Stocks’ Gains Vanish as Bond Market Signals Worry Over the Fed’s Stand

In afternoon trading, the

Dow Jones Industrial Average
fell 8 points, after the index tumbled 129 points Wednesday to close at 34,168 points. The

S&P 500
dropped 0.5%, while the

Nasdaq Composite
declined 1.4%. The indexes were all solidly in the green earlier in the day.

Positive economic data initially helped sentiment. Growth in gross domestic product for the fourth quarter was 6.9%, beating expectations for 5.5%. Initial weekly claims for unemployment benefits slipped to 260,000, better than the expected 265,000 and lower than the prior result of 290,000. 

Importantly, the GDP number also included a heavy dose of spending by companies to rebuild their inventories. Spending on inventories contributed the highest portion of GDP growth since 2020, according to 22VResearch. 

Higher corporate inventories of goods could help reduce inflation. That could mean that, while the Fed is ready to increase rates, it may not do so as quickly as some fear.

“Maybe you see four rate hikes on the upside but to get five or six or seven, that’s over done,” said Keith Lerner, co-chief investment officer at Truist. “We think that the inflation trends will improve.”

That’s all positive, but stocks are not finished reflecting the Fed-related risks. No one knows how aggressively the Fed will act — and how large the dent to economic growth will be when the Fed hikes.

“The recent volatility may continue to play out as the Fed officially takes away the punch bowl of monetary support,” wrote Louis Navellier, founder of Navellier & Associates. 

Wednesday, the Fed said that it will lift interest rates soon, and Chairman Jerome. Powell said that the economy is strong enough to handle several increases. The markets have known for months that rate increases are on the cards, but investors appear to have been spooked as he appeared to take an increasingy hawkish tone. For the most of the pandemic era it was doing whatever it took to support the economy and markets, and now it is reversing that policy. 

All in, the Treasury bond market is saying there is a decent chance the Fed will go too far, too fast. The 2-year Treasury yield is up on the day to 1.19% from a Wednesday low of 1.02%. Meanwhile, the 10-year yield was down Thursday to 1.81% from a Wednesday high of 1.88%. The difference between the 10-year and 2-year yields is now 0.60 percentage points, down from 0.83 points on Jan. 18 when the 10-year yield hit a pandemic-era high. 

That’s a declining yield curve—a signal that Treasury investors see still-high inflation—and Fed rate increases in the near term, but that those hikes will choke off demand so much that inflation will be low in the long term.

“The spread is dwindling,” Lerner said. “That may be signaling there may be growing concerns that the Fed’s going to make a mistake.” 

Sure enough, the stock market is still showing signs of wariness. The S&P 500 is trading below its 200-day moving average, a sign that investors are not yet confident enough to buy stocks at prices consistent with their longer-term trends. And even once the index rises above its 200-day moving average, “you’re going to have multiple resistance points,” Lerner said. “It’s not going be an all clear” to buy stocks.

Earnings are also rolling in. About 12% of the S&P 500’s market capitalization will have reported earnings Thursday, according to Credit Suisse. 

So far, earnings reports have looked fine. Three-quarters of companies have beaten earnings estimates in the fourth-quarter reporting season thus far. That may sound like a positive development for the stock market, but most stocks haven’t been seeing big gains after earnings, according to Wells Fargo. 

Overseas, the pan-European

Stoxx 600
rose 0.7%, while Tokyo’s

Nikkei 225
dropped 3.1% over the course of the Asian trading day.

Here are five stocks on the move Thursday:

Lam Research

(LRCX) was down 6.9% after the supplier of equipment to the semiconductor industry reported worse-than-expected quarterly revenue and forward-looking guidance, attributed to supply-chain issues.

Tesla

(TSLA) was down 12%. The electric-vehicle powerhouse reported record quarterly profit ahead of Wall Street’s expectations—but its outperformance was below average.

ServiceNow

(NOW) stock jumped 9.1% after the company reported a profit of $1.46 a share, beating estimates of $1.43 a share, on sales of $1.61 billion ,above expectations for $1.6 billion. 

JetBlue Airways

(JBLU) stock gained 2.7% after the company reported a loss of  36 cents a share, narrower than the estimate of a loss of 39 cents a share, on sales of $1.83 billion, above the expected $1.82 billion. 

McDonald’s

(MCD) stock fell 0.5% after the company reported a profit of $2.23 a share, missing estimates of $2.34 a share, on sales of $6.01 billion, below expectations for $6.03 billion. 

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com and Jack Denton at jack.denton@dowjones.com