Global stock market resilience is on full display as major equity indexes remain within touching distance of all-time highs, confounding forecasters who predicted a significant downturn this year.
The numbers tell a striking story. According to data from Investing.com, global equity indexes are only 2% below their peaks and have climbed over 12% since the start of the year. This performance is particularly remarkable given the headwinds markets have faced.
The third quarter proved especially turbulent. Borrowing costs surged across the globe. US Treasury yields—the benchmark for global borrowing rates—exceeded 5% for the first time since before the 2007 financial crisis. This sharp jump in rates typically weighs on stock valuations. Yet equities shrugged off most of the pressure.
The divergence between stocks and bonds widened dramatically. While equities held firm, global bonds suffered their worst period in years. Investors holding fixed-income securities took significant losses. For many portfolio managers, the mismatch created a puzzle: why were stocks so resilient when traditional economic signals suggested caution?
Why Global Stock Market Resilience Has Held Strong
The answer lies partly in corporate earnings. Companies have delivered results that justify current valuations. S&P 500 earnings are expected to jump at least 30% this year. That’s a substantial acceleration.
Strong earnings growth acts as a counterweight to rising rates. When companies earn more, investors are willing to pay higher prices for their stock even if bond yields are climbing. This dynamic has supported valuations despite the less-friendly interest-rate environment.
Geopolitical tensions added another layer of risk in recent months. Oil prices surged on supply concerns. Typically, such shocks trigger stock market sell-offs. Instead, markets absorbed the news and moved higher. Energy stocks benefited from higher crude prices, while other sectors found support from economic data that remained reasonably solid.
The artificial intelligence boom also played a role. Tech stocks, particularly those tied to AI infrastructure and software, drove much of the market’s strength. These companies command premium valuations because investors believe their growth prospects justify current prices.
The Bond Market’s Painful Adjustment
The bond market tells a different story. Rising rates create immediate losses for existing bondholders. If you bought a bond yielding 2% and rates rise to 5%, your bond’s value falls sharply. Unlike stocks—which can appreciate if company earnings grow—bonds face a ceiling. Once rates rise, older bonds become less attractive.
This year has been brutal for fixed-income investors. The combination of higher rates and longer duration exposure has wiped out gains accumulated over several years. Some bond funds have posted negative returns exceeding 10% annually. For retail investors who shifted into bonds seeking safety, the experience has been painful.
Central banks tightened policy aggressively to combat inflation. The US Federal Reserve raised rates repeatedly through 2022 and into 2023. Other major central banks followed suit. While these moves have helped cool inflation, they’ve created a higher interest-rate environment that makes borrowing more expensive for companies and individuals alike.
Yet stock markets have largely ignored this headwind. Equities are pricing in the possibility that inflation will continue declining, allowing central banks to eventually cut rates. That scenario would benefit both stocks and bonds. If inflation stays sticky and rates remain elevated, the picture becomes cloudier.
Economic Reality Check
The question hanging over markets is whether current equity valuations are justified. Companies are earning more, which supports higher stock prices. But are earnings growth rates sustainable?
Recessions periodically strike the global economy. They reduce corporate profits. When profits fall, stock prices typically follow. Investors worry that the combination of higher rates, geopolitical uncertainty, and consumer pressure could trigger a downturn.
Inflation remains above central bank targets in most developed economies. While it’s fallen from its 2022 peaks, it hasn’t returned to the 2% levels seen before the pandemic. If inflation re-accelerates, central banks may need to keep rates elevated longer than markets currently expect. That would extend the period of pain for bondholders and potentially pressure stock valuations.
Earnings growth expectations of 30% for the S&P 500 represent a significant beat from recent years. Sustaining that growth becomes harder as the base gets larger. Next year’s growth rates may moderate. If they do, stocks could face downward pressure unless rates decline sharply.
What This Means for Investors
The divergence between stock and bond performance has created a challenging environment for diversified portfolio managers. Traditional balanced portfolios—typically 60% stocks and 40% bonds—have underperformed pure stock portfolios this year. The bond losses have dragged down total returns.
This scenario rewards risk-on positioning. It punishes defensive strategies. For investors who moved into bonds expecting stability, the experience has been frustrating.
Going forward, the key variable is Fed policy. If central banks begin cutting rates in 2024, both stocks and bonds could perform well. Stocks would benefit from lower discount rates and potentially accelerating growth. Bonds would appreciate as yields decline.
If rates stay elevated, stocks may continue holding up—supported by earnings—while bonds languish. This split market performance would persist.
FAQ
Q: Why are stocks near all-time highs when interest rates are so high?
A: Corporate earnings have surged, with S&P 500 earnings expected to rise at least 30% this year. Strong earnings growth justifies higher stock valuations even when borrowing costs are elevated. Additionally, investors are betting that inflation will decline, allowing central banks to cut rates in the future.
Q: Are bonds still a safe investment if they’ve lost so much value?
A: Bonds purchased today offer higher yields than before (over 5% for US Treasuries). These yields compensate investors for future inflation risk. However, existing bondholders have suffered losses. New investors entering the bond market at current yields may find better risk-adjusted returns than those who bought bonds when yields were lower.
Q: Could stock markets fall if earnings growth slows?
A: Yes. Current stock valuations assume earnings will continue growing robustly. If companies’ profits grow more slowly than expected, stock prices could decline. Economic downturns or sustained high interest rates could pressure corporate profitability.
Q: Why have stocks outperformed bonds so dramatically this year?
A: Rising interest rates immediately hurt bond prices. Stocks, meanwhile, have benefited from strong corporate earnings. The split performance reflects the different ways these asset classes respond to a rising-rate environment.
Q: What would need to happen for bond prices to recover?
A: Interest rates would need to decline. If central banks cut rates—typically triggered by slowing inflation or recession fears—existing bond prices would rise as newer bonds would offer lower yields. This typically happens when economic growth weakens.
