At the start of October, US Treasury yields surged to 5.34% in just one day, their highest level since 2002. The move highlighted just how sharply the bond market backdrop has shifted in recent months. Under normal circumstances, that would be expected to weigh on equity markets, yet markets have remained relatively resilient, as evidenced by almost 1% growth in US equities by mid-October. The question is: why aren't higher bond yields having the impact many investors would expect?
Higher yields can create several challenges for equities. A higher risk-free rate reduces the present value of future profits, while higher financing costs put additional pressure on companies reliant on debt. These pressures are especially relevant to today’s market leaders, many of which are valued on substantial future earnings and are committing significant amounts of capital to sustain their growth.
While movements in bond yields can influence the direction of equities, the underlying cause of those movements is, perhaps, more important. The contrasting market environments of 2008 and 2022 help illustrate this.
2008
The global financial crisis provides a clear example of yields falling for negative reasons. The housing downturn placed the banking system under severe strain, making banks increasingly reluctant to lend. As credit conditions tightened, confidence deteriorated and households and companies cut spending, intensifying fears of a recession. Investors consequently sought the safety of high-quality government bonds, pushing prices higher and yields lower, even as equities tumbled.
2022
By contrast, 2022 provides an example of yields rising for negative reasons. As economies emerged from the pandemic and inflation climbed well above target, central banks tightened monetary policy rapidly. Higher interest rates made newly issued bonds more attractive than existing lower-coupon securities, forcing their prices down and yields higher. Rising yields increased discount rates and borrowing costs, creating a difficult environment for equities and placing valuations under pressure.
These two periods demonstrate that the direction of yields alone does not determine the outlook for equities. The economic forces driving them matter just as much.
If 2008 was a growth shock and 2022 an inflation shock, 2026 is defined by a more delicate tug-of-war between resilient earnings and persistently high yields. At present, we are seeing renewed fears of higher inflation following a sharp rise in global energy and oil prices, driven by ongoing geopolitical conflict in the Middle East. Combined with continued supply chain and food inflation pressures, this has increased the possibility that interest rates will stay higher for longer.
What sets the current environment apart, however, is that economic activity remains resilient and corporate earnings remain strong. Higher yields may reduce the valuation investors are willing to place on those earnings, but if profits continue to grow quickly enough, share prices can remain resilient even as valuation multiples come under pressure.
This leaves investors facing a key question: can corporate earnings remain strong enough to offset the pressure from persistently high yields? If inflation keeps central banks from cutting rates, bond yields are likely to remain elevated, continuing to weigh on equity valuations. As long as earnings growth remains robust, share prices may prove resilient. However, if profits begin to disappoint, that balance could shift quickly and equities may come under greater pressure.
There is, however, a more constructive scenario. Inflation could continue to moderate while economic activity and corporate earnings remain resilient. Improving productivity and easing cost pressures could allow companies to continue growing without generating the same inflationary pressures. This could give central banks greater scope to adopt a less restrictive stance, potentially easing pressure on bond yields. Equities would then retain the support of growing earnings while facing a less challenging valuation backdrop.
Taken together, the experiences of 2008, 2022 and today demonstrate that the relationship between bonds and equities is far from straightforward. Falling yields are not necessarily positive, just as rising yields are not automatically negative. What matters is why yields are moving and what those movements tell us about growth, inflation and corporate earnings.
For now, resilient profits, particularly among AI-related companies that remain a key focus for investors, have helped US equities absorb the pressure from higher yields. Whether that resilience continues may depend on whether earnings can keep growing fast enough to justify the valuations investors are willing to pay.
This uncertainty reinforces why we avoid positioning portfolios around a single view on growth, inflation or interest rates. Instead, we remain globally diversified and focused on high-quality investments supported by long-term structural trends.
