Why rising bond yields might not be the real threat to stocks

Bond yields have surged sharply, drawing market attention. A common theme is that higher yields are negative for equities, and recent days have supported that view.

Earlier this week, Treasury yields climbed, with the 10-year reaching 4.81% — its highest since October 2023. Equities weakened, and growth and tech stocks fell.

It is generally understood that higher Treasury yields create a tougher environment for stocks. But why?

The basic explanation is that safer government bonds offer higher returns, raising the hurdle for riskier assets like stocks. Higher yields also increase the discount rate on future corporate earnings. This particularly hits long-duration growth stocks, explaining why tech shares struggle when real yields rise sharply.

However, not all bond yield increases convey the same message to markets, in my view.

When yields rise due to improving economic growth, corporate earnings strengthen, boosting investor sentiment. In such cases, equities can perform reasonably well, as stronger earnings offset the higher discount rate drag.

The current yield increase is not of that kind.

Instead, it stems from renewed inflation expectations and a term premium fueled by rising fiscal risks — a far less comfortable mix for stocks.

Inflation-driven yields compress equity valuations without the offset of stronger earnings growth. Adding rising energy costs, corporate margins also face pressure.

Yields have eased slightly from the highs since yesterday, giving stocks some temporary relief. The softer ADP employment data also reduces pressure on the Fed to tighten policy this month.

One more major hurdle remains this week: the US jobs report on Friday.

A weaker non-farm payrolls number could lower yields by diminishing expectations of a Fed rate hike, potentially supporting equities. That would be the relief investors hope for to end the week.

While a very weak report could raise growth concerns, that is not the current focus.

However, if such relief arrives, it might be temporary.

At this point, the ideal for equities is not just lower yields, but lower yields for the right reason: cooling inflation, less restrictive Fed policy, and resilient economic growth.

The bond market, however, is signaling a different economic outlook, particularly regarding corporate earnings.

Considering that, the true issue for stocks is not higher yields themselves, but the reasons behind them.