Unemployment Reports and Market Dynamics: Navigating Volatility in Bonds, Stocks, and ETFs

Bond yields are shifting, unemployment forecasts are steady, and short positions in ETFs like TLT and HYG reveal market risks. Investors face diverging paths between expensive equities and undervalued bonds, as volatility amplifies bond movements post-unemployment reports.

Our previous research pieces on unemployment and CPI have focused on the yield curve.

The short-dated segment (less than a year) has been going straight down for a year.

The longer-dated segment has been trending higher, but not uniformly: it goes up, then down, then up again.

The 5-year has been the minimum point of the curve until recently, making the curve both upward and downward sloping.

The 30-year yield is below the 20-year yield, but not by much.

Now, the curve is normal from 1 to 20 years, uniformly upward, with no dip at 5 years.

This is related to the election, where the market is concerned with balanced budgets.

The TLT short position is at a high for the past month, coinciding with the biggest move up in the long-dated yield. Therefore, the short position in the ETF is effectively a bet on higher yields.

The IEF position (intermediate-term bonds) is up since the election but remains near historic lows. The 5-year yield has risen significantly in the past month, though the short position remains moderate.

The consensus is for 4.2% unemployment, which is the same as the previous forecast. The average change has been 0.1%, and the average deviation has been 0.1% away from the forecast.

Stocks have been up by 0.21% on average following unemployment reports, while bonds have fallen by 0.35%. The returns of stocks and bonds are negatively correlated. The standard deviation (volatility) has been 0.93% for stocks and 1.46% for bonds, so most of the action has been on the bond side. This move in stocks is slightly higher than average but mostly a non-event for the market as a whole. The bond move, however, is 1.5 times the average.

HYG and other hybrid bond ETFs (which combine equity and bond exposure) had an average return of 0%, with a standard deviation of only 0.4%. These ETFs have been the safest place to be both recently and during unemployment reports. The short position in HYG is at a high, as credit conditions are worsening.

In terms of relative value between bonds and stocks, using the earnings yield (1 / PE) and the 10-year Treasury yield, bonds currently look cheap, and stocks look expensive. This is due to the expansion of PEs driven by the AI boom. A similar dynamic occurred during the internet bubble. Investors are not being compensated for the risk of owning stocks based on earnings, but instead are expecting continued equity gains, similar to the nearly 25% annual growth seen in the last two years—growth not seen since 1998.

The TLT short position indicates the market expects this trend to continue, while the SPY short position is neutral. Therefore, the market is not actively playing this trade, and if anything, is positioned for a reversal. The S&P short position is higher than it was earlier in the year, but lower than last year.

The short position in TLT signals expectations for lower bond prices and higher yields, but the short position in SPY is neutral

This research underscores the importance of monitoring yield curves, unemployment data, and short positioning to understand market dynamics. With bonds signaling value and stocks showing stretched valuations, investors must weigh risks amid rising volatility and evolving credit conditions. Short positioning in TLT and HYG highlights the market's focus on higher yields and potential downturns.

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