During an extraordinary few days when the worlds of U.S. politics, policy, economics and company earnings collided, the divergences that run through the country\u2019s equity and bond markets have come into sharp relief.<\/p>\n
For the bond market, the split separates short-dated Treasuries that price off the Fed\u2019s policy rate and longer maturities that are more sensitive to U.S. debt and deficit concerns.<\/p>\n
And for the benchmark S&P 500, that line is between the \u2019Magnificent Seven\u2019, along with a few other tech and artificial intelligence-focused megacaps, and everyone else.<\/p>\n
These types of divides have always existed to some extent, but they have become more apparent this year given the historic concentration on Wall Street and rapid deterioration in the U.S. fiscal outlook.<\/p>\n
The dramatic moves in U.S. assets over the last few days serve as a microcosm of these deeper divergences.<\/p>\n
The split in the bond market burst open on Friday.<\/p>\n
Triggered by surprisingly weak jobs figures and President Trump\u2019s shock decision to fire a senior official in the agency responsible for collecting the data, the two-year Treasury yield plunged 25 basis points and the 2s\/30s yield curve steepened by 20 basis points. These were the biggest moves in one year and two and a half years, respectively.<\/p>\n
The slump in yields, especially at the short end of the curve, indicates that investors\u2019 supposed concerns about fiscal indiscipline quickly evaporate as soon as growth-sapping cracks in the labor market appear. So much for the bond vigilantes.<\/p>\n
Tellingly, there was no pullback on Monday. Indeed, Treasury prices climbed even higher, pushing the two-year yield as low as 3.66 per cent, its nadir since May.<\/p>\n
Long-dated yields have declined too, but not as aggressively, resulting in Friday\u2019s dramatic steepening of the 2s\/30s curve to levels that, with the exception of April\u2019s brief tariff tantrum, haven\u2019t been seen for more than three years.<\/p>\n
Investors may wince at the size of the federal debt and the Treasury\u2019s funding needs but still want to load up on two-year bonds when they think rate cuts are coming. This parallel thinking isn\u2019t new, but the stark difference in the narratives driving the front and back ends of the curve is notable.<\/p>\n
The U.S. equity market concentration story is familiar to everyone by now, but the last few days underscore how jaw-dropping – and seemingly entrenched – it is.<\/p>\n
Blockbuster earnings reports from \u2018Mag 7\u2019 constituents Meta, Microsoft and Apple juiced another wave of outperformance in Big Tech stocks, reviving debate about concentration risk, bubbles and the long-term benefits of AI.<\/p>\n
By some measures, a few Big Tech firms now account for as much as 40 per cent of the total U.S. stock market cap. Tech is more expensive relative to the broader S&P 500 index than ever, even compared to the dotcom bubble, according to Bank of America.<\/p>\n
Wall Street\u2019s average valuations and earnings growth are therefore increasingly being driven by Big Tech. Strip out the top 10 firms, and the rump S&P 490 has barely registered any earnings growth in the last three years, according to SocGen\u2019s Andrew Lapthorne.<\/p>\n
Again, there are multiple narratives at work here. It may be true that overseas investors want to reduce their U.S. equity exposure, but don\u2019t want to miss out on the Big Tech boom. So even if foreign investors start shedding some U.S. assets \u2013 and that\u2019s debatable \u2013 they aren\u2019t apt to be jettisoning the likes of Nvidia and Microsoft.<\/p>\n
This is a delicate juncture for investors. Wall Street is at record highs, but concentration risk has also rarely been higher. The outlook for long-dated bonds is worrying given current fiscal and inflation dynamics, yet the short end looks much more attractive, though even that is complicated by the economic and unique political pressures bearing down on the Fed.<\/p>\n
The divergences in U.S. markets may narrow, gradually or suddenly, or they may continue unabated for some time. Without a crystal ball, it\u2019s tough to know exactly what the catalyst for mean reversion would be.<\/p>\n
One thing is likely guaranteed though: in this environment, it will pay to be nimble.<\/p>\n