Near record highs, stocks face fresh test from bond yields

New York (CNN) — The S&P 500 on Friday clinched its eighth straight weekly gain, the index’s longest winning streak since 2023. The reasons might sound familiar: strong corporate earnings and AI enthusiasm as investors look past concerns about the war with Iran.

But in the bond market, bad vibes are shaking investors – and could check stocks’ ability to keep climbing. US Treasury yields, which help set interest rates across the economy, are trading at their highest levels in a year. Yields rise when bond prices fall.

Traders now expect the Federal Reserve to keep interest rates on hold in the coming months, with chance of a rate hike later this year, according to CME FedWatch. That’s because the Strait of Hormuz remains closed, oil prices are at four-year highs and inflation expectations are moving higher.

Higher Treasury yields mean more expensive loans and mortgage rates, burdening consumers when sentiment is at record lows, according to the University of Michigan’s long-running survey of consumers.

When Treasury yields rise above one year-highs, “it gets harder for the stock market to ignore; it gets harder for everyone to ignore,” said Rob Williams, chief investment strategist at Sage Advisory. “It affects housing affordability. It affects everything.”

Relentless rally versus rising borrowing costs

Corporate America continues to post strong profits. The S&P 500 is set to post the highest quarterly earnings growth rate since 2021, according to FactSet.

The S&P 500 has clinched 18 record highs this year and is less than 0.5% away from hitting another.

The AI buildout and tax cuts from President Donald Trump’s “One Big Beautiful Bill Act” have helped push shares higher, with gains concentrated in technology and AI-related stocks.

The S&P is weighted by market value, meaning the more valuable the company, the more influence it has on the index. Since the war with Iran began, the S&P 500 is up about 8.6%. But across that same time period, an equal-weighted version of the S&P 500 is up less than 1%.

“It’s just an increasingly narrow set of things that are working,” said Jeff Klingelhofer, portfolio manager at investment firm Aristotle. “For now, at least, the market is looking to only those things, and perhaps not appropriately looking towards some of the warning signs.”

Meanwhile, since March 30, the 10-year yield has risen from 4.34% to about 4.56%.

Klingelhofer said he recognizes the tailwinds for stocks, including AI. But he said he was surprised by the way investors are looking past the way higher yields could strain consumers, despite warning signs like auto loan delinquencies.

“I don’t think markets are appropriately focused on all of the potential headwinds,” Klingelhofer said.

Resilient growth versus inflation scare

Bond investors are demanding higher yields to compensate for the risk of inflation sparked by the nearly three-month-old US-Israeli war with Iran and worries about ballooning government debt in some countries.

Meanwhile, “greed” is driving the stock market, according to CNN’s Fear and Greed Index. The index has pointed to “greed” since April 15, when the S&P 500 hit its first record high since the war began.

Treasury yields typically move based on expectations for inflation and economic growth. While inflation is unnerving some investors, economic growth is also a factor boosting yields and stocks.

The Atlanta Federal Reserve’s daily tracker of economic growth pins US GDP at a healthy 4.3%. Unemployment in April was unchanged at 4.3%, relatively low.

“Steep moves in interest rates have the potential to undermine consumer resilience, but the current margin, while notable, is less immediately impactful on the average American,” said Kriti Gupta, global investment strategist at JPMorgan Private Bank.

The stock market could shrug off the rise in yields if investors focus on the strong economy. The picture becomes more nerve-racking if they focus instead on stubborn inflation, with a fine economy but weary consumer.

It all comes back to oil prices and the Strait of Hormuz. If oil prices continue to trade near $100 per barrel – up more than 68% since the start of the year – inflation concerns will persist and yields could rise further.

A core measure of the Consumer Price Index that strips out food and energy rose 2.8% year-over-year in April. If core CPI heats up to more than 3% year-over-year in the coming months, higher yields are likelier to pressure stock prices, noted strategists at Barclays. CPI tracks the average price change for common goods and services.

The stock market can digest higher yields if the economy keeps growing well, Gupta at JPMorgan said. But if inflation fears intensify and bond market volatility increases, it could outweigh the positive outlook on economic growth.

“And that line is what the US market is grappling with as the timeline shifts around a resolution to the conflict in Iran,” she said.

The-CNN-Wire
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