Market Update 5th October 2026

Who’s afraid of the big bond yield?

In theory, there is no difference between theory and practice. But in practice, there is. The relationship between bond yields and stock markets is one such situation where things are more nuanced than they look.

We’re told it is straightforward. Mathematically, a rise in yields means a fall in bond prices. A rise in bond yields and thus a fall in their price should cause a drop in the stock market. This largely reflects how investors need to earn a premium for taking the extra risk of investing in equities compared to the returns available on traditionally lower-risk choices like government bonds from a country like the UK or US.

Therefore, we’d expect to see a negative correlation between bond yields and equity returns. But historically it has not been as strong as one might think. And this year it has completely broken down. Why?

In short, it is because confidence around government finances is weaker, while corporate performance has been exceptional (particularly among mega-cap stocks).

A US government default is still pretty much unthinkable, but its fiscal position is weaker than it has been for some time. It has a spending deficit of $2 trillion annually and, a debt to GDP ratio of over 100%. The UK also has similarly shaky figures. Alongside other factors such as the unpredictable nature of inflation and stubbornly low GDP growth it logically follows that the risk associated with government debt is a little higher these days.

This deterioration in confidence around government finances has not been consistent with a period of corporate weakness. In fact, there has been a remarkable contrast.

I have previously used this column to highlight the strength of earnings growth, which is particularly evident at the biggest companies. Looking at the top 5 names in the US market, we can see that the analysts have consistently needed to revise their forecasts about the pace of growth. Expectations for their 2026 earnings are, on average, 36% higher today than they were in January. Over 2025, their estimates increased by 10%, and in 2024 their results came in 22% above where forecasts started the year.

Clearly AI, or SI as Donald Trump has instructed everyone to call it, has been turbocharging progress for these tech giants, but if we zoom out a little and look at the whole market, we get a similar theme. Share prices haven’t held up everywhere, but we continue to see good results from a wide range of sectors, and we are hopeful of continued progress in the upcoming third quarter results season.

This growth has more than offset what has actually been a big compression in valuation. This seems to have gone under the radar for many. A year ago, investors were happy to pay around 23 times expected earnings for the US market. Today, the multiple demanded has dropped to under 20. This rating is still higher than has typically been the case over a long period, but this is again influenced by the strength of expected profit growth. Forecasts for high teen percentage increases in the next two years dwarf longer term average growth rates. It stands to reason that this above average growth justifies an above average valuation. The growth adjusted PE (PEG- price to earnings to growth) ratio is the lowest it has been in the US for over 30 years. The UK has a similarly low number.

I believe the exceptional earnings growth is the biggest single reason why we have seen continued growth in equity markets despite the issues in the government bond market.

Should this growth subside, there are clearly risks. Potential catalysts for a slowdown vary, from macro risks like the effect stubborn inflation may have on consumer spending to sector specifics like the uncertain payoff from the capital being ploughed into AI (sorry, SI). The less demanding ratings the market already trades on would hopefully limit the damage, but I cannot explain how positive earnings surprises have been a major reason equity markets have been so resilient, and then immediately pretend it would all be fine should performance disappoint.

That said, there are clear attractions to investing today. Even short-term yields on government debt are comfortably ahead of inflation rates, and that’s never a bad position from which to start. The much maligned property sector could get a boost from the new Your First Home scheme, and within equities, growth in both the UK and US markets looks strong, the valuation metrics mentioned earlier are appealing, and each enjoy conservative levels of debt.

With that in mind, we have all the more reason to have a keen eye on third quarter numbers. My hopes are high that recent momentum can be sustained, although of course there are no guarantees. Whatever comes through, we shall keep you in the loop with our takes on results as they are released.

George Salmon – Senior Research Analyst

Hawksmoor Investment Management Limited is authorised and regulated by the Financial Conduct Authority (www.fca.org.uk) with its registered office at Sterling Court, 17 Dix’s Field, Exeter, Devon EX1 1QA. This document does not constitute an offer or invitation to any person in respect of the securities or funds described, nor should its content be interpreted as investment or tax advice for which you should consult your independent financial adviser and or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. The editorial content is the personal opinion of George Salmon. Other opinions expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represent the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. Currency exchange rates may affect the value of investments. FPC26776.