Updated from 7:45 p.m. ET to include information on the higher running temperature of Apple's new iPad. NEW YORK ( TheStreet) -- Plenty of digital ink is being spilled these days about what the recent rise in the yield on the 10-year Treasury means for the relentless rally that stocks have enjoyed since early October. Sam Stovall, chief equity strategist at S&P Capital IQ, laid out the competing scenarios in commentary earlier this week. "Would higher rates instantly depress equity prices, serving as a depressant in intrinsic value calculations, along with reducing corporate EPS due to an increase in interest expenses?," he wrote. "Or might stock prices maintain their historical upward bias since investors fleeing bonds would be attracted to higher-growth equities, provided these rates stayed below a particular threshold?" To that end, Stovall ran the numbers to see what the historical trend has been, discovering that stocks may have a plenty more upside before rising rates become a problem. "Since 1953, history shows that the S&P 500 maintained a positive median monthly price performance, in spite of rising interest rates, up until a 6% yield on the 10-year T-note," he wrote. "Once rates crossed that 'line in the sand,' however, the median monthly price change for the '500' slipped into negative territory." In fact, the data hints that the best could be yet to come, Stovall said. "Indeed, the median monthly price change in the S&P 500 improved to 1.7% when rates rose within the 3%-4% range, versus the median price gain of 1.2% when rising rates were still below 3%," he wrote. "Prices averaged 1.3% between 4%-5%, but began to slip, posting an average advance of 0.7%, when rates were rising between 5%-6%. Above 6%, however, the returns became negative." Stovall theorized that investors have likely bought stocks in the past through periods of rising rates when an improving outlook for the economy and corporate profits was part of the impetus for yields moving higher, which makes sense. What's heartening for the current market is that in the past rising rates have led to an expansion of the S&P 500's price-to-earnings multiple. Earnings growth is expected to be fairly tepid in the first quarter with analyst expectations calling for just 2.8% year-over-year growth, according to Thomson Reuters.
"Since 1953, whenever the yield on the 10-year note was below 3%, the median P/E on trailing S&P 500 GAAP earnings was 13.1X," he said. "It expanded to 17.9X and 18.6X when rates climbed into the 3%-4% and 4%-5% ranges, respectively, only to top out at 22.5X in the 5%-6% range." As of Friday's close at 1404, the S&P 500's trailing P/E ratio was 16.3X, so the market is a little ahead of the historical precedent since the 10-year yield settled at 2.36% on Tuesday. Stovall is always careful to note that history isn't gospel, and S&P Capital IQ's stance is that investors "maintain at least a neutral exposure to equities, and emphasize the cyclical groups over the defensive ones." That said, the "sweet spot" of this rally may actually lie ahead. "The 'sweet spot' for equity prices appears to be a rising rate environment between 3% and 4%, as a growing economy reduces unemployment while increasing corporate earnings, yet does not trigger growth-slowing efforts by the central bank," Stovall said. "In this zone, equity prices have posted their strongest monthly median price increases, when compared with other zones below and above the 6% threshold, and sector performances have been favorable for all, with leadership coming from the cyclical sectors and below-average performances coming from the defensive sectors." As for Wednesday's scheduled news, Discover Financial Services ( DFS) is the headline earnings report on Wednesday. The credit card company is set to deliver its fiscal first-quarter results after the closing bell, and the average estimate of analysts polled by Thomson Reuters is for earnings of 93 cents a share in the February-ended period on revenue of $1.82 billion. The stock has been on a tear in 2012, rising 35% and outpacing rivals Visa ( V), up 17%; MasterCard ( MA), up 14%; and American Express ( AXP), up 21%. Still, Discover shares remain cheap with a forward price-to-earnings multiple of 9.1X vs. 16.8X for Visa, 16.3X for MasterCard and 12.1X for AmEx. Based on Friday's close, the S&P 500 is trading with a forward P/E of 13.4X. The sell side is slightly bullish ahead of the report with 16 of 25 analysts covering Discover at either strong buy (9) or buy (7), and the 12-month median price target at $36, implying potential upside of 13% from Tuesday's close at $31.86. The company itself also apparently likes its stock at current levels, announcing a new $2 billion buyback program earlier in March.
