Strong Growth Meets Rising Rate Pressure

Executive Summary

Major equity indices finished the week higher, supported by strength in a relatively narrow group of large-cap technology and AI-related companies, even as the broader market struggled beneath the surface. Strong economic growth, resilient labor markets, and improving corporate earnings continue to provide a solid foundation for financial markets. At the same time, sharply higher Treasury yields, elevated energy prices, narrow equity-market leadership, and a more hawkish Federal Reserve have raised the bar for risk assets. The key question is whether continued earnings growth can offset the pressure from higher interest rates and increasingly restrictive financial conditions.

Key Takeaways:

• Market leadership remains unusually narrow. Major equity indexes remain near record highs, but the median S&P 500 stock sits well below its 52-week high, leaving the market increasingly dependent on a relatively small group of large-cap technology and AI-related companies.
• Treasury yields have become a more significant headwind. The 10-year yield moved above 5.2% as stronger economic growth, elevated oil prices, Treasury supply, and hawkish central-bank commentary pushed borrowing costs higher.
• Economic growth has reaccelerated. September business surveys reached their strongest levels in several years, capital-goods orders exceeded expectations, and the Atlanta Fed’s GDPNow estimate points to robust third-quarter growth.
• Corporate fundamentals remain supportive. Third-quarter S&P 500 earnings growth expectations have risen toward 30%, while revenue forecasts and bottom-up earnings estimates have also improved during the quarter.
• Federal Reserve policy remains restrictive. Policymakers continue to emphasize persistent inflation risks and the possibility of additional tightening, even as U.S.-China discussions have reduced some near-term trade uncertainty.

Financial Markets

U.S. equity markets finished mostly higher last week, although headline index performance continued to mask unusually weak market breadth. The divergence between index-level performance and the average stock has become increasingly significant. The median S&P 500 constituent now sits approximately 16% below its 52-week high, even as the cap-weighted index remains roughly 1% below record highs. Strong performance from a relatively small group of large-cap technology and artificial intelligence beneficiaries continues to support the major indices, but narrow leadership leaves the market more exposed if momentum in those companies begins to fade.

Oil prices provided some relief, declining for a second consecutive week, as renewed U.S.-Iran diplomatic headlines reduced concerns about near-term energy disruptions. Lower oil prices supported equities by easing some of the inflation pressure that has contributed to higher interest rates. That improvement remains fragile, however, as markets begin the new week on a more defensive footing following President Trump’s rejection of Iran’s latest proposal to reopen the Strait of Hormuz and restart negotiations. With renewed military action reportedly still under consideration following the November midterm elections, energy markets remain a significant source of uncertainty.

The more consequential market development has been the sharp rise in Treasury yields. On Wednesday, the 2-year yield reached 4.94%, its highest level in more than two years, and the 10-year climbed above 5.2%, its highest level in nearly two decades. The move appears to reflect stronger economic growth and higher real-rate expectations, reinforced by robust September business surveys, elevated oil prices, soft Treasury auctions, and increasingly hawkish central-bank commentary. The speed of the increase bears watching: the 10-year yield has risen roughly 25 basis points over the past two weeks and 40 basis points over the past month, approaching the type of rapid move that has historically created greater pressure on equities.

Corporate fundamentals remain an important counterweight. Consensus expectations for third-quarter S&P 500 earnings growth have climbed toward 30%, up from 26.7% at the end of June, which would mark a third consecutive quarter of earnings growth above 25% and an eighth straight quarter of double-digit gains. Bottom-up earnings estimates have also risen about 1.6% during the quarter, compared with the more typical 2% to 3% decline, while revenue growth expectations have improved to roughly 11.9%. Robust earnings and sales growth continue to support valuations, even as higher interest rates raise the hurdle for risk assets.

