Non-farm "explosion" a week later, U.S. stocks and corporate bonds respond: surge!

A week ago, the worst employment report since the pandemic sent the market into a frenzy, with investors betting that the economy would slow sharply. But just a week later, the performance of the stock and corporate bond markets seemed as if the report had never happened, with traders appearing to have cast aside macroeconomic concerns and once again heavily betting on risk assets.

This week, high-risk asset trading rebounded across the board, continuing the astonishing rally that previously ignored numerous signals of economic slowdown. The Nasdaq 100 index recorded its largest weekly gain in over a month, Bitcoin halted its short-term decline, and the high-yield corporate bond spread narrowed for five consecutive days, completely erasing the pessimism following the employment data release. Strong corporate earnings and renewed enthusiasm for artificial intelligence are the latest driving forces behind this "risk-on" sentiment.

Despite the stock market's strong performance, the U.S. Treasury market's concerns about the economic outlook have not dissipated, with the yield on the 10-year U.S. Treasury still below pre-employment report levels. According to JP Morgan data, the current probability of recession reflected in the stock and corporate bond markets is only in the single digits, far lower than the pricing in the U.S. Treasury market. The latter has recently even bet that the Federal Reserve will cut interest rates up to three times in the coming months, indicating deep concerns about the economic outlook.

Although the U.S. Treasury market has repeatedly shown signs of recession panic, a recession has yet to materialize. However, historical data from the past few years indicates that the judgments of the risk asset market are often correct. The optimism in the stock and corporate bond markets, contrasted with the cautious attitude of the U.S. Treasury market, is becoming the focus of Wall Street's attention.

Divergent Narratives Across Markets

Last Friday's employment report once shocked the market, showing that U.S. wage growth had fallen to its lowest level since 2020 on a three-month moving average basis. Following the data release, the two-year U.S. Treasury yield recorded its largest single-day drop in 2023, and the S&P 500 index also fell by 1.6%.

Subsequently, the reactions of different markets began to diverge. Although U.S. Treasury yields slightly rebounded this week, the yield on the 10-year Treasury is still about 10 basis points lower than before the report was released, reflecting that concerns in the bond market about economic growth have not dissipated.

In contrast, the stock market has regained lost ground, with the Nasdaq 100 index rising 1.7% compared to the closing price the night before the report was released, and the S&P 500 index rising on three of the five trading days this week. In the corporate bond market, the spread on investment-grade bonds hovers near its lowest level since 2005, indicating extreme optimism.

Mark Freeman, Chief Investment Officer of Socorro Asset Management LP, stated:

"It's hard to make sense of this. The best explanation is that the high-yield bond and stock markets are conveying the same message — no recession, extremely high valuations, and therefore high risk itself."

Corporate Earnings and Capital Inflows Support Risk Sentiment

Behind the resilience of risk assets is a strong corporate earnings season. Data shows that the S&P 500 index is expected to see a 10% increase in earnings for the second quarter, which is four times the pre-earnings season forecast, greatly boosting market sentiment.

Winnie Cisar, Global Strategist at CreditSights Inc., stated:

"Overall, strong technicals, the market's belief that the Federal Reserve will not fall behind the curve and has ample policy space to implement easing, along with better-than-expected earnings, have collectively supported risk assets."

She added that despite doubts about the fundamentals, investors are being driven by strong capital inflows, particularly in the corporate bond market, which keeps spreads resilient.

Chris Hussey from Goldman Sachs noted that some may believe the market is overly complacent, facing a high price-to-earnings ratio close to 23 (which has never occurred except during the 2001 tech bubble). Meanwhile, we are seeing unusual volatility in several stocks, indicating that the market is experiencing a "retail" frenzy similar to what we saw during the tech bubble in 2021.

In addition to the similarities in retail technical factors, there are also technical factors from the Federal Reserve at play. These factors played a significant role in the post-financial crisis era and may now influence the post-pandemic boom in the same way. In fact, if the U.S. does not fall into recession, there has not been a period since the 2008 financial crisis where the Federal Reserve was cutting rates and the stock market did not deliver substantial returns in the following 12 months.

Goldman Sachs cautioned that the impact of tariffs on earnings may only become apparent in the third quarter:

"Currently, tariffs and other policies may hinder corporate profits and even the overall economy, but if disappointing corporate earnings do occur, we may need to wait until the third quarter earnings season to see the results."

"The Bond Market is Always Right"? Growth Concerns Persist

Other data released this week showed that the U.S. services sector weakened amid ongoing price pressures, with initial jobless claims rising to their highest level since November 2021, and consumer inflation expectations also increased. These factors have heightened uncertainty about the economic outlook.

Matt Maley, Chief Market Strategist at Miller Tabak + Co., pointed out:

"Many people do not realize that in an expensive stock market, a decline in long-term interest rates is actually bearish for stocks. When there is a divergence between the stock market and the bond market, the bond market is almost always the correct side in terms of economic fundamentals."

Que Nguyen, Chief Investment Officer of Equity Strategy at Research Affiliates, also believes that in the context of the economic cycle being in the late expansion phase, one should trust the indicators from the U.S. Treasury market rather than the "very, very optimistic" high-yield corporate bond indicators. She added that trying to infer clear economic information amid the seemingly volatility injected into every major asset by Trump's constantly changing policies is becoming increasingly futile.

However, recent history seems to side with the stock market bulls. In recent years, similar asset divergences have occurred multiple times, including in 2023 and 2024, despite repeated recession fears in the U.S. bond market, an economic recession has never materialized.