Investors can't help but wonder at what level rising interest rates will give the stock market a reason to pause.
Some traders have pointed to a yield right about the place where the 10-year finished the day on Wednesday, just above 3.5 percent. But a number of strategists are looking for a higher level before stocks start to get burned.
"If you start pushing up north of 4 percent, stocks will pay attention," said Jordan Kotick, global head of technical strategy at Barclay's Capital. Kotick said 4 percent has proven to be a barrier, including the last time the 10-year reached it in April.
"I think the magnitude and trajectory does raise some concerns," said Jeffrey Kleintop, chief market strategist at LPL Financial. "I think if we get much above 4 percent, I think stocks would have to pause and consider the economic ramifications of what that might be, and whether the Fed would have to take any additional action to keep rates down, and what that might mean."
But Jack Ablin, chief investment officer at Harris Private Bank, says there's no special level that will trigger a flight from stocks. "I look at valuation differential between stocks and bonds. It's as gaping a difference as I've ever seen. Historically, I like to look at earnings yield on the S and P 500, which is 7.2 and I match it up against the 10-year BBB bonds, which are about 4.9 percent. Historically, those are roughly the same," he said, noting the current large disaparity.
"My conclusion is stocks are probably fairly priced. Bonds are overpriced, yields too low. ..In theory, rates should be able to move higher without impacting valuations in stocks one iota. We're calling for roughly a 100 basis point rise in rates on top of this," he said.
Ablin said that move would not necessarily derail stocks. "There's still an adequate cushion in my view that rates can move higher without upsetting the apple cart. I just don't know where the magic line is," he said.
Ablin issued his outlook for 2011 Wednesday. "Stocks are reasonably priced, so I think we could eke out modest gains. My guess for 2011 is 8 percent is going to be the best returns we're going to see," he said.
What to Watch
For Thursday, traders are watching weekly jobless claims, released at 8:30 a.m. Housing starts and the third quarter current account are also released at 8:30 a.m. and the Philadelphia Fed survey is reported at 10 a.m.
Some major earnings are expected before the bell Thursday, including Discover Financialand FedEx, which is seen as an economic bellwether.Research in Motion and Oraclereport after the closing bell.
Financial stocks will be a focus Thursday. The Fed holds a 2:30 p.m. webcast meeting on proposed new rules on debit card fees. The ruling could impact banks, as well as credit card companies like Visa and MasterCard. Treasury Secretary Tim Geithner attends a Congressional oversight panel hearing on the TARP bank bailout program at 10 a.m.
Citigroup unveils its new bank of the future in New York City, and CEO Vikram Pandit will appear in an exclusive interview with CNBC's Michelle Caruso-Cabrera on "Power Lunch" at 1 p.m.
The CFTC also issues much-anticipated new proposals Thursday for position limits, which could impact commodities markets.
Driving Rates Higher
Stocks traded higher early Wednesday, but afternoon selling in the bond market drove yields sharply higher, and stocks moved lower. Traders said some of the selling was related to investors moving out of Treasurys into other issues, like an Ohio Build America Bond offering and corporate issuance. The Dowended down 19 at 11,457, and the S&P 500 was off 6 at 1235.
"There's a lot of pain in the market. There's a lot of forced selling going on," said Rick Klingman, who heads the Treasury desk at BNP Paribas.
The Senate Wednesday approved the tax cut package that would extend Bush-era tax cuts for two years. The bill now moves onto the House. Analysts have pointed to that bill as a catalyst for bond market selling, since the compromise was first discussed by President Obama last week. The bill includes a one-year break on Social Security taxes for individual taxpayers. Based on the package, economists raised their 2011 growth forecasts, which has been so far bullish for stocks and negative for bond prices.
"I think anytime you see markets moving rapidly in one direction or other, it tends to be destabilizing and stocks are giving up a little today," said Kleintop after Wednesday's market close.
Rates have been moving higher since hitting a low in October, but the last two sessions have been particularly volatile. Rates shot even higher after the Fed Tuesday reaffirmed its intention to carry out its quantitative easing program. The Fed launched the program to buy a total $600 billion in Treasury securities in November, and since then rates have risen. In theory, quantitative easing was expected to have driven rates lower.
Mortgage rates have climbed along with Treasury yields, and the 30-year mortgage is now back at 5 percent.
"The market should be concerned about the trajectory and about how fast we're moving in that direction, but not the level. In the first quarter of this year, we averaged around 3.7, 3.8 on the 10-year and stocks were around this level, so these levels on rates certainly do not suggest stocks shouldn't be here, that they should be moving lower," Kleintop said.
"We're just getting back to a reaccelerating economic environment like we saw in the first quarter of this year, as we come out of the summer soft spot, you'd expect rates to rise and stocks to move along with it," he said.
The dollar gained 1.2 percent against the euro Wednesday, as sovereign debt worries once more weighed on the European currency. A two-day European Union heads of state summit begins Thursday.
"I think the outcome there is going to be disappointing for the euro. The Germans seem to be sticking firmly to their view of not expanding the stabilization fund, not going down the road to euro bonds.. a super sovereign. It's basically that the national governments have to take the steps needed to maintain financial stability and that's putting more pressure on the ECB which is pushing back," said Brian Dolan of Forex.com.
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