Dow finishes 270 points higher as cyclical stocks lead, Nasdaq drags as Treasury yields rise

By Joseph Adinolfi and Isabel Wang

U.S. stocks finished higher on Thursday with cyclical sectors like financials, materials and industrials seeing the strongest gains, while higher Treasury yields dragged on the tech-heavy Nasdaq.

What happened

On Wednesday, the Dow Jones Industrial Average fell 74 points, or 0.22%, to 33,853, the S&P 500 declined 2 points, or 0.04%, to 4,377, and the Nasdaq Composite gained 36 points, or 0.27%, to 13,592.

What drove markets

Financial stocks got a boost Thursday after the country's largest lenders passed the Fed's annual stress tests, in which 23 banks proved they could withstand a hypothetical "severe" global recession that would see them brook losses of up to $541 billion as well as a 40% decline in commercial real estate prices.

The Invesco KBW Regional Banking ETF (KBWR) jumped 2.1%, and the SPDR S&P Bank ETF (KBE) rose 1.7%.

Although the stress-test results were welcome news following the collapse of Silicon Valley Bank and other U.S. lenders earlier this year, economists cautioned that risks to banking-sector stability persist.

"The U.S. banking sector has stabilized, helping avoid a full-blown credit crunch, but the shock represents another headwind for bank lending and broader U.S. activity, and risks have not fully dissipated for more vulnerable banks or the sector as a whole," said James McCann, deputy chief economist at abrdn. "In particular, banks with large fixed income holdings, less sticky deposits, exposure to commercial real estate lending and poor geographic diversification remain at risk," he said.

Meanwhile, the latest revised reading on first-quarter U.S. GDP helped to boost the Dow along with industrials, materials and small-cap stocks like those comprising the Russell 2000 , which was up 1.1%.

Data showed gross domestic product was revised up from a previously reported 1.3% growth rate, the Commerce Department said Thursday, undercutting widespread expectations that the U.S. economy is heading toward a recession. The U.S. economy is also expected to expand between 1% to 2% in the second quarter that ends on Friday, based on the most recent Wall Street forecasts.

Another report showed the number of Americans who applied for unemployment benefits last week fell to a one-month low of 239,000. New jobless claims declined by 26,000 from a revised 265,000 in the prior week.

While cyclicals led the market higher, the Nasdaq dragged due to a spike in Treasury yields driven in part by the GDP numbers, said Eric Diton, president and managing director of the Wealth Alliance, during a phone interview with MarketWatch.

"Growth stocks are the most sensitive to higher yields," Diton said. "This is really a follow-through on Jay Powell's comments from yesterday when he talked about the need for aggressive tightening."

Federal Reserve Chair Jerome Powell this week reinforced his willingness to combat inflation with more aggressive monetary policy at the ECB annual forum in Sintra, Portugal on Wednesday. Powell reiterated the theme in Madrid, Spain on Thursday the risks of "overdoing" or "underdoing" rate hikes still are not in the balance yet.

The yield on the 2-year Treasury soared 15.6 basis points to 4.876% up from 4.720% on Wednesday.

See: Powell says risks of 'overdoing' or 'underdoing' rate hikes still aren't in balance yet

Some analysts cautioned that investors shouldn't read too deeply into Thursday's market moves because low trading volume ahead of the holiday weekend, as well as quarter-end portfolio adjustments by money managers, likely overshadowed other factors.

"I'd be careful not to attribute too much of these movements to anything in particular," said Michael Lebowitz, portfolio manager at RIA Advisors. "It's a combination of illiquid markets and quarter-end rebalancing."

Investors also responded to dovish commentary from Atlanta Fed President Raphael Bostic, who broke with the Powell-led majority at the Fed by pushing back against the notion that the central bank should hike borrowing costs further.

Still, futures markets have moved to price in more hikes. Traders now see an 86.8% chance of a quarter-of-a-percentage-point rate hike on July 26, which would lift the fed funds rate target to between 5.25%-5.5%, according to the CME FedWatch Tool.

Beyond that, they're pricing in a 26.8% chance of another quarter-percentage point move in September, up from 16.4% a day ago.

Just one trading day remains in what's been a robust first half for U.S. stocks. The S&P 500 has risen 14.4% this year, while the Dow industrials is up 2.8% and the tech-heavy Nasdaq Composite has jumped by 30% year to date, according to FactSet data, on track for its best first half since 1986, according to Dow Jones Market Data.

See: The Nasdaq-100 is headed for its best first half on record, but obstacles to further gains lie ahead

Megacap technology stocks like Apple Inc. and Nvidia have driven more than 55% of the gains in the S&P 500 so far this year, according to Dow Jones data. But the rally has started to broaden since the start of June as sectors like industrials and financials, which had lagged earlier in the year, leapt higher.

-Joseph Adinolfi

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06-29-23 1618ET

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