By Jamie McGeever

ORLANDO (Reuters) – Rude corporate health allows Wall Street stocks at record highs to shine a light on the U.S. Economy – even though their less optimistic bond market counterparts are raising a red flag about the same outlook.

The truth may lie somewhere in the middle, but in many ways this has been the case since bullish bond managers and equity investors are paid to remain optimistic and pessimistic about the economic conditions outside.

Investors are encouraged this week to find a way.

Inverted U.S. Treasury yield curve – 30-year yields fell below 10 year for the first-time since 2019 and 20-year was the lowest since last year’s bond debut. This is because data shows that the U.S. economy has slowed significantly in the past quarter.

Yet, the speed continued to climb towards an all-time record.

The equity strategists will be focusing on growth wobbles and inflation as well as the imminent Fed taper and a likely increase in interest rates for next year. The S&P 500’s recent 6% slip looks increasingly like a blip.

Cash flows to corporate are good. Some 82% of the S&P 500 companies that have reported Q3 results so far have beaten earnings expectations, and revenue growth is offsetting higher costs, with 77% of firms beating revenue forecasts.

Profits for S&P 500 companies are expected to grow 37.6% year-on-year in the third quarter, according to Refinitiv data. This is a sharp drop from the previous quarter. However, Q2’s growth was driven to new heights of above 60% last year by an April-June pandemic.

The outlook is positive, even though earnings growth has been strong despite the negative base effects. This has helped to reduce lofty earnings/price ratios and makes stocks more affordable, even though they are near records.

Firms are now putting the huge amount of cash they have accumulated, after cutting dividends and investing, as well as raising cash through asset sales.

Morgan Stanley Economists at the NYSE believe the U.S. is experiencing its strongest economic capex cycle since 1940s. This was due to business investments in intellectual property and equipment.

They believe that capital investment will reach pre-COVID levels by the end. Their research also shows that real investment growth for the first six months of the year averaged 11.1%.

Many measures still show that stocks offer better returns than bonds. There is something of a virtuous circle at play here too: a gloomy bond market depresses long-term yields and makes equities more attractive, especially big tech, which accounts for more than a fifth of the S&P 500’s market cap.

When growth is high and bonds yields fall, stocks may be in a position to benefit.

“It all comes back to TINA – there is no alternative,” says Jon MacKay, senior strategist at Schroders (LON:

INVERSION OF YIELD CURVE

However, the warnings from the bond market about a weak economy are becoming more louder, as implied in the inversion yield curve.

According to figures released Thursday, the annualized rate at which the U.S. economic growth increased in July and September was 2.0%. This was 6.7% less than in the prior quarter and lower than the forecast of 2.7% in a Reuters poll.

Actually, the actual economy contracted 0.1% even if inventories rose by 2.1%. This is exactly what the Atlanta Fed’s real-time GDPNow forecast predicted.

On the news, the rate of flattening in the yield curve, which was underway for several weeks and particularly at the end has accelerated.

Inversion happens at the most liquid part of the curve. However, inversion remains inversion and flattening forces are being applied towards the curve’s short end.

There is currently a gap of 39 basis points between 10 and 30 year Treasury yields. It is also the smallest difference in over two-and a half years.

The strength of Wall Street and the U.S. consumers is crucial for the future success of Wall Street as well as the economy. The concern is increasing that inflation could impact consumer spending. This would negatively affect both corporate revenues as well as economic growth.

Alex Bryson and David Blanchflower (an economist and ex-Bank of England policymaker) strongly argued in this month’s working paper that there are “clear downward trends in consumer expectations since May” which point to a recession. However, employment data and data on wage growth suggest otherwise.

According to them, “It appears that there is every probability that the U.S. enters recession at 2021”

It is an ambitious call, they admit. It is possible that Wall Street will feel the cold if the economic climate continues to fall into winter.

(By Jamie McGeever. Editing by Andrea Ricci.