By Purvi Agarwal, Sruthi Shankar and Medha Singh
Sept 15 (Reuters) - Add the summer bond-market rout to the list of market upheavals that U.S. stocks have largely shrugged off.
Despite a sharp rise in U.S. Treasury and overseas government bond yields over the past few weeks, the S&P 500 sits just less than 3% below its August 13 record high, as the promise of AI-driven profit growth and economic resilience prompts investors to buy the dips — and perhaps limits the impulse to rotate into bonds.
Investors
are watching if the calm lasts. The last time the 10-year Treasury yield touched 5% was October 2023. That one-day episode was accompanied by a mild selloff in stocks. A more sustained rise above 5% in 2007, in the run-up to the global financial crisis, came just before the S&P 500 shed nearly 5% over two months and much more later.
Here's a look at what's helping stocks:
AI TRADE GOING STRONG
Rising yields typically pressure high-growth stocks because much of their appeal lies in expectations for future profits whose value diminishes as discount rates climb.
This time around, some tech behemoths such as Apple and Microsoft are trading just below their record highs as the AI boom shows few signs of slowing and earnings keep surging.
High-flying chip stocks have lost some shine in recent months, including a broad pullback on Monday, driven in part by concerns about a possible slowdown in domestic AI investment, but some say for now it is a natural move after eye-popping gains earlier in the year.
"We're leaning more into semiconductors; we think there's going to be an even tighter supply-demand dynamic next year when it comes to memory," said Laura Cooper, global investment strategist and head of macro credit at Nuveen.
SOLID EARNINGS GROWTH
Second-quarter earnings for S&P 500 companies are expected to have grown 53% year-on-year, or 49.5% excluding the energy sector, according to LSEG I/B/E/S data. Profits are expected to jump 35% in 2026, up sharply from the 14% growth last year.
Both Alphabet and Amazon reported strong growth in their cloud computing businesses on the back of the AI boom. Stripping out mark-to-market gains at the two companies, the adjusted growth rate is 35%.
"The double headwinds of rising bond yields and oil prices are now testing the market's resilience, but stocks have not lost their key pillar of support, which is fast-rising earnings," said Angelo Kourkafas, senior global strategist-investment strategy at Edward Jones.
ECONOMY HUMMING ALONG
The U.S. economy has stood resilient despite the price pressures stemming from the Iran war.
U.S. job growth accelerated sharply in August, suggesting an improvement in the labor market as employment in leisure and hospitality rebounded after two straight monthly declines.
"Consumers, labor markets and corporate balance sheets have generally held up better than feared. Many investors spent the past three years expecting recession. Instead, they got slower but positive growth," said analysts at Aberdeen.
Inflation pressures have been running high, but consumer spending remains robust, though customers are seeking lower-cost alternatives.
The Bureau of Economic Analysis last month revised up consumer spending estimates to 3.4% from the originally reported 3.2%, in an indication that the individual consumption that supports two-thirds of U.S. economic activity had held up through the first half of the year.
SMALL CAPS A BRIGHT SPOT
Smaller firms often rely on external borrowing to fund their operations, making them vulnerable to higher interest rates.
Despite that sensitivity, the Russell 2000 index of smaller U.S. companies has sharply outperformed the benchmark S&P 500 this year, helped by strong earnings and as investors sought exposure to parts of the market beyond high-growth technology stocks.
While the higher yields have weighed on the small-cap stocks recently, driving the index down more than 5% from its mid-August record high, many expect the momentum to continue.
"Almost all of the lead was built in the first half, when the domestic growth story was doing the heavy lifting: reshoring, an M&A pickup, deregulation and earnings that are far more levered to the U.S. economy than to the mega-cap AI trade," said Tracy Shuchart, senior economist at NinjaTrader.
"If the Fed holds, that is a tailwind for the Russell, because the group has the most to gain the moment the market stops pricing higher for longer."
STOCKS-BONDS CORRELATION TURNS POSITIVE
Typically, in unfavorable economic situations, investors chase the safety of bonds while risk assets, such as stocks, tend to fall.
This time, the Iran conflict has driven up oil prices and fueled interest-rate hike expectations, triggering a bond-market rout that pushed government bond yields to multi-year highs globally as investors demanded more premium to hold debt.
Analysts note that a positive correlation between stocks and bonds emerged post the COVID-19 pandemic-induced inflation shock. This implies stocks and bonds could move in the same direction, dimming the appeal of bonds as a safer investment compared to stocks.
"Given that sovereign bonds no longer diversify or hedge risk assets as effectively, allocations to bonds have been falling while investors have turned to short-term hedging strategies," strategists at HSBC said in a note.
"Allocations to equities have soared, supporting higher valuations."
(Reporting by Purvi Agarwal, Medha Singh, Sruthi Shankar, Utkarsh Tushar Hathi, Sudeshna Ghoshal in Bengaluru, editing by Colin Barr and Sriraj Kalluvila)
