Why Are Stocks and Bond Yields Rising at the Same Time?

Key Takeaways

• Bullish earnings estimates helped lift the S&P 500 to a record high on Tuesday, despite headwinds from surging Treasury yields.
• Strategists say earnings strength and rising yields are byproducts of the US economy’s rapid growth.
• Some investors fear growth depends too much on the AI data center buildout, which depends on a handful of tech companies whose finances are being tested by massive investments.

Conventional wisdom says rising Treasury yields put pressure on stocks by raising the risk-free rate of capital and increasing borrowing costs for the companies and consumers whose spending fuels the economy. Yet US stocks notched fresh records on Tuesday, the day after the 10-year Treasury yield closed at a 24-year high above 5.3%.

Despite the incongruity of yields and stocks rising at the same time, market strategists say both trends are driven by a growing economy. “Most of the increase in interest rates has been related to stronger economic growth, not increased fears of inflation,” says Jeffrey Buchbinder, chief equity strategist at LPL Financial.

Real yields, or the return a bond investor can expect after accounting for inflation, are at their highest levels since 2007, according to the Cleveland Fed. That they’ve increased faster than inflation expectations this year signals that rising nominal yields reflect economic growth, according to Mason Mendez, global real assets analyst at Wells Fargo.

Meanwhile, stocks have been buoyed by the market’s expectation that upcoming third-quarter earnings reports will reflect the economy’s strength. Analysts forecast that the S&P 500 increased earnings by 29.5% last quarter—its third consecutive quarter of growth above 25.0%, according to FactSet.

Several quarters of exceptional growth have only increased Wall Street’s confidence in corporate America’s profitability. According to Christian Galipeau, head market strategist at Franklin Templeton Institute, full-year S&P 500 earnings estimates have increased every week this year, “which explains the resilience of the tape in the face of higher oil and higher bond yields.”

While analysts predict all 11 equity sectors to post larger profits than a year ago, growth is expected to be strongest in areas benefitting from what are otherwise thorns in the economy’s side. High oil prices stemming from the conflict in the Middle East likely caused energy sector profits to double last quarter. Oil price woes also stunted the Federal Reserve’s progress toward taming inflation, compelling officials to raise interest rates in September and signal more hikes to come.

Similarly, the AI data center buildout—the largest US investment cycle since the 19th-century railroad boom, according to Wells Fargo—has become something of a double-edged sword for the economy and stock market. Demand for AI-enabling hardware continues to exceed supply, driving up prices and boosting tech sector profits by an estimated 65% in the third quarter.

At the same time, the buildout has forced tech giants to borrow, increasing demand for capital and possibly helping push bond yields higher. “When you see corporate 10-plus duration [debt] issued at a 100% higher level than it was last year, you have to imagine there’s a little bit of crowding out there,” says Charlie Ripley, chief investment strategist at Allianz Wealth Management.

Some investors predict AI spending will continue to counter the headwinds of rising interest rates. “As long as the market is more focused on the buildout and rising investment from tech, we think this market can hold up well even if rates move a little bit higher,” says LPL’s Buchbinder. He says the 1990s, when the telecommunications buildout coincided with the Dotcom Bubble, are an instructive parallel. “The 10-year Treasury yield averaged around 6% in the back half of the 1990s,” he says, “so the stock market certainly handled higher rates well then.”

But one of Wall Street’s most acute fears is that the AI buildout will follow the telecom boom’s trajectory too closely, with hyperscalers adding too much computing capacity and speculative fervor driving stock prices to unsustainable heights. Investors also fear the AI economy’s concentration—a small group of chip and tech hardware companies benefitting from an even smaller group of hyperscalers’ enormous investments in one nascent technology—makes it a less-than-ideal growth engine.

That concentration was reflected in the stock market in recent months as tech mega-caps rallied and the average stock faltered. “You tend to need to have more breadth to have a very long-lasting and sustained bull market rally,” says Buchbinder. “We think this market will broaden out again,” he adds, “but it’s probably going to take lower oil prices to make that happen.”