Wednesday marks the start of the second half of 2015, a period that could test the stock market with higher interest rates and more sluggish earnings growth.
"To me, the risk of the summer, when it comes to yields, is the jobs reports coming in strong, and that says the Fed's got to hike," said David Bianco, chief U.S. equity strategist at Deutsche Bank. "It doesn't necessarily mean earnings are getting better. It just means the labor markets are getting better, which has been the case for two years."
Economists expect 232,000 nonfarm payrolls additions when the June report is released Thursday, and a one-tenth drop in the unemployment rate to 5.4 percent, according to Thomson Reuters.
"The jobs number is the big deal," said Barclays chief U.S. economist Michael Gapen. "I think the color around it will be important." Gapen said it will be key to see whether there is any upward pressure on wages, an early sign of inflation. He expects a modest 0.2 percent increase in average hourly earnings. "You need the payroll number to be associated with the reduction in slack or a firming in wages."
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Gapen, and many economists expect the first rate hike to come in September, after a summer of better economic data. He expects to see 250,000 nonfarm payrolls. "If we get a big miss, September is tough …with 300,000, you'd have to think September is in play," he said in response to a question on different scenarios.
Stocks were lower in the past week, with the S&P 500 ending at 2101, down 0.4 percent in its ninth weekly move below 1 percent in a row. For the quarter to date, the S&P 500 is up 1.6 percent, and it is up 2.1 percent for the year to date. Wall Street's strategists still expect to see an average 6 percent gain through the year end, according to CNBC's Strategist Survey.
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"We see about 5 percent upside through the end of the year," said Dan Suzuki, Bank of America MerrillLynch U.S. equity strategist. "We think that upside will come with more volatility, as the year progresses. We have the risk of Europe, but the key driver of volatility is going to be the Fed. Ultimately, it's not going to be as big a deal as some of the bears are arguing."
But Suzuki said the Fed could be enough of a catalyst to cause a stock market pullback. "We do think it's going to add to volatility, and we wouldn't be surprised to see a 5 to 10 percent correction as we digest the tightening," he said.
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Treasury yields moved higher in the past week, with the 30-year bond yielding 3.24 percent Friday afternoon, the highest since September 2014. Traders also watched the German bund, which has been leading the U.S. Treasury market.
Bond strategists say Treasury yields could head lower as the month end approaches Tuesday, but Thursday's jobs report could be eventful for the bond market, and if nonfarm payrolls are strong, yields could move higher.
Bianco noted that the bond market moved higher (and yields fell) after the Fed's June meeting, after which Fed Chair Janet Yellen said the economy was not strong enough to raise rates. "The bond market reacted positively to that but also, at the same time, you had Greece … let's say Greece is resolved, does that mean that 10-year yields jump another 20 basis points upward?" Bianco said. "Let's say 3 percent is not that far away. Then how attractive does the equity market look?"
Bianco said stocks that pay high yields, and have bondlike characteristics have already been paying the price of higher yields. He said investors will notice that an alternative to those stocks is being created as interest rates rise.
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"It's not so attractive to make people run away from stocks … but it is putting on pressure. Everything from defense companies in industrials to pharmaceuticals in health care—a lot of bond substitutes, where things are pretty OK, have been under pressure, as yields have been rising. The yields substitution has bled out into many parts of the S&P so it's important that the ascent in 10s is slow," he said.
Bianco also said he's concerned about the upcoming earnings season. Thomson Reuters expects S&P 500 companies' net income per share to decline by 3 percent, after a 2.2 percent gain in the first quarter.
"It's another earnings season, where in the end there's not going to be much sales growth, very little earnings growth at all," he said. "It's not wonderful, but that's what we're up against, and will the second half really have an acceleration? People will realize the first half was a wash. There was no profit growth. It was borderline profit growth."
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The lack of growth concerns strategists, who also see high valuations as a problem for the market, but Suzuki said the earnings picture may not be as bad as it seems on the surface.
"Similar to what you saw going into the first quarter, analysts are expecting a negative year on year for earnings for Q2. But what we saw last quarter was it started out with the negative expectations and ended up positive," he said. Suzuki said he expects to see profits close to flat. "Everybody's talking about how weak the growth was. Excluding energy, earnings were up 9 percent."
Meanwhile, oil prices were flat on the week. West Texas Intermediate crude futures were at $59.61 per barrel late Friday.
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