Economics

Recent data increasingly suggest that U.S. growth has reaccelerated following a more moderate period earlier in the year. September’s preliminary Purchasing Managers’ Index (PMI) rose to 58.4, its strongest reading since July 2021, with manufacturing and services both accelerating meaningfully. Business investment also remained strong, as core capital goods orders rose 1.6%, well above expectations, reinforcing the role of technology, AI infrastructure, manufacturing capacity, and equipment spending as important supports for expansion. Consistent with these trends, the Atlanta Fed’s GDPNow estimate continues to point toward third-quarter real GDP growth near a 5% annualized pace. The trade-off is that stronger activity is occurring alongside renewed cost pressures, with input inflation at its highest level since October 2022 and supply-chain delays becoming more widespread. With interest rates, oil prices, and monetary policy all more restrictive, some moderation in the current pace of growth would not be surprising and could ultimately help ease inflationary pressures.

Consumer and labor-market indicators remain comparatively solid, though confidence continues to lag the hard data. ADP’s higher-frequency payroll measure showed private employment gains improving for a fifth consecutive week through early September, while initial jobless claims remained exceptionally low at 197,000, pointing to limited layoffs and continued labor-market stability. Consumer sentiment, however, remains subdued. The final September University of Michigan reading was revised modestly higher to 48.1 but stayed below August levels, while one-year and longer-term inflation expectations held at 4.6% and 3.4%, respectively. Consumers continue to express concern about fuel prices, trade disputes, and the broader economic outlook, even as employment, spending, and business activity remain resilient. For now, the consumer and labor market continue to support the expansion, but a gradual cooling would be consistent with a more sustainable growth and inflation backdrop.

Policy

Federal Reserve communication following September’s rate increase remained distinctly hawkish. Chicago Fed President Goolsbee argued that repeated supply shocks from energy, tariffs, and other sources can no longer be ignored if they persist long enough to influence broader inflation, noting that restoring price stability after a lasting negative supply shock may require difficult trade-offs between inflation and employment. His comments stood in contrast to Chair Kevin Warsh’s post-meeting view that the Fed may be able to return inflation to target without materially weakening the labor market. Other policymakers echoed the broader concern that repeated shocks could become embedded in inflation expectations, with several indicating that additional policy adjustments may ultimately be necessary. Taken together, the message remains consistent with the September rate increase: economic activity is durable enough to tolerate tighter policy, while inflation remains sufficiently elevated to keep price stability at the center of the Fed’s debate.

U.S.-China relations were the other major policy focus. President Xi Jinping’s state visit to Washington produced incremental progress but little evidence of a broader strategic breakthrough. The two countries extended their trade truce through January 10^th, advanced plans for more favorable tariff treatment on approximately $30 billion of goods, and established a bilateral dialogue focused on artificial intelligence and related risks. At the same time, U.S. officials indicated that China continues to lag on some existing trade commitments, leaving important disagreements unresolved. For markets, the significance of the summit lies less in any single announcement than in the continued effort by the world’s two largest economies to prevent strategic competition from escalating into renewed economic confrontation. Potential meetings around the November APEC gathering and the December G20 summit could provide additional opportunities to make progress on trade, technology, critical minerals, and other key issues.

Conclusion

The investment backdrop remains fundamentally supportive, but the hurdle for risk assets has risen. Corporate earnings expectations continue to improve, business investment remains strong, labor market conditions are stable, and recent data suggest that economic activity has reaccelerated. Those fundamentals help explain why equities have remained resilient despite a significant rise in interest rates.

At the same time, the combination of elevated oil prices, a 10-year Treasury yield above 5%, narrow equity-market breadth, and a Federal Reserve willing to tighten further leaves less room for disappointing inflation or growth data. Strong economic activity can continue to support earnings, but it also reduces the urgency for monetary-policy relief and may keep the cost of capital elevated. The central question is increasingly whether corporate profit growth can continue to outpace the pressure from higher rates. In this environment, diversification, quality, and disciplined attention to valuation remain especially important as investors balance exceptionally strong fundamentals against increasingly restrictive financial conditions.

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