Bond investors are betting on inflation and interest rates staying high for a long time. Stock investors are betting that won’t be a persistent problem, but their convictions are being tested.
Inflation reports this week showed sharp rises in both consumer and producer prices, which jumped in April at their fastest pace in several years, pushed by soaring oil prices and hefty corporate investment in artificial intelligence infrastructure. Treasury yields — the market’s interest rates — rose in response, reflecting bond investors’ fears about stubborn inflation pushing the Federal Reserve to raise interest rates.
On Friday, the 10-year Treasury yield, which underpins borrowing rates from consumer mortgages to business loans, jumped above 4.5 percent, its highest level in a year. It has risen more than half a percentage point since the start of the war in Iran, and roughly half of that increase is attributable to rising inflation expectations, based on prices in inflation-protected government securities.
The S&P 500 stock index dropped about 1 percent on Friday, its worst day since March. Still, the index remains on course for its seventh consecutive week of gains, the longest winning streak since 2023.
Normally, the prospect of rising inflation and higher interest rates would weigh on stocks, but some investors are concluding that strong corporate profits and hefty investment in A.I. can keep driving a rally.
“I think something is happening here,” said Michael Purves, the chief executive officer at Tallbacken Capital, a fund manager. “It’s not just a trade. I think it’s a big structural shift.”
Over recent weeks, an average of four out of five companies in the S&P 500 have reported better than expected earnings for the first quarter, and their earnings exceeded analysts’ expectations by an average of almost 20 percent, far more than is usual.
Many executives have stressed that their companies’ investments in A.I. were a big driver of current and future profits.
Alan Ellingson, the chief financial officer of DraftKings, talked about being “A.I. first” on a recent earnings call. Brian Chesky, the chief executive of Airbnb, said 60 percent of the code written by its computer engineers was done using A.I. Hiroki Totoki, the chief executive of Sony, told analysts that “A.I. is one of the most important themes for us to consider” for the company’s future growth.
In a recent research report, analysts at Barclays noted recent earnings by three A.I companies that were so strong they seemed scarcely believable.
TSMC, the “manufacturing backbone of the entire industry,” according to the analysts, reported first-quarter revenue of nearly $36 billion, up 41 percent from a year earlier, comfortably above its expected growth of 30 percent. Lattice Semiconductor posted 86 percent growth in earnings per share alongside a 42 percent rise in revenue. Intel reported 29 cents per share in earnings, compared with expectations of just a penny.
“These are not speculative projections,” wrote the analysts. “These are reported numbers.”
The A.I. boom is spilling over into other industries, helping to boost share prices across multiple sectors. Microsoft, Meta, Alphabet and Amazon have forecast combined spending just shy of $1.5 trillion on capital expenditures over the next two years. That is income for the construction companies, air-conditioning outfitters, roofers, chip makers and so on surrounding the A.I. infrastructure build-out, boosting demand for their services, and pushing those share prices higher.
Comfort Systems, which installs and maintains heating, ventilation and air-conditioning systems, doubled its gross profit for the first quarter from the same period a year earlier. Its stock price has also doubled just since January. Trent McKenna, the company’s chief operating officer, said much of that increase and upcoming projects was driven by the building of data centers.
That engine is powering the economy and stock market, despite the rise in oil prices stemming from the war in Iran and inflationary effects of tariffs.
Since the war, the S&P 500 has risen roughly 8 percent. But with companies expanding their businesses faster than analysts expected, the value of the S&P 500, by some metrics, is now cheaper than it was before the start of the war.
The price-to-earnings ratio — which measures a company’s stock price in relation to its earnings — shows that while investors are paying more to own the index, they are getting more in return. And they expect that trend to continue. In February, the price of the index was almost 27 times its earnings, but it has fallen to around 22 times — which is still elevated — based on the new, higher expectations for company earnings over the coming year.
Stuart Kaiser, an analyst at Citi, said that the market was still somewhat stretched, but that further increases to stock prices were “not out of reach.”
That would seem at odds with investors’ expectations for higher inflation and potentially higher interest rates.
Higher inflation tends to lead the Federal Reserve to keep interest rates elevated or even raise them, in an effort to slow the economy and the pace of price increases.
This week, bets on the Fed’s keeping rates steady over the next 12 months started to shift toward more investors betting on rate increases early next year, reflected by the prices in interest rate futures markets. This comes despite the confirmation of Kevin Warsh, who has long argued for lower rates, as Fed chair by the Senate this week.
“I think the world needs to be prepared that we may be going into a higher-inflation, higher-interest-rates, higher-stock-market world,” Mr. Purves said.
