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A key market indicator is signaling a recession

<i>Seth Wenig/AP</i><br/>Stocks have rallied sharply in October
Seth Wenig/AP
Stocks have rallied sharply in October

By Paul R. La Monica, CNN Business

Recession worries continue to haunt Wall Street. A key indicator in the bond market is flashing signs of a potential downturn.

The spread between super short-term 3-month Treasury yields and the benchmark 10-year yield briefly inverted late Tuesday and did so again Wednesday. That means that yields for shorter-term bonds were higher than longer-term ones. Both are currently hovering around 4%.

That’s a bad sign — and often precedes recessions — because it shows how nervous investors are. Typically, short-term bonds have much smaller yields because investors expect to get paid higher returns to borrow money for longer periods of time.

Another key yield curve, the difference between 2-year and 10-year Treasuries, has been consistently inverted since early July after briefly inverting in March.

So why are stocks up this month?

Still, stocks have rallied sharply in October, despite continued worries about rampant inflation globally, a strong dollar hurting multinational companies and the political and economic turmoil in the UK. A lot of the optimism has to do with the fact that investors are hoping the Federal Reserve will soon start to slow its pace of interest rate hikes.

But there’s another reason. Earnings have actually been, to quote “Curb Your Enthusiasm’s” Larry David, pretty, pretty good. Just steer clear of the once red-hot tech sector.

Google owner Alphabet and Microsoft disappointed investors with their latest outlooks later Tuesday. Chip giant Texas Instruments and streaming music company Spotify also underwhelmed Wall Street.

All four stocks tumbled Wednesday. And that’s a big reason why the Nasdaq fell 2%, even as the broader market held up a little better. The Dow ended the day up a measly 2 points, while the S&P 500 was down just 0.7%. But the Dow was up more substantially earlier in the day, and the S&P 500 was also briefly in green.

Top techs (i.e. what used to be dubbed FAANG stocks before name and ticker changes) make up a big chunk of the weighting of the S&P 500. Investors are now waiting to hear from the likes of Facebook owner Meta Platforms, which reports earnings after the closing bell Wednesday, and Amazon and Apple, which report Thursday afternoon.

Weakness in tech is dragging down profit forecasts for the broader market. According to data from FactSet senior earnings analyst John Butters provided to CNN Business Wednesday morning, analysts are now forecasting profit growth of just 0.6% in the third quarter for the S&P 500. That’s down from estimates of 1.5% as recently as Friday.

Wall Street is predicting that profits will drop for both the tech and communications services sectors.

“I still don’t love tech. There are not a lot of values there. These companies aren’t growing to the sky anymore,” said Brian Frank, chief investment officer of Frank Funds.

More to the market than FAANG

Look beyond tech though and there are many more bright spots to be found in Corporate America’s report cards.

Credit card giant (and Dow component) Visa reported earnings and revenue that surpassed analysts’ expectations, and the company also boosted its dividend. Kraft Heinz posted solid results Wednesday morning, sending its stock higher. That good news comes on the heels of strong results from GM and Coca-Cola Tuesday morning.

There are many parts of the economy that are still doing fine. Along those lines, FactSet’s data shows that analysts are expecting double-digit percentage growth in earnings for consumer discretionary companies, industrials and real estate firms. And energy sector profits are forecast to more than double, thanks to the surge in oil prices this year.

Two other encouraging signs? Nearly three-quarters of the S&P 500 companies that have reported earnings so far have topped forecasts. (The earnings misses, naturally, get more attention on Wall Street.)

What’s more, demand still seems to be holding up for many companies. Revenue is expected to grow 8.6% in the quarter, according to FactSet. So the weaker earnings are more a function of higher costs as opposed to a significant slowdown in sales.

“Overall, earnings are doing well given the environment,” said Max Wasserman, senior portfolio manager with Miramar Capital.

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