Moving the elephant

.

  By Guest Blogger Doug Rowat

.

Capital markets are enormously complex yet surprisingly simple. They’ll always tilt, on a risk-adjusted basis, in the direction where there’s the greatest opportunity to make money.

This is one reason why equity markets performed so well during the Covid crisis. As we know, things weren’t great in 2020. We were locked in our homes, there were no vaccines, the US unemployment rate at one point reached nearly 15%, and the global economy was mired in recession. Yet the S&P 500 did great.

There were many reasons for this, not least of which was optimism that vaccines would eventually be developed; however, one key factor was simply that equities, comparatively speaking, remained the best game in town.

With central banks busy cutting interest rates to support their struggling economies, bond yields hovered near zero percent. The US 10-year Treasury yield, as a key example, bottomed in 2020 at less than 0.50%. You might have yearned for safety during Covid, but a half a percent yield wasn’t enticing. Stocks afforded the better risk-adjusted upside and, indeed, this is where the scales eventually tilted with the S&P 500 advancing more than 18% on a total-return basis in 2020.

Now the situation appears reversed. US bond yields for many maturities have, with plenty of media fanfare, breached above 5%. As of this writing, the US 10-year Treasury yield sits at 5.29%, considerably more attractive than the 0.50% Covid level. Unquestionably, this poses a new risk for equity markets. Again, capital markets behave like a scale, and if a more attractive way to make money emerges (relative to the risk) then money will always tilt in that direction.
However, before you unceremoniously dump all your equities and pivot to bonds, give the following some thought.

First, though 5%+ yields are ostensibly attractive, equity returns in recent years have far eclipsed anything that bonds might offer. The S&P 500 and S&P/TSX Composite, for example, over the past three years have both returned 23% annually on a total-return basis.

Second, while there’s no certainty that this performance will continue, one of the most important drivers of the recent equity bull market—strong corporate-profit growth—remains intact. US earnings growth so far this year has been extraordinary and consensus expects this to continue. In the near term, Q3 S&P 500 earnings are currently expected to increase more than 24% y-o-y, which would mark the 8th consecutive quarter of double-digit growth. And in the medium term, 2026 and 2027 full-year earnings-growth expectations continue to impress:

S&P 500 annual earnings (green) and revenue (orange) growth rates

Source: Zack’s Investment Research

And, finally, while the Fed’s benchmark overnight rate is expected to rise further, thus contributing to these elevated bond yields, history suggests that equity markets adjust just fine to higher interest-rate environments. September marked the Fed’s first rate hike in roughly three years, and while the S&P 500 does historically take a dip after the Fed’s initial rate increase, it then finds its footing and continues to advance. In fact, in six of the past seven rate-tightening cycles, the S&P 500 has recorded a positive gain a year later with the average gain approaching 10%:

The S&P 500 usually powers through Fed tightening

Source: Goldman Sachs Global Investment Research

And though it seems impossible to envision at the moment, don’t discount the possibility of progress in The Middle East. The resumption of even partial tanker traffic through the Strait of Hormuz, for example, would act as a catalyst for equities by dampening inflation concerns. And Trump, needless to say, needs a win ahead of the November mid-terms. Downside risk is easy to focus on because the media endlessly feeds us negative-outcome scenarios but never lose sight of the possible upside risks.

So, yes, bond yields are becoming a headwind for equities but be cautious if you think that they’re enticing enough for the scale to tilt entirely in the opposite direction.

Strong corporate earnings remain the big elephant resting comfortably on the equity side of the scale.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd

Source: https://www.greaterfool.ca/2026/10/10/moving-the-elephant/