Market’s Uneven Response to Higher Rates

Higher rates are exposing weakness beneath resilient headline equity indices, favoring technology while undermining rate-sensitive sectors and weakening the diversification role of long-term bonds.

• U.S. 10-year Treasury yields rose by more than 0.65% since early August and roughly 1.35% from the March low, with the increase driven mainly by higher real rates rather than inflation expectations.
• Large-cap U.S. equities were only slightly lower in September because technology gained about 5%, while 10 of 11 equity sectors were flat or negative.
• The Russell 2000 and the S&P 500 consumer discretionary sector each fell 9% from their August highs, while U.S. homebuilders declined approximately 16% from their summer peak.
• The author argues that bonds should be treated as an income source rather than an equity hedge because stock-bond correlations are at 25-year highs; he recommends underweighting consumer, housing-related and small-cap stocks while rates remain elevated.
• Technology is supported by strong AI-related earnings, but hyperscalers are issuing substantial debt to finance a $1 trillion capital-spending program, increasing their sensitivity to higher yields; a 5% 10-year Treasury yield could be manageable, whereas 6% would be more difficult.

Takeaway: Portfolio resilience is narrow and dependent on technology earnings, so investors should avoid relying on long-duration bonds for protection and remain cautious on rate-sensitive equities, while recognizing that further gains in technology are vulnerable to higher yields.