@theMarket: Bonds are breaking bad but equit

PITTSFIELD, Mass. — Bond market volatility has thrown investors for a loop as yields across the board have risen to multi-year highs.

Oil prices are also gaining, forcing global central banks into a higher-for-longer interest rate posture. Equity investors simply yawn.

Thirty-year Treasuries hit 5.44 percent--a 20-year high. The Ten-year registered 5.23 percent while shorter-term maturities all registered multi-year highs. Meanwhile, as diesel fuel broke $6.50/gallon, Brent crude was above $106/bbl, while U.S. WTI oil was trading above $94/bbl.

And yet despite the backup in yields, the stock market finished the week with gains. On Monday, the Nasdaq hit a record high and finished the week up more than 1.5 percent. There was "talk" on Tuesday that Americans and Iranians would reach an agreement while meeting at the UN General Assembly's 81^st session. Oil and gold prices fell; bond yields did as well.

And then came Wednesday. Let's start with the release of last month's Purchasing Managers' Index (PMI)—both the Manufacturing and Services PMI were much better than expected, revealing rising demand and costs. The results signaled a stronger economy ahead but with rising costs.

This was followed in the early afternoon by a failed $70 billion, five-year Treasury auction. Buyers went on strike. To attract interest, the rate promised on the bonds had to be raised. Yields on existing bonds exploded higher and ended the day at 5 percent. It was the worst auction since 2018. This was followed by another ugly auction of the seven-year on Thursday, which pushed yields even higher.

Is it any wonder that during a talk at a housing conference, Federal Reserve Governor Michael Barr was quoted as saying "more tightening will likely be needed." Several other Fed heads echoed those sentiments during the rest of the week. By Friday, the Ten-year benchmark government bond was 5.21 percent, with most bond vigilantes eyeing 5.30 percent in the days ahead.

As for that peace deal, hope springs eternal over in the stock market. I am still dumb founded that markets believe these White House peace-around-the-corner claims that bubble up every time the markets threaten to fall. The pullback in energy prices reversed by Wednesday.

The Iranians claim they want to return to the Memorandum of Understanding terms to negotiate some truce. That seems to be the extent of the three-hour meeting between Trump's son-in-law and the Iranian president. With the midterms around the corner, the administration appears desperate to at least hold the line on oil prices for the next few weeks. And oil is the key to the stock market.

The administration is working as hard as they can to keep stocks from falling before the election. They hope that people will vote with their pocketbook. In this case, with strong returns in their retirement accounts, more people will vote for the status quo than not.

In the case of a truce in the Middle East, it is up to whether Iran's real leaders, the cadre of hardline Revolutionary Guard bosses, are willing to play ball. Those bad guys were probably disappointed this week when the GOP-controlled Senate continued to rubber-stamp the president's war.

The Republicans narrowly defeated legislation which would have demanded an end to the war. Meanwhile, diesel prices continue to climb, hitting $6.52/gallon. Diesel is actually above $8.00 in California. Nationwide, diesel powers almost everything that moves or is made.

By the time the smoke cleared on Friday, prediction markets priced in the probability of another rate hike in October and December at more than 60 percent. That puts the Fed between a rock and a hard place. If they raise rates, it will increase interest rates on the short end of the curve.

That is where the U.S. Treasury auctions offer most of our government fixed-income instruments to finance our increasing debt load. A rise in rates will cost us more in interest payments, which is the amount the nation pays to borrow money. If they don't raise rates, then inflation continues to accelerate.

The tremors from the climb in U.S. bond yields have reverberated around the globe, pushing bonds higher this week in Japan, Australia, and New Zealand. Europe has followed suit, with German, French, Italian, and Greek fixed income yields moving higher and higher.

So, with yields breaking bad, why is the equity side of the equation holding up so well? The S&P 500 Index is less than 1.5 percent away from all-time highs. But looks can be deceiving. Remember that the large mega-cap stocks, the AI hyperscalers, represent almost 40 percent of most equity indexes. Higher bond yields would least impact these companies because of their strong cash flow and prospects.

Under the hood, almost 70 percent of the S&P 500 constituents are already at least 10% below their 52-week highs and in correction territory. That amounts to the most extreme breadth divergence in ten years. Rising yields hurt small businesses the most. The small cap Russell 2000 Index is where the carnage is occurring. That index is down more than 5 percent over the last month.  The bulls argue that there is no cause for alarm.

The PMI data shows a growing economy thanks to the multi-trillion-dollar expansion in investment capital fueled by AI. As such, rising interest rates are a natural function of a growing economy. All this investment is driving corporate earnings across the economy.

What does it matter if the borrowing rate moves up a percent or so when the payoff from AI investment in the years to come will be multiples of that cost? As long as AI continues to grow, the stock market will grow with it. So say the bulls.