Why Stocks and Bond Yields Are Both Reaching New Heights

With summer winding down and students heading back to school, I wanted to take a moment to share some thoughts on where financial markets are today and what is currently shaping your portfolio.

Over the past several months, the stock market has climbed to new record levels while, at the same time, interest rates (the cost of borrowing money) are near their highest points in roughly two decades. This is a positive development for investors and their financial plans, but it also raises some natural questions. High interest rates are often thought of as slowing down the economy and the stock market, so what is pushing both of these factors higher at the same time?

What is driving the stock market higher?

Major stock market indexes have delivered strong double-digit returns so far this year, with gains spread across many different sectors. Energy stocks have benefited from higher oil prices, technology companies continue to draw investor excitement around artificial intelligence, and industrial companies have done well as the domestic economy holds up. This wide participation across the market is an encouraging sign, because it means the rally is not limited to just one or two areas.

Perhaps the biggest factor behind this year's stock market rally is corporate earnings, which refers to the profits that companies generate. Over the long run, stock prices tend to follow the direction of corporate profits. Current forecasts suggest that earnings for the S&P 500 are expected to grow at over 30% this year, which would be well above the historical average of around 8%.¹ When companies are producing strong profits, stock prices tend to reflect that strength over time.

Rising interest rates are also worth understanding, because rates can go up for different reasons. When rates rise because of concerns about inflation (the general rise in prices over time), that can hurt both stocks and bonds. That is largely what happened in the period following the pandemic.

However, rates can also rise because the economy is growing, which pushes up what are known as “real yields,” meaning bond yields after accounting for inflation. Rising real yields tend to reflect confidence in economic growth rather than fears about inflation. That is largely what has been happening this year, which helps explain why stocks have continued to climb even as rates remain elevated.

What do higher interest rates mean for bonds?

Bond prices and bond yields (the income a bond pays) move in opposite directions. When yields rise, bond prices fall. Because of this, rising rates have kept bond returns relatively flat this year. It may feel puzzling to see stock holdings reach new highs while bond holdings sit largely unchanged, but this is actually how a well-built portfolio is designed to work. Different types of investments move in different directions at different times, and that balance is intentional.

There is also an important bright side to higher rates. Bonds are now paying more income than they have in many years. High-quality corporate bonds and U.S. Treasury securities (bonds issued by the federal government) are currently offering income levels that simply were not available during the long stretch after the 2008 financial crisis, when interest rates were kept near zero for many years. For investors who rely on their portfolios for income, or who want to offset the risk of stocks with more stable investments, this is a meaningful development.

Specifically, the 10-year Treasury yield recently reached approximately 4.9%, a level not seen since late 2023, and the 30-year yield has moved above 5.3%, a level last seen around 2006.² While higher rates do make borrowing more expensive across the economy, they also create opportunities for long-term investors.

Investing for the long term

Stocks and bonds serve different roles in a portfolio, and both are doing their jobs in the current environment. Stocks are benefiting from strong corporate earnings and steady economic growth. Bonds are providing more income than they have in years, which helps cushion the ups and downs that stocks can bring. Together, they support the kind of balance that allows investors to stay focused on their long-term goals rather than reacting to every shift in the market.

It is natural for the stock market to hover near all-time highs during periods of sustained growth. That said, this does not mean volatility (sharp short-term swings in prices) cannot occur. Periods of uncertainty are a normal part of investing and can arise from many sources, including changes in Federal Reserve policy, world events, or shifts in economic data. What history consistently shows is that long-term investors who stay the course and maintain a balanced mix of investments tend to fare better than those who move in and out of markets trying to predict each twist and turn.

As always, please do not hesitate to reach out if you have questions about what the current environment means for your specific situation. I am always happy to walk through how your financial plan is positioned to navigate these conditions.