Stocks & Bonds In Rally Mode Again

The Dow and S&P 500 soared at the open, following on yesterday’s rally. All eleven market sectors are trading higher. Commodities are down (oil, gold, silver, natural gas). The bond market is trading slightly higher after yesterday’s monster rally. This tells us investors don’t believe the Israel/Hamas war will spiral out of control.

As wonky as it may sound, I need to highlight yesterday’s rally in Treasury bonds, which pushed yields broadly lower across all maturities. Bloomberg News cited two proximate causes. First, a couple of Fed officials broke the recent mold and started hinting about an end to interest rate hikes. It’s about time. Second, geopolitical risk just ticked up. The shock of terrorist attacks on Israeli civilians, coupled with that country’s clear determination to retaliate, sent traders running for safety. But I want to offer a third—and better—reason. Treasuries have suffered terribly since May. In fact one of the most widely held long-term Treasury bond funds fell 15% over the last five months. And remember, these are high quality bonds, and shouldn’t jump around like stocks. My point is that losses of that magnitude over such a short period of time are simply unsustainable. So it should come as no surprise that bonds are getting a little relief.

It is no secret or coincidence that equity investors’ biggest fear at the moment is rising long-term bond yields. That’s because they’re sort of beyond the Fed’s control, and hint that investors are increasingly worried about profligate government spending, the difficulty of financing much higher deficits, and maybe higher inflation over the long run. And that’s why over the last few weeks we’ve heard recession talk creep back into the narrative. Investors know that high long-term lending rates threaten the financial health of government, businesses and consumers. Which is why yesterday’s dip in yields was greeted so warmly by stock investors. At least for the moment it takes some of the pressure off.

Meanwhile, however, the economy remains robust. Last Friday the BLS released its September jobs report, which stunned investors. The economy generated 336,000 new jobs during the month, beating economists’ consensus forecast by a factor of two. Also, BLS revised up payroll estimates for July & August by 119,000. Those numbers alone suggest demand for labor is accelerating rather than slowing as other data suggest. And indeed, the unemployment rate held steady at a very low 3.8%, and the underemployment rate ticked down to 7.0%. Typically, stronger payrolls lead to higher wage growth as employers complete for available workers. But in this instance wage growth actually decelerated to an annualized rate of 4.2% vs. 4.3% expected. That’s the slowest rate of wage growth since July 2021. Does this imply growth that’s non-inflationary?

This morning Pepsi (PEP) announced third quarter results that exceeded forecasts. The CEO said consumer spending is “pretty healthy,” and “when they fill up their tank, they’re still buying a Pepsi and a bag of chips.” Echoing this sentiment, JP Morgan CEO Jamie Dimon recently said, “They’re still spending money and they still have more money than they did pre-Covid.”