What about companies? If a company has a BBB rating, which is still considered investment grade, it will pay 4.61% to borrow money (by selling bonds) for 10 years. Assuming that +2.81% spread to 10-Year Treasury Notes, that same company would have paid only 3.36% a year ago, more than 1% less. You better believe that the higher borrowing will impact the investment decision making with corporate treasury departments. In other words, they will spend less. The point here is that the credit markets have already tightened up on a practical level and that tightening is already likely to having an affect on yours, mine, and corporate purchase decisions. Last time 10-year and 2-year Treasury note yields were at today’s levels was in late 2018 when the Fed shifted its hiking policy to cutting. The Fed Funds rate was around 2.5% and 30-year fixed mortgage rates were around 4.5%… lower than they are today. Though the Fed must raise rates in the coming months, it is doing so only to get them to the point where they can lower them once again in the future. The markets have already done the job of applying the brakes.

WHAT’S SHAKIN’

The Coca-Cola Co (KO) shares are higher by +0.38% in the pre-market after the company announced that it beat EPS and Revenue estimates by +10.07% and +6.77% respectively. The company did mention that its strong quarterly sales gains were a result of its raising product price points in order to offset higher material and labor costs. Dividend yield: 2.69%. Potential average analyst price target upside: +4.3%.

Newmont Corp (NEM) shares are lower in the pre-market after Bernstein downgraded the stock to MARKET PERFORM and lowered its 12-month price target.On Friday the company announced that it had missed EPS targets by -3.5% while beating Revenue estimates by +0.98%. In the past month 61% of analysts have modified their price targets for the mining company, 11 up, 2 down, 6 unchanged, and 2 dropped. Dividend yield: 2.95%. Potential average analyst price target upside: +9.0%.

ALSO, THIS MORNING, Otis Worldwide (OTIS) missed on Sales targets while Activision Blizzard (ATVI) missed on both EPS and Sales.

FRIDAY’S MARKETS

Markets took a beating on Friday as renewed inflation scares and higher bond yields caused strong selling in equity markets. The S&P500 fell by -2.77%, the Dow Jones Industrial Average dropped by -2.85%, the Nasdaq Composite Index sold off by -2.55%, the Russell 2000 Index declined by -2.55%, and the S&P500 Index was lower by -2.82%. Bonds slipped and 10-year Treasury Note Yields fell by -1 basis point to 2.89%. Cryptos traded lower by -3.16% and Bitcoin was off by -2.45%.

NXT UP

• Chicago Fed National Activity Index (March) is expected to have fallen to 0.45 from 0.51.
• Dallas Fed Manufacturing Index (April) may have fallen to 4.8 from 8.7.
• Announcements after the bell: Whirlpool, Crown Holdings, SBA Communications, Cadence Design Systems, and Universal Health Services.
• Later this week: plenty more earnings along with more housing numbers, regional Fed reports, Consumer Confidence, Durable Goods Orders, GDP, PCE Deflator, Personal Income, Personal Spending, and University of Michigan Sentiment. Please refer to the attached economics and earnings calendars for details.