US equities have so far shown limited signs of stress despite a sharp increase in government bond yields, leaving investors to weigh whether strong corporate earnings and continued enthusiasm for AI can continue to offset tighter financial conditions, according to a report by Reuters.
The S&P 500 is less than 3% below its 13 August record, even as Treasury yields and those of other major sovereign markets have climbed significantly in recent weeks.
The resilience of risk assets is being closely watched as the US 10-year Treasury yield approaches levels that have previously coincided with periods of greater equity-market volatility. The yield last reached 5% in October 2023, when stocks experienced a relatively modest sell-off. A more prolonged move above that threshold in 2007 preceded a decline of almost 5% in the S&P 500 over two months before the subsequent deterioration became considerably more severe.
One factor supporting equities has been the persistence of the AI investment cycle. Higher yields normally put pressure on companies whose valuations depend heavily on profits expected further into the future, since those earnings become less valuable as discount rates rise.
However, major technology companies including Apple and Microsoft remain close to their record levels, supported by expectations of continued AI-related spending and strong earnings growth.
Some semiconductor stocks have weakened after substantial gains earlier this year, including a broader decline across Asian AI-linked equities this week amid concerns that domestic investment could moderate. The pullback has nevertheless been characterised by some investors as a correction following the sector’s sharp earlier performance.
Corporate earnings are providing another source of support. Second-quarter S&P 500 earnings are expected to have increased 53% year-on-year, or 49.5% when energy companies are excluded, according to LSEG I/B/E/S data. Full-year 2026 earnings are projected to rise 35%, compared with 14% growth in 2025.
Alphabet and Amazon have both reported strong expansion in their cloud businesses, with AI demand contributing to growth. Excluding mark-to-market gains, their combined adjusted earnings growth was reported at 35%.
The wider US economy has also remained relatively resilient despite price pressures associated with the Iran conflict and higher energy costs.
Employment growth accelerated in August, helped by a recovery in leisure and hospitality employment following two consecutive monthly declines. Analysts at Aberdeen said consumers, labour markets and corporate balance sheets had generally performed better than anticipated, with the US economy delivering slower but positive growth rather than the recession many investors had expected.
Inflation remains elevated, although consumer spending has continued to hold up. The Bureau of Economic Analysis last month raised its estimate of consumer spending growth to 3.4% from an initial 3.2% reading, indicating that household consumption remained relatively robust through the first half of the year.
Small-cap stocks have provided another area of interest for investors looking beyond the dominant technology names. Although smaller companies are typically more exposed to higher borrowing costs because they rely more heavily on external financing, the Russell 2000 has outperformed the S&P 500 this year.
The small-cap index has nevertheless fallen more than 5% from its August record as yields have climbed. Its earlier gains were supported by expectations around domestic growth, reshoring, increased M&A activity, deregulation and earnings that are more closely linked to the US economy than the largest AI-focused technology companies.
For alternative investors, another important consideration is the changing relationship between equities and bonds. The traditional portfolio dynamic in which government bonds provide protection when equities fall has become less reliable since the inflation shock following the Covid-19 pandemic.
The Iran conflict has added to that challenge by pushing oil prices higher and increasing expectations of tighter monetary policy. The resulting bond sell-off has driven sovereign yields to multi-year highs across several major markets.
HSBC strategists said the reduced diversification provided by sovereign bonds has contributed to declining bond allocations and greater use of short-term hedging strategies, while equity allocations have increased.
The combination leaves investors assessing whether strong earnings and economic resilience can continue to absorb the pressure from higher yields, or whether sustained increases in borrowing costs will eventually translate into greater volatility across risk assets.
