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Tuesday Look Ahead: Markets Respond to Tail Winds for Now

Rising interest rates and commodities prices could easily turn from tail winds to head winds for stocks.

Paul Giamou | Aurora | Getty Images

But on Monday, investor focus was on the positives, and that included a burst of merger activity, better recent economic news and corporate earnings, as well as an easing of tension in the Middle East. The Dow jumped 69 to 12,161, and the S&P 500 was up 8 at 1319. The Dow and S&P are both up about 5 percent year to date.

"It's another levitation.. It was on extraordinarily low volume and I don't think we can blame it on Chinese New Year. The inertia is forward," said Art Cashin, director of floor operations at UBS.

The Treasury market, meanwhile, saw a pullback in the short end but buyers moved into the long end. The 2-year yield rose to 0.768 percent, and the 10-year fell to 3.644 percent. The dollar was flattish against the euro, at 1.3585, and up just slightly against the yen.Goldfell $0.70 per troy ounce to $1347.60, andoilslipped $1.55 per barrel to $87.48.

There is little data for markets Tuesday. The NFIB small business survey is released at 7:30 a.m., and the Treasury auctions $32 billion in 3-year notes at 1 p.m.

Richmond Fed President Jeffery Lacker speaks at 8:45 a.m. on the economic outlook; Atlanta Fed President Dennis Lockhart speaks at 12:30 p.m., and Dallas Fed President Richard Fisher speaks at 1:30 p.m.

Earnings are expected from ArcelorMittal, Toyota, UBS, Beazer Homes, Teva, Sara Lee, Entergy, Avon Products and Agco. Disney, McAfee and Pitney Bowes report after the closing bell.

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Rising Rates

Traders have been keeping an eye on the Treasury market, as rates jumped last week. Monday's moves were more subdued. "The market was incredibly quiet today. We sort of pivoted around in the 10-year," said Charlie Parkhurst, co head of Barclays Treasury desk.

"I think the whole market is terribly cheap. The (jobs) numbers from Friday are probably ambiguous enough that the down trade wasn't warranted," he said. Investors sold bonds and rates moved higher Friday, after the January jobs report showed creation of just 36,000 non farm payrolls, well below expectations. But the report also showed the employment rate decline to a surprising 9 percent.

LPL Financial chief market strategist Jeff Kleintop, in a report Monday, said the move in yields has been in response to improving economic news and inflation signals from rising commodities prices. He said the 10-year's break last week above 3.65 percent has caught the attention of investors who are watching the 4 percent level. Four percent is a level where some analysts see rates begin to challenge equities.

But Kleintop disagrees, and sees a yield of 5 percent as the problematic level for stocks. "If this pace of rising yields were to continue over the next four months, they could reach nearly 5 percent by this summer, a level not seen since July of 2007. While higher rates are bad news for bond investors, the good news is that rising yields may mean rising stock prices at least for some time yet. It is at 5 percent where yields begin to become a negative for stocks," he wrote.

Kleintop explained, in the note, that he studied the correlation between rates and stocks and when the yield on the 10-year was below 5 percent, stock prices and bond yields could rise together. He noted the opposite was true when yields were above 5 percent, and they became a negative for stocks because growth is accompanied by higher inflation. Below 5 percent, rising yields reflect improving economic conditions, not inflation, he noted.

Questions? Comments? Email us at marketinsider@cnbc.com

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