Recession fears melt away as bond yield spreads fall to new 2023 lows, suggesting more upside for the stock market

• Recession fears are dissipating as bond yield spreads fall to new 2023 lows, according to Bank of America.
• The decline in spreads reflects rising investor confidence in corporate earnings.
• If earnings are solid, "this would confirm the ongoing rally in US equities and sets us up for further upside," DataTrek said.

The recession fears that were so prominent at the start of the year are beginning to dissipate as bond yield spreads fall to new 2023 lows, according to Bank of America.

The bank said in its July credit investor survey that while a possible recession remained the top concern among respondents, the share of that worry fell to the lowest level since May 2022. Other top fears among bond investors include inflation, rising interest rates, and geopolitical risks.

Bond yield spreads refer to the premium investors receive for taking on more risk by buying corporate junk bonds compared to buying safer US Treasurys. As the spread declines, it signals that investors are growing more confident about corporate profits and the broader economy.

According to DataTrek Research, the falling bond yields should equate to continued upside in the stock market as long as second-quarter earnings hold up.

"Corporate bond spreads reflect incremental confidence in future earnings and cash flows, so the fact that they are near their 2023 lows is significant," DataTrek Research co-founder Nicholas Colas said in a Monday note. "Should Q2 earnings come in well (as we expect), spreads should make new lows for the year. This would confirm the ongoing rally in US equities and set us up for further upside."

According to the ICE BofA US High Yield Index Option-Adjusted Spread, bond yield spreads for junk bonds set a new 2023 low on Friday, hitting 3.90 percentage points.

There's another data point that bodes well for the stock market going forward, according to Colas, and that's the declining Google search volumes for the words "Dow Jones."

The takeaway is that with fewer Americans so focused on the rally in stocks this year, that ultimately bodes well for further upside in stocks and the broader economy.

"A lack of broad attention on rising stock prices is, in our view, mostly good news for the US economy. Americans as a whole focus on stock prices when they are falling and ignore them when they rally. Since equity valuations are on a stable footing just now, the latter dynamic is at play. Yes, it would perhaps be better if US consumers paid some attention to rising stock prices since that might boost confidence and spending. But that is clearly not how things work, and that's ok," Colas said.