Stock markets have risen to new highs despite geopolitical tensions and a jump in energy prices. However there is a growing risk that rising bond yields, along with a slowing economy or inflationary pressures, could trigger a stock market correction, according to Goldman Sachs Research.

Why are stocks rising to record highs?

The main reason equities are making new highs is because of robust earnings growth, writes Peter Oppenheimer, chief global equity strategist and head of Macro Research in Europe, in a report. Stock market gains reflect the ongoing expansion in the global economy and the extraordinary growth in technology- and energy-related earnings.

Rising bond yields could pose a challenge to equity gains, however. After years of ultra-low interest rates, long-term bond yields have increased significantly. The yield on the 30-year US Treasury has moved above 5%, reaching its highest level since 2007. Yields of similar maturity bonds in Germany, Japan, and other major markets now range between 3.5% and 6%.

Why are bond yields climbing?

Bond yields are climbing in response to increasing inflation risks as well as growing government-debt issuance, which is resulting in more competition for capital, according to Goldman Sachs Research. The demand for capital is also rising to build out infrastructure for artificial intelligence (AI) as well as for critical infrastructure such as energy and defense.

The market moves have caused the correlation between equities and bond yields to turn negative—stocks have climbed as bonds have declined in price. Rising bond yields have also compressed equity risk premiums, meaning investors are being paid less to take on the additional risk of owning stocks instead of risk-free assets like government bonds.

“If oil disruptions continue into the second half of this year and inflation expectations rise further, there is a real risk of a speed bump for equity markets,” Oppenheimer writes.

Will the stock market fall if interest rates rise further?

In the past, sharp increases in bond yields have coincided with negative stock market returns. “While bond yields have been rising, the speed of the adjustment is important and could become a trigger for an equity correction,” Oppenheimer writes.

“A sharp increase in bond yields from current levels presents an additional meaningful risk for equity investors,” he adds.

Is the stock market at risk of falling?

Oppenheimer points to some other reasons stock investors should be cautious. Momentum rallies (rapid gains in stocks as investors buy companies that are already performing well) across regions have reflected strong underlying profit growth. But these rallies also raise the risks of a stock correction amid deteriorating GDP growth and rising inflation.

At the same time, Goldman Sachs Research’s Risk Appetite Indicator reached its highest level since 2021 (its reading of 1.1 last week was in its 99th percentile since 1991).

“Rising optimism is also reflected in the surge in retail participation, particularly in the US,” Oppenheimer adds. The firm’s trading desk estimates that retail trading volumes have risen by 28% since mid-April.

What are the best opportunities for stock investments?

While the risk of a stock correction in the near term is rising, Oppenheimer says that shifts in the distribution of the market’s winners and losers could present opportunities for investors.

For nearly 15 years, stock market returns followed a pattern: the US outperformed other regions, technology outperformed other sectors, and growth-oriented stocks outperformed value-oriented ones.

That pattern is now breaking down, Oppenheimer writes. Rising long-term interest rates—reflecting a combination of rising term premium and rising government debt burdens—have reduced the value of very long duration growth stocks (fast-growing companies expected to have substantial profits far in the future). The increase in interest rates is also undermining the valuations of “defensive” and “quality” parts of the equity market, which are most sensitive to interest rates and were largely valued as proxies for bonds.

At the same time, there’s been a dramatic increase in capital spending (capex), primarily by major US hyperscalers. That marks a major shift from the decade and a half after the global financial crisis when there was little appetite or incentive for companies to invest heavily in capex, according to Goldman Sachs Research. 

The sharp increase in capital spending is benefiting not just chipmakers and technology hardware companies but also traditional industrial and energy businesses involved in building physical infrastructure. “The old pattern of US, technology, and growth outperformance has given way to a more eclectic mix of returns across geographies, sectors, and factors,” Oppenheimer writes.

Are HALO stocks a good investment?

As a result, companies with heavy physical assets but low risk of obsolescence (sometimes called HALO stocks) are being favored by investors at a time when they are increasingly worried about the impact of increased competition on capital-light businesses. “For the first time in many years we see emerging pockets of value in the growth space and emerging pockets of growth in the value parts of the market,” Oppenheimer writes.

This article is being provided for educational purposes only. The information contained in this article does not constitute a recommendation from any Goldman Sachs entity to the recipient, and Goldman Sachs is not providing any financial, economic, legal, investment, accounting, or tax advice through this article or to its recipient. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, express or implied, as to the accuracy or completeness of the statements or any information contained in this article and any liability therefore (including in respect of direct, indirect, or consequential loss or damage) is expressly disclaimed.