Stocks Ignore Bonds’ Reaction to Jobs

This morning’s September Nonfarm Payrolls report was a stunner.  Economists expecting a stagnant or modestly easing labor market had to be shocked.  We saw an increase of 336,000 jobs, well above the 170k consensus and exceeding even the highest estimate of 250k.  Furthermore, August’s result was revised higher by 40k to 227k; since the two-month revision was +119k, it also means that July was revised up by 79k.  Predictably, bond yields rose, but after an initial selloff, stocks are currently higher.  Why?

For starters, if we go deeper into the report, we see that there are indeed some market friendly items.  (Bear in mind that we seem to be in a “bad news is good news” environment – at least some of the time – so what liquidity-obsessed stock traders want to hear is not necessarily a positive for workers.)  The month-over-month change in average hourly earnings was +0.2%, which was the same as last month and below the +0.3% consensus.  The unemployment rate was unchanged at 3.8%, slightly above the 3.7% consensus.  Taken as a whole, there is certainly nothing in the payrolls number to suggest that a rate cut is coming imminently, but there also may be insufficient wage pressure to require another hike. 

I have asserted that fixed income traders have a different world view than their equity counterparts.  As we wrote in June:

“…there are two fundamentally different mind sets at work in the financial universe.  By definition, equity players tend to take a “glass half full” approach to investing, while those in the bond market tend to take the opposite approach.  This dichotomy results from the vastly different risk/reward dynamics investments that are inherent in each asset class.”

When one buys a bond, the buyer’s final return is capped by a bond’s promised combination of principal and interest payments.  That’s the definition of fixed income.  Those investors tend to focus upon what might disrupt the final value of their expected contractual payments.  In short, it is more critical for them to focus upon what could go wrong, since they know what will occur if all goes as planned.

Conversely, because stocks have unlimited upside, those who invest in them tend to be more focused on what could go right.  Intelligent traders and investors, those who succeed in the long-term, of course have a well-tuned respect for risk, but face it: the reason one buys a stock is usually for its potential for appreciation. 

Thus, on a day like today, when the two sets of investors can legitimately view the same economic results through two different lenses.  And to be fair, as the morning has continued, it appears that bond traders’ pessimism is ebbing.  Yields rose, particularly at the long end of the curve, but reversed after the 30-year yield failed to sustain its rise above 5%.  At their worst, that yield was over 13 basis points higher; now it is up slightly less than 2bp.  The 10-year is currently 4bp higher, much improved from its peak rise of about 16bp.

So, if bonds have moved off peak pessimism and the worst of the pre-market equity selloff had dissipated shortly after the stock market opened, it does indeed seem fair for stocks to rally.  And the change has been quite stunning.  The S&P 500 (SPX) bottomed around 10:00 EDT and was 1.6% above its lows by 11:45.  The move in the NASDAQ 100 (NDX) was even larger at over 2% in that period.  The rally has broadened out, with NYSE advancers now outpacing decliners by about 2:1, which when it was 4:1 in the other direction at this morning’s lows.

When we Iook toward what sector moved the indices off their lows, my focus turns to the seven stock “sector” that we highlighted yesterday.  The “Magnificent Seven” began to turn higher as stocks were finding their footing, and by 11:15 we saw six out of seven higher.  As I finish this piece at noon, only Tesla (TSLA) is marginally lower, thanks to news about further price cuts, but I have full faith in the stock’s fanboys to push it into the green if the broader market cooperates.

A big assist clearly comes from the options market.  In case you’d forgotten, today is Friday.  That means that weekly options all become zero-dated.  We noted the phenomenon of Friday afternoon gamma squeezes as early as April 2021, long before so-called 0DTE options existed.  On bullish days we saw a pattern of buyers loading up on expiring calls in a rising market, then rolling them into higher strikes as the original options went into the money.  We saw it originally in key ETFs like SPY and QQQ, but as the line between the indices and these stocks blurs because of their heavy weighting, it can be difficult to separate cause and effect.

One “tell” however: VIX is only off modestly to 17.75.  Remember, it tends to decline anyway when a market moving economic number is behind us.  Equity traders are certainly not clamoring for volatility protection today (with the clamor for calls keeping the measure afloat somewhat), but they are hardly as complacent as they were a few weeks ago.