Have Bonds Killed the Stock Market Rally? Maybe Not.

The S&P 500 is within touching distance of its all-time peak, set in mid-August. (Michael M. Santiago/Getty Images)

Key Points

• The stock market’s resilience is largely due to a strong second-quarter earnings season, with S&P 500 profits rising 34.5% from last year.
• Rising Treasury yields and a 33% surge in Brent crude prices over the past two months are raising concerns about stickier inflation.
• Data from Bank of America suggests that large institutional buyers have been piling into stocks over the past week.

The bond market’s long summer slump, tied to concerns over debt, inflation, big tech borrowing and an inscrutable Federal Reserve, has been an undeniable headwind for stocks, but hasn’t stopped the broader equity rally in its tracks.

The S&P 500 is trading roughly around the same levels as early June, when the Nasdaq Composite last hit a record high and the chip sector was leading the broader market advance on the back of an AI investment wave that was reinventing the global tech narrative.

Curiously, though, that early June peak for tech stocks came nearly three weeks before a global bond market selloff sparked by two things: a surge in Treasury yields following Kevin Warsh’s first rate decision as Fed Chairman, and Warsh’s address to a central bank forum in Portugal on July 1.

In fact, 10-year yields have added more than 40 basis points since starting their relentless summer climb in late June, and hit a November 2023 high of 4.815% in early Wednesday dealing. Over the same time frame, the S&P 500 has added around 2.6%.

That’s a steady, but by no means spectacular, advance that pegs its year to date gain at around 11.6%.

The move is largely the result of the wildly successful second quarter earnings season, which saw collective S&P 500 profits rise 34.5% from last year thanks in large part to the AI investment wave that has powered the tech sector higher for much of the past four years.

LSEG forecasts see 30% earnings growth for the final two quarters of the year, taking the overall 2026 tally to around 34%, well more than double last year’s total of 14%.

Money hasn’t left the stock market, either, and appears to have rotated from the tech sector into energy, healthcare, materials, and industrial stocks over the past two months.

Data from Bank of America , in fact, suggests that large institutional buyers, as well as hedge fund clients, have been piling into stocks over the past week, following two weeks of outflows.

Single stocks purchases, however, have well outweighed cash into sector ETFs, suggesting investors are becoming far more selective in terms of how they allocate their cash.

The S&P 500 is still within touching distance of its record peak, set in mid-August, and Wall Street is still looking for the benchmark to challenge the 8000 point mark by the end of the year.

But the headwinds can’t be ignored.

“At some point, higher yields are a painful experience for equities,” said Natalia Lojevsky, managing director at CIFC Asset Management.

“The equity market has been remarkable in the way that it’s been able to look through or look past these rising yields, because they’ve sort of been on the higher side for some time now,” she added. “But eventually, it starts to catch up, and I think that’s what’s happening.”

Beyond the surge in Treasury yields, which is likely to remain the market’s focus until JPMorgan kicks off the third quarter reporting season on Oct. 13, the late summer rise in global crude prices is also concerning.

Brent crude futures have gained nearly 33% over the past two months, and traded north of $95 a barrel for the first time since early June on Wednesday, as the U.S. and Iran traded strikes in their six-month conflict in the Gulf region.

“That has investors worried about stickier inflation, as rising input costs put upward pressure on prices across the economy,” said Bret Kenwell, U.S. investment strategist at eToro.

He says that concern is “amplified by the seasonal backdrop and questions around global energy reserves.”

The U.S. Strategic Petroleum Reserve, in fact, hit its lowest level in 44 years last week, Energy Department data indicated on Tuesday, with just 286.6 million barrels of crude in stock. That’s around 40% shy of its full capacity.

Both the rise in crude prices, manifested most simply through higher gas costs, which are now a third higher than last year at $4.20 a gallon, and the lift in Treasury yields could blunt consumer spending, as well. And that’s a key driver for U.S. growth prospects.

“It’s not an immediate feedback mechanism, but clearly, lingering higher rates across the U.S. Treasury curve are going to start to affect people’s wallets,” said Larry Holzenthaler, senior portfolio manager at Catalyst Funds.

“Consumer demand seems to be okay, especially at the upper part of the curve, but if the lower part of the ‘K’ starts to really feel the impact, everyone will feel it in terms of an economic slowdown,” he added.

Fighting through these concerns in September, historically the stock market’s weakest month, with the midterm election cycle in play, won’t be easy. But patience could be rewarded.

“October has historically been the standout month in midterm years, averaging close to 3.0% returns, with November not far behind at 2.7%,” said George Smith, portfolio strategist at LPL Financial.

Who wins the House and Senate won’t sway those numbers either, and the S&P 500 has gained an average of 15% over the 12 months that followed every midterm election of the past 40 years.

“Every cycle and environment is unique, and history is a guide rather than a guarantee, but the tendency for stocks to strengthen once the midterms are in the rearview mirror is strong and worth keeping in mind,” Smith said.

That might be one thing the bond market can’t influence.

Write to Martin Baccardax at martin.baccardax@barrons.com

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