Stocks continued to fall on Thursday, as investors reacted to poor earnings reports from several companies scattered across various industries. By 11:20 a.m. EDT, the Dow Jones Industrials (DJINDICES:^DJI) had fallen more than 50 points, with broader-market benchmarks also in the red. As much as investors focus on the stock market, though, two other financial markets hold several clues to what's happening with stocks and what the future might hold as well.
A tale of two markets
Over the past couple days, investors have seen two major reversals in what had been dominant trends in recent months. The dollar has started to lose a substantial amount of ground against foreign currencies, particularly the euro. At the same time, interest rates have started to climb, with Treasury yields moving above key levels and portending further rises ahead.
The reversal of conditions in the foreign exchange market could have a net beneficial impact for investors. Throughout the past several earnings seasons, many multinational corporations in the U.S. have reported poor results specifically because of the dollar's strength, as weaker foreign currencies make the revenue those companies bring in abroad worth less in dollar terms.
To be clear, the dollar's rebound amounts to just 4% during the month, and even at $1.12 to the euro the dollar is still far stronger than the $1.30 to $1.35 a euro fetched as recently as last summer. Moreover, even if the dollar stays weak, it will take time for its impact to work its way into corporate profits. Still, a sustained reversal would increase investor confidence in the prospects for economic growth elsewhere in the world and remove the perception that the U.S. is the only place worth investing right now.
Conversely, rising rates could have a negative impact on stocks. Treasury yields have climbed to 2.1%, up a quarter-percentage point from just two weeks ago as investors increasingly believe the Federal Reserve won't hesitate to raise interest rates even with weak economic conditions abroad. U.S. corporations' debt levels have increased enough in recent years that rising rates could eventually put substantial pressure on their interest expense line items, hurting earnings.
Most companies have been wise enough to lock in low rates through longer-term financing, so rising rates won't immediately hurt those stocks. Still, when you add in the fact that higher rates will give more people an incentive to flee the stock market and invest in fixed-income securities, the recent push higher in Treasury yields is troubling.
Fleeing stocks entirely isn't the answer to concerns about current market levels, but it's smart to look at your portfolio to make sure its risk level is consistent with your needs and comfort level. Making modest changes to reflect your risk tolerance makes sense in any market environment, but it's especially smart before a major drop takes away part of the value of your holdings.