Discover saw its credit quality improve in 2011, bringing down related costs, and Wall Street will be looking for more of the same this time around. The company's delinquency rate for credit card loans over 30 days past due came in at 2.39% in the fiscal fourth quarter ended in November, a performance that was 167 basis points better than the year-ago equivalent quarter. One metric to pay attention to will be the balance of loans delinquent over 30 days, which came in at $1.2 billion last quarter, barely budging on a sequential basis. Guggenheim Securities has a buy rating and a $37 price target on the stock ahead of the report but its estimate for earnings of 90 cents a share is slightly below consensus. The firm thinks the company's upcoming investor day on March 22 may be a bigger event than the quarterly results. "The focus of business initiatives at investor day should include: a) success in the payments business; b) direct banking initiatives and execution of the expanding direct banking strategy; c) update on the entry into the residential mortgage business; and d) emerging international opportunities," Guggenheim said. "Furthermore, investors will likely focus on catalysts to drive the fundamental business and the Y/Y growth rates. Potential earnings catalysts include: 1) credit cost could remain lower longer than anticipated and 2) Discover's execution and timing of the announced $2 billion share repurchase authorization." Check out TheStreet's quote page for Discover Financial Services for year-to-date share performance, analyst ratings, earnings estimates and much more. Other companies slated to open their books on Wednesday include Actuant Corp. ( ATU), BankAtlantic Bancorp. ( BBX), General Mills ( GIS), H.B. Fuller Co. ( FUL) , Herman Miller ( MLHR), Luby's ( LUB), Shoe Carnival ( SCVL), and Sonic Corp. ( SONC). General Mills is reporting its fiscal third-quarter results before the open, and Wall Street is expecting a profit of 55 cents a share in the February-ended period on revenue of $4.07 billion. The stock hasn't participated at all in the broad market rally, falling 4% year-to-date, and the company came in a penny short last time around. Also worth noting is that Apple's ( AAPL) latest winning streak is up to three sessions now, and the stock hit another all-time high of $606.90 on Tuesday despite reports that the new iPad runs much hotter than the previous model. Consumer Reports addressed the issue late Tuesday, saying the device runs 13 degrees hotter than its predecessor when playing games and that the battery didn't appear to be charging when plugged in while playing games. The Consumer Reports tester said "it felt very warm but not especially uncomfortable if held for a brief period" about the iPad, but there still seems to some likelihood that this issue will need to be addressed. Meanwhile, the economic calendar is light with the Mortgage Bankers Association weekly application activity index due at 7 a.m. ET; existing home sales for February due at 10 a.m. ET; and weekly crude inventories arriving at 10:30 a.m. ET. The consensus estimate is calling for existing home sales of 4.6 million in February, a slight increase from 4.57 million in January, but Briefing.com sees a dip down to 4.45 million. The market will be watching to see if January's number gets revised as well. Last time around, December's tally was dropped to 4.38 million from a previously reported 4.61 million.
And finally, Oracle ( ORCL) will be an active issue on Wednesday after Larry Ellison & Co. reported an above-consensus profit in its fiscal third quarter and issued a strong outlook. The stock was last quoted at $30.58, up 1.6%, on volume of more than 5 million, according to Nasdaq.com, ranging from a high of $31.54 to a low of $29.61 during the extended session. Excluding items, the database giant earned 62 cents a share in its fiscal third quarter ended Feb. 29, up 15% from the same period last year, and well above analysts' forecast of 56 cents a share. Revenue totaled $9.06 billion on a non-GAAP basis, beating Wall Street's expectation of $9.02 billion. Revenue from new software licenses rose 7% year-over-year to $2.37 billion, helping push total software revenue to $6.42 billion, an increase of 8% from last year. Revenue from services was flat at $1.14 billion while revenue from hardware systems fell 11% to $1.47 billion. The performance provided some redemption for Oracle after its surprising miss in the second quarter when earnings came in 5% below Wall Street's view and revenue from new software licenses rose just 2% from the prior year. The stock fell sharply in late December following the second-quarter report, and was just now getting back to those levels this month. For its fiscal fourth quarter ending in May, Oracle forecast non-GAAP earnings of 76 to 81 cents a share vs. the average estimate of analysts polled by Thomson Reuters for a profit of 76 cents a share in the quarter. -- Written by Michael Baron in New York. >To contact the writer of this article, click here: Michael Baron.