Rates Rise, But Equities Climb Higher

Treasury yields surged this week, but strong corporate earnings ultimately carried more weight for equity investors. Despite considerable volatility in both bonds and stocks, the S&P 500 advanced a little over 1% for the week, reinforcing an important market dynamic in which corporate earnings growth continues to outpace the valuation pressure created by higher interest rates.

The 10-year Treasury yield moved above 5%, recording its highest readings in almost two decades. The latest statements from the Federal Reserve have attributed the rise in long-term yields primarily to a robust economy and heavy AI-related investment, not to inflation spiraling out of control. Historically, equities tolerate rising real yields reasonably well when there is a strong growth backdrop. In other words, this yield move is being read as most likely growth-driven, rather than panic-driven.

On the macroeconomic front, consumer spending remains healthy, unemployment is steady and the economy continues to support future revenue and profit growth expectations.

The resilience of stocks reflects the exceptional earnings growth of the S&P 500. Approximately 86% of S&P 500 companies exceeded second-quarter earnings estimates, while aggregate profits have grown at their fastest pace since 2021 (at over 50%). The earnings boom doesn’t appear to be over as consensus expectations currently call for nearly 30% earnings growth in the third quarter.

AI-related investments remain a major contributor to earnings growth. The largest hyperscalers are expected to spend approximately $755 billion on capital expenditures this year, benefiting semiconductor, hardware, industrial and power companies throughout the data-center supply chain.

Not all equities, however, were immune to the rise in yields. Growth-sensitive and interest-rate-sensitive areas came under pressure during the week, while energy stocks benefited from higher oil prices.

On the fixed income front, bonds took a hit, driven by several factors. U.S. business activity reached its highest level in nearly five years, strengthening the case that the Federal Reserve may not be finished tightening monetary policy. A poorly received five-year Treasury auction added pressure, while elevated oil prices revived some concerns again about inflation. By late week, futures markets were assigning approximately two-thirds probability to another Fed rate increase in October.

Oil added another source of volatility. Prices climbed as geopolitical tensions involving Iran raised concerns about global supply, before easing on reports that U.S. and Iranian officials were exploring a phased agreement to reopen the Strait of Hormuz. Although oil remained elevated, the prospect of improved shipping access helped reduce some of the week’s inflation anxiety.

Geopolitics also influenced investor sentiment. Chinese President Xi Jinping visited Washington, D.C. for a summit with President Trump, during which the United States and China extended their trade truce by two months. While the agreement did not resolve the more difficult questions surrounding tariffs, technology restrictions and trade enforcement, it reduced the risk of an immediate escalation between the world’s two largest economies.

While higher yields remain a risk as they could constrain economic activity, for now, earnings growth is outrunning the drag from higher rates. That balance explains why stocks were able to absorb a difficult week in the bond market and continue moving higher.

Takeaways for the Week
earnings growth is outrunning the drag from higher rates. That balance explains why stocks were able to absorb a difficult week in the bond market and continue moving higher.
Takeaways:

• Treasury yields rose sharply as strong economic data, weak auction demand and higher oil prices increased expectations for another Federal Reserve rate hike. Bonds declined, with longer-duration portfolios experiencing the greatest pressure
• Equities remained resilient because exceptional corporate earnings continued to outweigh the drag from higher interest rates. AI-related investment and healthy economic growth helped the S&P 500 and Nasdaq finish the week higher despite considerable volatility

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