Bonds Are Panicking. Stocks Aren't

Bonds fell almost every day last week, pushing interest rates higher. Yet the Nasdaq is still close to record highs, and few investors are once again comparing today's market to the dotcom bubble. The real question is why rates are rising and which parts of the market they actually hurt.

Oil is the biggest short term factor. As the Iran conflict pushes energy prices up, bond yields have risen with oil almost step for step. Looking closer, though, most of the rise in five year yields reflects expectations of stronger growth, not higher inflation. That difference matters. Rates rising on inflation fears is a warning sign. Rates rising on growth is a sign of confidence in the economy.

The latest data points toward growth. The Fed's preferred inflation measure (PCE) is at 3.4%, but private trackers such as Truflation show underlying inflation continuing to ease. Wage growth also slowed this month, and without fast rising wages, inflation is unlikely to spiral the way it did in the 1970s. Unemployment rose slightly to 4.2%, mainly because more people started looking for work. Senior Fed officials have also signaled they are in no hurry to raise rates in October.

Rates are not unusually high either. With the economy growing at about 6.5% before adjusting for inflation, a 10 year Treasury yield just above 5% is still below the middle of its normal range. Since 1999, higher rates have not squeezed the economy the way they did in earlier decades. In 2022, rates rose far faster than they are rising today, and the U.S. still avoided a recession.

The main reason is that the market looks very different now. In 2008, technology companies along with Alphabet, Amazon, Meta and Tesla made up about 10% of the S&P 500. Today they make up 56%. Higher rates are mainly hurting older, rate sensitive businesses, which is why most stocks hitting new lows are in consumer staples and utilities, not technology. The number of stocks taking part in the rally improved slightly over the last two sessions, but there is still plenty of room for it to broaden.

AI remains the main growth driver. It is now moving beyond businesses to personal AI assistants that run constantly in the background and need large amounts of computing power and memory. Around 90% of global data center financing is in the U.S., which supports a strong dollar and keeps commodity prices in check.

Two risks keep us cautious. First, large technology companies that once had more cash than they needed are now borrowing heavily to fund AI, and the cost of insuring their debt is rising. Second, as major private AI companies prepare to go public, investors will learn whether their valuations are backed by real revenue or by hype.

Our view is that AI infrastructure remains one of the most promising themes. With the market near record highs, we are closely watching market breadth, oil prices, bond yields, inflation and Anthropic's reported IPO, and we will adjust as these develop.