Why hasn't the US stock market crumbled with bonds at 5%? AI investment holds the answer

The yield on the 10-year US Treasury note has broken through 5%, yet Wall Street has held up with surprising resilience. Conventional wisdom holds that a sharp rise in long-term rates erodes the present value of future earnings, hitting technology and growth stocks hardest — but this time, analysts say a steep surge in corporate profits fueled by the AI investment boom is absorbing much of the shock.

According to Reuters on Tuesday (local time), the S&P 500 remains within 3% of the all-time high it set in August, even after a recent pullback. That stands in sharp contrast to the 10-year Treasury yield, which climbed as high as 5.041% during trading — its highest level since 2007.

Rising bond yields are generally bad news for equities. As rates climb, the discount rate applied to a company's future earnings increases, reducing their present value. Technology and growth stocks — whose valuations lean heavily on expectations of future rather than current earnings — tend to take a disproportionate hit.

Higher yields also make bonds more attractive on their own terms. When investors can earn around 5% from US Treasuries without taking on equity risk, the incentive to hold stocks at elevated valuations diminishes.

Yet the market is behaving differently from past episodes of rate-driven stress. Shares of Apple, Microsoft and other large-cap technology companies continue to trade near all-time highs.

The most powerful force propping up equities is corporate earnings.

According to LSEG, second-quarter profits for S&P 500 companies are estimated to have risen 53% from a year earlier. Strip out the energy sector and the growth rate still comes to 49.5%.

Full-year earnings growth is forecast at 35% — more than double last year's 14%. The figures suggest that AI investment has moved beyond mere expectations of future growth and is now translating into real gains in sales and profits.

Alphabet and Amazon are posting strong growth in their cloud businesses on the back of surging AI demand. The race to develop AI models is simultaneously driving demand for data centers, semiconductors and cloud services, lifting the earnings of companies across the ecosystem.

Edward Jones said that while "the dual headwinds of rising bond yields and higher oil prices are testing the market, the rapid earnings growth that is the core support for equities has not gone away."

What makes this moment particularly unusual is that AI is pulling equity and bond markets in opposite directions at the same time.

Microsoft, Alphabet, Amazon, Meta, Oracle and other so-called AI hyperscalers are expected to invest about $795 billion in AI infrastructure — data centers, semiconductors and related buildout — this year. That figure is projected to swell to $1.08 trillion next year.

The flood of corporate bond issuance needed to finance that spending is weighing on the bond market. With the US government already flooding the market with Treasuries to cover its fiscal deficit, Big Tech's simultaneous push into the corporate bond market is sharply expanding the overall supply of debt.

For investors, a larger menu of bonds to choose from means they can demand higher yields. That is one reason the AI investment boom is being identified as a factor pushing long-term rates higher.

Yet the same AI spending plays the opposite role in the stock market. Massive data center investment is driving demand for semiconductors, servers, power infrastructure and cloud services, feeding through to higher sales and profits at the companies involved and supporting their share prices.

The result is two forces running in parallel: "AI investment expansion → more corporate bond issuance → higher bond yields" acting as a headwind, while "AI investment expansion → higher corporate earnings → rising share prices" acts as a tailwind.

That is why market attention has shifted away from the fact that the 10-year yield has crossed 5% and toward a more pressing question: how long can the earnings growth that AI is generating continue to offset the damage from high rates.

As long as AI investment and corporate earnings keep growing at their current pace, stocks have room to withstand elevated rates. But if rates stay above 5% for an extended period — raising borrowing costs for companies — or if AI investment begins to slow, the high-rate shock that has so far been masked could start to show up in share prices in earnest.