The stock market has emerged unscathed

Bad economic news has once again turned out to be good news for the stock market. The S&P 500 rose to weekly highs, whilst the Nasdaq Composite hit a new record high against the backdrop of disappointing US employment figures for September. The chances of a Fed rate rise at its next meeting have fallen to 18% from 71% a week earlier, boosting stock buyers’ confidence.

Geopolitical tensions and Treasury bond yields at their highest since 2002 are dragging the S&P 500 down. However, this effect is more than offset by the robust US economy, expectations of a pause in rate rises, a resurgence in demand for big tech, and impressive corporate results.

Wall Street is forecasting a 65% increase in earnings per share (EPS) for technology sector companies in July–September, pulling the figure for the entire S&P 500 up to 24%. If this proves to be the case, it will be the third consecutive quarter in which EPS growth has exceeded 20%. Coupled with forecasts from the Atlanta Fed’s leading indicator of an acceleration in economic growth from 2.2% to 3.7% in the third quarter, this is providing a tailwind for stock markets.

Investors are not particularly alarmed by the rally in 10-year Treasury yields above 5%. Northwestern Mutual notes that, historically, a 100-basis-point rise in yields has been required to affect the fundamental valuations of shares and corporate earnings. If this pattern holds, the equity market’s vulnerability will increase as yields approach 6%.

Bank of America believes the strong US dollar is a headwind for the S&P 500. Investors are being cautious about investing in the equity market, as the rally in the USD index signals risk aversion. Once the greenback peaks, the broad stock index will gain fresh momentum and break through its all-time highs. Another favourable development could be the peaking of yields in the bond market. The performance of the small-cap share index may also prove to be a sensitive indicator of risk appetite: a rebound from the 200-day moving average would be a positive signal, whilst increased selling from current levels would signal the start of a deeper correction.

Summary: Weak jobs data boosted hopes of a Fed pause. Strong earnings and the US economy support the S&P 500, but rising yields and the dollar increase the risk of a correction.