Tldr:
- 30-year Treasuries topped 5%, pushing up borrowing costs and putting pressure on extended equity valuations across US markets.
- The S&P 500 is trading at 21.3 times forward earnings, well above its long-term average of 16 times, leaving stocks vulnerable to a yield-driven sell-off.
- Corporate profits in the first quarter rose nearly 28% year over year, with spending on AI infrastructure emerging as a key driver of growth.
- A prolonged closure of the Strait of Hormuz could unleash a new inflation regime that stock markets have not yet fully absorbed.
Bond yield There are growing concerns among investors as US stock markets appear unprepared to face rising inflation risks.
Despite strong first-quarter earnings and AI-led productivity gains, geopolitical tensions linked to the Iranian conflict are pushing energy prices higher.
The 30-year Treasury bond exceeded 5%, while the 10-year benchmark yield exceeded 4.5% last week. Analysts warn that stock valuations remain stretched, leaving markets vulnerable to a potential sharp correction.
Higher valuations correspond to higher Treasury yields
The S&P 500 has risen more than 17% from its low in late March, posting a year-to-date gain of more than 8%. However, the index is trading at 21.3 times forward earnings estimates, well above its long-term average of 16.
Rising bond yields tend to pressure these valuations by increasing borrowing costs for businesses and consumers alike.
Peter Toews, President of Chase Investment Advisory, Captured the mood clearly. “I think there is a real fear that inflation will be an integral part of the economy in the future.” He said.
“You don’t see any signs of it going down right now, and that’s a real fear, and it will drag the market down if it continues.”
Paul Karger of TwinFocus described a divided outlook among his high-net-worth clients. “Breakfast, lunch and dinner: the question is always how to make sense of this divided view.” He said.
He adopted a “barbell” strategy – holding heavy positions in cash, gold and commodities while maintaining exposure to large-cap growth stocks.
Jack Ablin of Cresit Capital pointed to the closure of the Strait of Hormuz as a critical variable. He warned that even a few months of disruption to oil and liquefied natural gas shipments could lead to “a whole new inflation regime for which investors were not prepared.”
The power of profits masks geopolitical fault lines
Corporate earnings have been a major support for stock markets during this period of uncertainty. First-quarter earnings track nearly 28% above year-ago levels, the strongest growth since late 2021. AI capital spending on data centers and chip infrastructure was the main driver of this growth.
Jeremiah Buckley of Janus Henderson noted that the boom in spending on artificial intelligence is already beginning to show results. “We are seeing the impact of the spending boom on AI and increased productivity.” He added that the momentum could continue until 2027.
However, high valuations in AI-related sectors are prompting caution from some analysts who see a pullback as possible.
Tim Murray of T. Rowe Price explained why traders remain reluctant to turn bearish. “Traders do not want to turn bearish if there is a possibility – as many believe – that the situation in the Strait of Hormuz could be resolved in just a few weeks. He said. This hesitation keeps markets supported even as risks grow beneath the surface.
John Higgins of Capital Economics warned clients on Thursday that equity markets are not pricing in inflation risks as well as Treasury markets already do.
BCA’s Matthew Gertkin added that “the Iran crisis has the potential to reshape the course of markets” for the rest of the year.
