It’s not often you read a headline for new highs in the US equity market (S&P 500 and NASDAQ) as well as headline for a 24-year high in the US 10-year treasury yield in the same week – but such is our current reality.

This sets up a very unusual game of tug-of-war in markets. On one side, you have a stock market that seems immune to any downward pressure (including rising interest rates that typically act as “gravity” to stock prices as Warren Buffett one said). And on the other side, you have a bond market that is clearly concerned with inflation, growth expectations, ongoing middle east conflict, the deficit, the strong dollar, or most likely, all of the above. Which side is “right”?

Closer Look at Equities

Typically as interest rates rise, equity prices fall. What is leading to ongoing equity strength even as rates rise? One factor that helped last week was news on the labor front – the September jobs report. The report was a case of “bad news is good news” as it was weak – showing 29,000 new jobs in the month versus expectations of 90,000. The unemployment rate also rose to 4.2%. Why did equities celebrate weakening labor news? The Federal Reserve cares not only about inflation – but also about full employment. Markets took some weakness (or lack of stellar growth) in jobs market as a sign the Fed may not hike again in October (the expectation for such fell right after the jobs report).

Earnings also continue to be very strong on the back of both added revenues and increasing margins. With equity prices fundamentally representing the present value of future cash flows, if the numerator (earnings) can rise faster than the denominator (interest rates), present values/prices can still rise. That dynamic will stop when earnings tip over but so far, we haven’t seen signs of that. As we enter another earnings season, this will remain a key dynamic for equities.

We also have a very strong growth backdrop in the US at the moment. Nominal GDP is ever-expanding and like AI or not, its buildout and associated infrastructure demands are providing a powerful growth engine in the US. The obvious question is how long this growth train will continue – and what will happen when it ends. Will the added productivity resulting from AI allow growth to continue? Or will we fall back down to earth?

Lastly, it’s important to separate the “market” from its constituents. Strong growth and returns in some areas is masking a lot of weakness beneath the surface. In September, only Tech and Comm Services were positive on the month. Given the weighting of those names (and the strong relative performance of certain individual companies in those sectors), equity markets continue to churn higher as many parts of the market/economy are being left behind

Closer Look at Fixed Income

On the other side of things is the bond market, which is suffering losses at the hands of rising rates. Both the value of the rate rises and the velocity of those moves is something to behold. Yields started ramping up post the Fed’s speech at Jackson Hole in August and have been on the move ever since. That speech focused on inflationary concerns and undoubtedly, inflationary pressures (largely stemming from the Middle East conflict and energy prices) are contributing to rising rates.

While no one can say when rates will fall, the return potential of fixed income is entirely dictated by the rate at the time of investment (provided the issuer remains solvent). As a result, it is increasingly likely that investors in fixed income will stand to earn a meaningfully positive return on an appropriately structured fixed income portfolio at these rates. Even if rates rise (causing principal values to fall), the current level of income stands to offset such losses and “net out” to a positive return profile.

Who Wins?

In this game of tug of war, my hope is that the investor ultimately wins – by attaining benefits from both asset classes in their mission to compound wealth over time. On the equity side, a disciplined approach to managing concentrations and sector exposure and a focus on quality should allow investors to benefit from this asset class over the long-term. On the fixed income side, for years, there was a beloved acronym “TINA” – standing for there is no alternative (to stocks). With rates at low levels and likely to rise, there were not as many compelling reasons to allocate funds to bonds in place of stocks. Today, with a risk free interest rate above 5%, it sure seems like there are several alternatives that just may help investors reach their goals.

Onward we go,