Stocks vs. Bonds Showdown: Why the S&P 500 Keeps Ignoring 5%+ Treasury Yields (For Now)

The 10-year US Treasury bond yield has climbed above 5.25%, and the S&P 500 hasn't flinched. The stock index sits just 2.2% below the year-end target of 7,900 — and it could overshoot that mark in the coming days now that crude oil shipments from Persian Gulf producers are reportedly averaging around 98% of pre-war totals (excluding Iran). Producers and shippers have found workarounds to their usual Strait of Hormuz routes, including alternative pipeline routes, ship-to-ship transfers, and naval-escorted night transits.

The big question: how long can stocks ignore bonds if yields keep rising despite lower oil prices? If yields are simply repricing to reflect stronger-than-expected economic growth, earnings will remain strong. The downside risk is to the stock market's valuation multiple if bond yields are rising on concerns about mounting government debt — possibly exacerbated by the unwinding of the yen carry trade.

For now, the call stands: S&P 500 targets of 7,900 by year-end and 8,400 by mid-year 2027.

Bonds: Real Yields Are Doing the Talking

The 10-year Treasury yield rose to 5.24% on Friday, and the 10-year TIPS yield climbed to 2.91%. Since the start of the year, the nominal yield is up 109bps, while the TIPS yield is up 95bps. Real yields account for nearly all of the increase, while inflation expectations have barely budged — a vote of confidence in the economy and a sign of strong demand for credit.

Friday's employment report disappointed: payrolls rose only 29,000 in September versus forecasts of 80,000–100,000, with 60,000 in additional downward revisions for July and August. The 10-year yield dipped on the news, then recovered — suggesting more than the economy's strength or weakness is driving yields. The 2-year yield sits at 4.78%, well above the 3.88% federal funds rate, discounting more Fed rate hikes ahead. The payroll miss looks like an outlier among otherwise solid labor market indicators.

Meanwhile, credit markets are starting to show signs of stress as rates move higher. Credit default swap spreads have widened in recent weeks.

Private credit is showing distress again. The Virtus Private Credit Strategy ETF and the VanEck BDC Income ETF have taken another leg down, coinciding with another quarter of heavy redemption requests at nontraded private credit funds — many of which remain above their 5% quarterly withdrawal limits. So far, the stress has stayed contained within private credit and hasn't spilled into the broad stock market.

Stocks: From Summer Stall to Fall Stall

The S&P 500 closed at 7,722.72 on Friday, just 1.0% below its August 13 record high. The summer stall has turned into a fall stall. The equal-weight S&P 500 is down 5.9% from its August 14 record high and is now only 2.0% above its 200-day moving average.

Concentration worries are back with the Magnificent-7's rebound since mid-August. XMAGS is up 13.6% YTD, versus 10.1% for MAGS and 12.8% for the S&P 500 — and the broad market's outperformance has shrunk considerably since August. The hyperscalers' rebound since late July has been led by Meta.

The Russell 2000 is down 7.7% from its August 14 record high and just 1.8% above its 200-day moving average. SmallCaps are extremely sensitive to interest rates — if high bond yields start to bite the economy, SmallCaps will be the first to react.

Earnings: The FEMO Story Remains Intact

The fabulous earnings momentum (FEMO) story is still alive. S&P 500 forward earnings rose to a record $406.45 per share last week, and the 2027 consensus estimate has flattened around $419. Both are expected to climb to $425 by year-end on better-than-expected Q3 and Q4 results. JPMorgan kicks off Q3 earnings season on October 13.

Industry analysts expect Q3 earnings to rise 23.4% y/y and Q4 earnings to rise 28.2%. Both estimates have edged down ahead of reporting season, as they usually do — and companies are expected to clear the lowered bar.

Valuation: More Downside Than Upside

Since mid-August, the stock market's slippage has come entirely from a lower multiple. S&P 500 forward earnings are up 28.2% YTD compared with 12.8% for the price index, while the forward P/E is down 12.8%.

The S&P 500's forward P/E is 19.0, the Mag-7's is 22.9, and SMidCaps' is below 15. The 7,900 S&P 500 target assumes an 18.6 multiple. With the 10-year yield above 5.00%, there's more downside than upside for valuations through year-end.

Sentiment: A House Divided

The two bull/bear ratios tracked are pointing in opposite directions. The Investors Intelligence ratio is 3.75, well above its 2.61 average, while the AAII ratio is 0.74, well below its 1.18 average. In short: newsletter writers are too bullish, and individual investors are too bearish.