Equity markets have shown surprising resilience in the face of rising bond yields throughout much of 2026, with the S&P 500 experiencing only a 2% drop from its August highs despite the U.S. 10-year Treasury yield climbing 53 basis points since the start of the year. This resilience is attributed to strong economic growth, healthy corporate earnings, and substantial capital expenditures in artificial intelligence (AI). However, equities are becoming more sensitive to yield movements, especially those reflecting inflation concerns or potential central bank policy actions. The pace and cause of yield increases are crucial, with gradual, growth-led rises being more digestible than rapid spikes in real yields or term premiums.
JPMorgan strategists highlight that robust corporate fundamentals, including healthy profit margins across the U.S., Europe, and Japan, and underleveraged balance sheets, provide a cushion for global stocks. The global share of companies expected to post positive earnings-per-share growth in 2026 is above 80%, indicating broad strength beyond the technology sector. The average corporate debt duration of 5-6 years also limits immediate vulnerability to rising interest rates. The firm believes equities can withstand 10-year yields approaching ~6%, supported by strong corporate earnings growth and AI-driven productivity gains.
Despite the current resilience, the absolute level of yields can eventually constrain economic activity by increasing the cost of capital, impacting corporate borrowing, mortgage rates, and discount rates for new investments. Higher real yields, which have risen over 70 basis points in a few months, typically make borrowing more expensive, slowing spending and corporate earnings growth. Yet, strong profit growth, particularly from AI-related investments, has offset this pressure, keeping the S&P 500's equity risk premium relatively stable. Vanguard notes a key risk if the 10-year Treasury yield settles meaningfully above 5%, as it would translate into a higher discount rate, potentially lowering equity valuations.
The market's current state reflects a tension where earnings yield has increased, and valuation has decreased, even with accelerating earnings growth. This contrasts with previous periods where strong earnings growth led to multiple expansion. While the precise connection between these trends is still being understood, a sustained period of structurally higher rates would likely weigh on U.S. equities due to increased funding costs. Therefore, while strong earnings and AI investments have provided a cushion, their continued strength is vital as the cost of capital keeps rising.
