AI Earnings Support US Stocks Amid Rising Bond Yields and Geopolitical Risks

US equities have demonstrated resilience this year, primarily supported by impressive earnings growth tied to the ongoing artificial intelligence (AI) capital expenditure cycle. However, rising government bond yields and escalating geopolitical uncertainties are beginning to weigh on investor confidence, according to Chris Wood, global equity strategist at Jefferies.

In a recent edition of his newsletter Greed & Fear, Wood highlighted that despite headwinds from higher bond yields and geopolitical challenges, US stocks have held their ground. The yield on the 10-year US Treasury note reached 5.34 percent, while the 30-year bond climbed to 5.69 percent, levels not seen since April and May of 2002 respectively. These elevated yields have started to exert pressure on stock markets and were partially responsible for a decline in Indian equities, which experienced an eighth consecutive week of losses.

Wood pointed out that the bond market’s shift is significant because it introduces growing risks for equities, especially as the US Federal Reserve adopts a more hawkish stance on monetary policy. Historically, rising bond yields often lead to increased borrowing costs and reduced investor appetite for riskier assets such as stocks.

Typically, US stock markets tend to weaken ahead of mid-term elections before bouncing back afterward. However, this year’s market behavior has deviated from that pattern. Wood attributed this anomaly to the particularly strong earnings growth driven by the AI investment boom, which has boosted corporate profitability and investor enthusiasm.

Despite the current strength, Wood warned investors to keep an eye on three critical factors influencing the market outlook. First, the duration of the AI capital expenditure cycle remains uncertain. While AI-related spending has been a powerful catalyst for earnings, questions remain regarding how long this cycle will continue and whether companies will see sufficient returns on these investments over time.

Second, Wood emphasized a renewed awareness that government bonds from G7 nations may be entering a structural bear market phase. This shift suggests that bond prices could continue to fall as yields rise, impacting fixed income investors and altering the broader investment landscape.

Third, geopolitical dynamics are increasingly complex. Shifting alliances, trade tensions, and regional conflicts contribute to an environment of uncertainty, which can impact global markets and investor sentiment.

Jefferies’ analysis comes amid a broader context where AI technology is driving significant capital allocation across various sectors, reflecting a larger trend of innovation-led growth. Companies investing heavily in AI infrastructure, software, and applications are currently delivering strong revenue and profit growth, which has helped support equity valuations despite macroeconomic challenges.

However, the interplay between rising bond yields and geopolitical risks introduces caution into the market outlook. Higher yields may eventually slow down economic growth by increasing borrowing costs for consumers and businesses. At the same time, geopolitical instability can disrupt trade flows, supply chains, and investor confidence globally.

Investors and market watchers will be closely monitoring how these factors evolve in the coming months, especially as the US heads toward its mid-term elections. The balance between sustained AI-driven earnings growth and the headwinds from financial and geopolitical risks will likely shape market performance for the remainder of the year.

In summary, while AI-related earnings have so far shielded US equities from some pressures, the rising cost of government debt and uncertain geopolitical conditions pose meaningful challenges. Market participants will need to weigh these competing influences carefully as they consider future investment strategies.