Stocks are ignoring the bond market, can it continue?

There are moments in markets when two signals begin flashing at the same time, and investors instinctively know the combination is uncomfortable. One of those moments is now. US equities remain near record highs while long-dated Treasury yields are climbing to levels not seen since before the Global Financial Crisis. The yield on the 30-year Treasury has pushed above 5%, territory last visited in 2007, and yet the Nasdaq and S&P 500 continue to behave as though financial conditions are not tightening at all. That divergence is becoming increasingly difficult to ignore.

US 30-year bond yield (2002 - 2026)

Past performance is not a reliable indicator of future results.

Traditionally, yields rising to these levels would force a repricing in equities. Higher yields increase discount rates, tighten financial conditions and make future earnings less valuable in present terms. Historically, markets have struggled to sustain elevated valuations in environments where borrowing costs rise sharply. And unlike previous inflation scares in the post-COVID period, this one is being reinforced by a genuine supply-side shock through energy markets, with the conflict in the Middle East pushing oil prices back above $100 and keeping inflation expectations elevated.

What makes the current environment unusual is that equities appear willing to absorb all of this because the earnings backdrop remains extraordinarily strong. The US market, particularly large-cap technology, is being powered by a level of profitability and margin expansion that investors believe can offset the drag from higher yields. The artificial intelligence boom has become the market’s central narrative, and for now it is strong enough to overpower concerns that would typically pressure valuations lower.

S&P 500 daily chart

Past performance is not a reliable indicator of future results.

That is the key distinction between today and previous late-cycle periods. In 2007, investors were also reassured by strong earnings and healthy-looking balance sheets, particularly in the banking sector. But underneath that optimism sat a financial system increasingly strained by tighter credit conditions. Today, the stress point is different. It is not housing or leverage at the core of the market narrative, it is whether the extraordinary spending cycle around AI infrastructure can continue long enough to justify current valuations.

The concentration of market leadership tells the story. The rally has become heavily dependent on a relatively small group of mega-cap technology companies, particularly those tied to semiconductors, hyperscaler spending and AI infrastructure. Nvidia sits at the centre of that ecosystem. Markets are effectively making a bet that the current capital expenditure cycle — led by Microsoft, Amazon, Alphabet and Meta — remains durable despite higher funding costs and rising macro uncertainty.

So far, the numbers support that optimism. Corporate margins continue to improve, earnings growth remains in double digits and productivity gains linked to AI are beginning to show through in the data. That has allowed investors to tolerate a macro backdrop that would normally be deeply uncomfortable for equities. In effect, markets are treating the AI revolution as a force strong enough to partially neutralise tighter financial conditions.

But there is a risk that this creates a dangerous asymmetry. Bond markets are signalling that inflation may remain structurally higher than previously assumed. Oil prices, government borrowing needs and persistent services inflation are all pushing yields upward. At the same time, valuations in US equities remain historically elevated. The cyclically adjusted price-to-earnings ratio is now approaching levels previously associated only with the dot-com era. In other words, markets are trading with “2000-style” equity optimism alongside “2007-style” bond market stress.

That combination is difficult to sustain indefinitely. The question now is not whether earnings are strong — they clearly are. The question is whether they can remain strong enough for long enough to offset a world where capital is becoming more expensive and geopolitical risks continue to build. If AI-driven productivity genuinely transforms corporate profitability over the coming years, today’s valuations may ultimately prove justified. But if the current earnings momentum slows while yields remain elevated, equities could become increasingly vulnerable to a repricing.

For now, investors continue to buy the growth story. The bond market, however, is beginning to ask how long that story can outrun gravity.