Inflation's a lot like cholesterol -- and stocks will be volatile until they can prove their resilience, these strategists say

Critical information for the trading day.

It wasn't that long ago -- OK, yesterday -- when U.S. stocks gathered strength, with the battered Nasdaq Composite registering its largest one-day jump since late August.

Ah well, back to misery. Stock futures are down, yields are rising, and over in Europe, natural-gas prices are going absolutely insane.

Strategists at Société Générale say inflation, like cholesterol, has good and bad kinds. The good kind is demand-driven, boosting revenue and earnings for companies and lifting assets and equity prices. The bad kind is supply-shock-driven, leading to rising costs and falling margins. "Proof that inflation can be good or bad: for a decade, economists complained about the lack of inflation in the euro area but now everyone fears its return," say strategists led by Roland Kaloyan.

The note is focused on European stocks but has lessons for U.S. equities as well. The strategists note the European earnings yield spread to U.S. Treasury yields is above its historical average, which they say suggests either a pricing in of a quarter-point rise in the Treasury yield or a reduction of about 4% in 12-month forward earnings.

A chart from Yardeni Associates shows the U.S. earnings yield spread to the 10 year also above its historical average.

The SocGen strategists expect the 10-year yield to continue to rise, reaching 1.7% by the end of the year and 2.25% in 12 months. They have a positive outlook on the market although volatility might remain high until third-quarter reporting season, which should be the moment of truth for whether companies have pricing power or not.

The strategists don't think the recent sector rotation is the beginning of a long-term trend. For instance, they say investors are buying oil and gas stocks to neutralize their positions versus benchmarks, but still see the heavy structural challenge of decarbonization. For investors who do want value, they advise buying banks, which should benefit from rising bond yields but have limited exposure to China, rising energy prices and supply-chain bottlenecks. They say the recent consolidation offers opportunities in technology and industrials.

The chart

Hard to find a more scorned asset than coal, and yet, here we are, with a parabolic spike in the original black gold. Its surge is mostly due to China, where production has been constrained both due to environmental as well as new mining safety standards. This spike in coal price has been a contributor to the surge in natural-gas prices, as power producers switch to gas, and analysts at hedge fund Man Group point out it's also disrupting Chinese production. U.K. natural-gas futures surged on Wednesday and have jumped 587% this year.

The buzz

The ADP employment report is set for release at 8:15 a.m. Eastern.

A summit between President Joe Biden and Chinese President Xi Jinping could be in the works ahead of a Swiss meeting on Wednesday of U.S. and Chinese security officials, according to the Financial Times.

Merck $(MRK)$ CEO Rob Davis told the FT that the pharmaceutical has more "firepower" after agreeing to buy Acceleron Pharma last week.

Palantir Technologies $(PLTR)$ won most of an $823 million U.S. Army contract to provide data and analytics services.

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The markets

As mentioned above, pretty rocky. Dow industrials futures fell over 300 points as Nasdaq-100 futures slumped as the yield on the 10-year Treasury rose.

Oil futures climbed to the highest level since 2014.