What Will Drive Markets in Q4? By TipRanks

Wall Street rounded out the week on a positive note on Friday, the first day of Q4. In the debt market, the 10-year U.S. Treasury bonds gained some ground as prices edged higher, driving yields below the psychological 1.50 percent mark. In the equity markets, all major indexes edged higher, led by small caps. In cryptocurrency markets, staged a strong rally. There was a weak spot, too—the foreign currency markets, where the dollar continued its slide against major currencies.

Will the positive tone of the first day of the new quarter carry through the end of the 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. Instead, we can point to three factors that will drive markets in Q4: earnings, bond yields, and Washington politics.

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. As a result, earnings are the critical variable in equity valuation models, which look beyond the short-term market gyrations fueled by emotions, to the fundamental value of listed companies.

So far this year, earnings have been strong for the broad market, and they will continue to be good, according to FactSet, which keeps a tally of corporate profits and analyst estimates.

“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 points out that Q3 earnings marked the most extended period of consecutive quarterly increases since FactSet began tracking this metric in 2002.

In short, earnings will continue to be a 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. They are also a key variable in equity valuation models. For example, bond yields are inputs in calculating the weighted cost of capital (WACC), which is used to discount future earnings and free cash values, to determine the intrinsic value of listed companies.

Lower bond yields make future earnings more valuable, pushing equity valuations higher. At the same time, higher bond yields make future earnings less valuable, pushing equity valuations lower.

For most of the year, the 10-year U.S. Treasury bond yields have stayed lower, flirting with the 1 percent mark. That has changed since early September, when bond yields turned north, flirting with the 1.50 percent mark. European bonds followed suit, with the 10-year German Treasury bond yields continuing to trade with negative yields, although they have risen from -0.45% to -0.2% over said…