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The nagging question for investors: Is 2% enough?

Michael Santoli
Michael Santoli

The market is living under the tyranny of the 2%. For so many crucial investor queries, it seems, the answer is coming up 2%.

Consider the array of indicators clustered around this number:

-The 10-year Treasury yield (^TNX) has retreated to 2.02%, on soft inflation measures, depressed global yields, the quest for safety and waning expectations of a Federal Reserve rate hike this year.

This is not a panicked level or an augur of serious recession risk. But a 2% U.S. government yield certainly doesn’t suggest much fear of economic reacceleration soon.

-In a notable bit of symmetry, the dividend yield on the S&P 500 index (^GSCP) is now in the same zone, at 2.15%. Very few investors awake each day deciding between adding fresh cash either to Treasuries or equities, but the asset classes are still tethered somewhat by relative yields.

Before 1960 or so, stocks yielding more than Treasuries was the norm, and has been quite rare since then, with most instances since 2009. For what it’s worth, the performance of stocks from the time S&P yields surpass Treasuries is quite strong over ensuing months and years.

-Markets are also fixated on 2% as the stated long-term goal for core inflation set by the Fed.This target has been elusive, though in the latest government inflation reading core prices were up 1.8% over the prior year.

-The American economy appears to be growing at roughly that 2% pace this year, though in fits and starts. Growth over the first half was 2.2%. And as official forecasts for the third quarter trend lower, below 2%, the year-to-date figure might arrive pretty close to that 2%.

Slow but positive growth, cool inflation readings and low interest rates are a combination that some are calling a Goldilocks environment – neither too hot nor too cold. Yet the bears, which in the story outnumber Goldilocks, will tell you this is not a backdrop that’s very friendly to risky assets at this point in the cycle.

For sure, there’s a sense that 2% growth and inflation undershooting 2% leaves us alternating between forward progress and stall speed, with little confidence that we’ll get relief from the unending ritual of awaiting a Fed liftoff that keeps getting deferred.

In fact, the latest Fed policy maker long-term forecasts for short-term rates – now near zero – show that most don’t see them getting up to 2% until at least 2017. The long-term neutral rate is still considered to be above 3%, which is a possibility too remote for most to bother contemplating today.

-Traders might be focused on another 2%: That’s how much the S&P 500 would need to gain from Thursday’s closing print to get back to breakeven for the year.

This might seem a lot to ask given the impressive 7.5% sprint higher since Sept. 28. Once again, the market looks a bit “overbought” in the short term and faces some nearby upside hurdles at levels where the August waterfall drop got started.

Yesterday’s action started to take on the look of a chase by investors who’d gotten to defensive and feared a more substantial fourth-quarter rally was underway. Credit markets have firmed, which was a necessary condition for a rebound. Earnings expectations were properly muted, though they’re still tracking for a 5% drop. M&A action is a boost to trader psychology.

And many will tell you that seasonal factors start turning positive for stocks right about now. But the almanac was telling us early October was sure to be nasty and we’ve gone straight up – so are we now sure of the calendar-based wisdom?

Certainly, investor sentiment still has room to brighten from grim levels of recent weeks. And one can be sure that if we rise another 2% to get back to where we started, the crowd will be crowing as if a tie is a win.