Two Major Reasons Why The Stock Market Refuses To Drop

Be it another interest rate hike by the Federal Reserve, or the turmoil within the banking system, the stock market just hasn't been able to fall significantly these days -- at least not significantly.

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This stubbornness could be attributed to a number of good reasons.

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First of all, let's take a look at the resilience of the market. The latest and clearest example of this can be seen in the recent panic in the banking industry. With all of this trouble - the failures of Silicon Valley and Signature banks, as well as Silvergate Bank SI -9.90% and First Republic Bank - all of this imperils the slowing economy that has already started.

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There are a few smaller banks such as State of Vermont Bancorp SIVBQ +37.63% and First Republic (ticker: FRC) along with a few others as well such as PacWest Bancorp PACW +2.02% (PCW) which have had customers withdraw billions of dollars, putting them into higher-yielding money market funds. In order to shore up liquidity, banks had to sell assets at losses in order to shore up capital, which led to less lending and spending in the economy. 

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Adding to the drama unfolding, we must not forget about the Fed's meeting in March, during which members decided to raise interest rates by another quarter-point, after a year in which rates had risen mostly by half-points and by three-quarters of a point. As a result of the higher rates, the economy is being forced to contract by pushing down demand, resulting in reductions in inflation.

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It is still important to note that so far this year, the market has held its own. After initially dropping down to its pre-SVB level in early March, the S&P 500 index has now risen a bit from its earlier level. 

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What is the reason for this? 

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First of all, let's take a look at the banking troubles, which at the moment appear unlikely to trigger a ruckus in the economy, at least for the time being.

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It should be noted that billions of dollars have been flown out of those high-yield money-market funds after the collapse of the SVB and banks have begun to ease up on their borrowings from the Fed, which reached a record after the collapse of the SVB. According to Bank of America, due to outflows from the money markets and a decrease in borrowing, there is a likelihood that money is returning to bank deposits and returning to the money markets.

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Next, you should add the sale of SVB's assets to First Citizen, which was completed last year. There has been some improvement in the system's ability to restore some confidence as a result of the deal.  

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As a result, the Fed decided to raise rates by just a quarter-point due to the banking mess playing no small part in their decision. As a result, many economists were predicting a mild recession rather than a deeper recession as a result of a larger bump in interest rates, and the central bank was concerned about that happening. The Fed has even been rumored to be taking a genuine break from raising interest rates, effectively capping off their growth.

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At present, the 10-year Treasury yield has dropped to just over 3.55% compared to just over 4% just a few years ago. Long-term Treasury yields are falling, which means that future profits will be more valuable, and stocks will be more attractive in the future. It works this way: When the long-dated yields for corporate bonds get dragged down by the lower long-term yields for long-dated bonds, the value of future profits gets the biggest boost. As a result, according to Wells Fargo, the long-dated investment-grade corporate bonds have declined from just over 5% a few weeks ago to just under 5% as of a few days ago.

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A combination of the yields on safe government bonds and the yields on the bonds that the company issues are used to discount the future earnings of the company. Alternatively, you might want to look at it this way: Analysts have aggregated earnings estimates for the next year for S&P 500, relative to its current level, yield just under 6%, which is still higher than investment grade bonds, but lower than the S&P 500 low yields. As a result, there is a trend in the stock market that is encouraging more risk-taking as yields are falling across the board. 

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Wells Fargo's chief U.S. equity strategist, Chris Harvey, wrote in his note to investors that lower yields and the expectation that there will be a tightening cycle soon should sustain higher stock prices for a while. 

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It's economy that worries everyone right now. Will it crumble, causing stocks to plummet?

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In general, higher rates tend to deter demand with a delay - yields are still well above where they were two years ago. However, the economy could still worsen even with banking jitters calmed for the moment. Wall Street could be knocked by a slump in corporate earnings. 

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Here's what you need to know: The market is strong for a reason. It's going to be bumpy.