Wall Street ended the week with a positive note Friday. This was the first day Q4. The 10-year U.S. Treasury bond gained ground in the debt market as the prices edged up, which drove yields lower than the psychological 1.50% mark. All major equity market indexes edged up, with small caps leading the charge. Strong rallies were seen in cryptocurrency markets. There was a weak spot, too—the foreign currency markets, where the dollar continued its slide against major currencies.

What will happen to the positive mood at the beginning of each quarter? It’s hard to say. One day’s gains don’t signal an upward trend, especially if that day follows several days of losses. Three factors will determine the direction of markets in Q4 are earnings, bond yields, Washington politics, and Washington policy.

Earnings

“Corporate earnings are the milk of Wall Street,” goes the adage in the circles of traders and investors who have been around for a long time. Therefore, earnings play a critical role in equity valuation models. These models look beyond emotions and short-term market fluctuations to determine the true value of listed companies.

Earnings have been good for the market so far in this year’s fiscal year. They will be strong going forward, says FactSet. It keeps track of analyst estimates and corporate profits.

“During the third quarter, analysts increased earnings estimates for companies in the for the quarter,” writes John Butters, VP and Senior Analyst of the company. “The Q3 bottom-up EPS estimate (which is an aggregation of the median EPS estimates for Q3 for all the companies in the index) increased by 2.9% (to $48.89 from $47.50) during this period.”

Butters highlights the fact that Q3 earnings saw the longest streak of quarterly increases in consecutive quarters since FactSet began to track this metric back in 2002.

Earnings will be an important tailwind for Wall Street.

Treasury Bond Yields

If corporate earnings are the “milk” of Wall Street, Treasury bond yields are the “alcohol” of Wall Street, one could say. Additionally, they are a crucial variable in equity valuations models. In order to establish the intrinsic value for listed companies, the bond yields can also be inputs to the WACC (weighted cost capital), which calculates future earnings discount and cash flows.

Future earnings are more valuable if there is a lower bond yield, which in turn makes equity valuations rise. Higher bond yields can make future earnings less valuable and lower equity valuations.

The 10-year U.S. Treasury bonds yields have been lower for most of the year. They flirt with the 1 percent level. Since September’s turn north in bond yields, which flirted with 1.50 percent, that has been a change. European bonds also followed this trend. The 10-year German Treasury Bond yields continue to trade with negative yields despite their rise from -0.45% t -0.2% in the past period. The 10-year Treasury bond yields in Japan grew to 0.07 % during that time.

As investors rethink their equity valuations, it is clear that bond yields have become a tailwind and are now a headwind.

Washington Politics

Washington politics used to be a major tailwind for the markets. This was during the start of the 2020 pandemic, when all political stripes joined forces to pass unprecedented fiscal stimulus programs. They were intended to alleviate the effects of the COVID-19 epidemic and help recover the economy from recession.

This tailwind has become a headwind as Washington needs to find a way to pay the stimulus bill. Washington also must deal with the debt limit that threatens to force the country into default. These matters have seen a lot of interference from politicians to put it mildly.

What’s the Bottom Line?

The tailwinds and headwinds from higher earnings as well as the headwinds and headwinds associated with higher bond yields and Washington politics are all affecting markets. It is difficult to forecast where the markets will be by the end of each quarter because this combination has made it very hard for us to know.

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