U.S. stocks started the week higher, with the Dow up 0.18%, S&P 500 gaining 0.66%, Nasdaq climbing 1.05%, and Russell 2000 advancing 0.50%.
The Nasdaq closed at another record high, while the S&P 500 moved to within 0.3% of its record close. Technology led the gains, although strength was broader than just the largest tech companies. Software, payments, industrial metals, healthcare and energy were among the stronger areas.
Perhaps most notable, stocks rallied even as longer-term Treasury yields moved higher again. Meanwhile, WTI crude fell 1.8%, continuing its recent retreat despite ongoing Middle East tensions.
Stocks Are Becoming More Comfortable With Higher Yields
The bond market remains one of the biggest questions facing investors. Long-term Treasury yields rose again Monday, but unlike several sessions in September, stocks largely shrugged it off. Part of that may reflect greater stability in short-term interest rates. Investors have recently reduced expectations for an immediate October Fed rate hike, taking some pressure off the front end of the Treasury market.
But it may also reflect a broader shift in investor attention. With third-quarter earnings season approaching, markets are increasingly looking toward corporate profits rather than simply reacting to every move in interest rates.
That’s important because the fundamental backdrop remains strong. Economic growth has been resilient, corporate earnings have continued expanding and AI-related investment remains elevated. The question is whether earnings can remain strong enough to justify current stock valuations even with long-term borrowing costs historically high.
Oil Falls Despite Continued Middle East Tensions
Oil prices declined Monday despite another busy weekend of Middle East developments. WTI crude fell 1.8% as regional oil supplies continued to prove more resilient than investors initially feared. Saudi Arabia’s East-West pipeline is reportedly operating normally after recent attacks, while Middle Eastern crude exports have actually risen above prewar levels in recent weeks.
At the same time, substantial geopolitical risks remain. Negotiations over reopening the Strait of Hormuz continue to face significant obstacles, while fighting around the Bab el-Mandeb shipping route has intensified. For markets, the key point is that geopolitical risk has not translated into the severe oil-supply disruption investors feared earlier in the conflict. As long as crude continues moving lower, that provides some relief for consumers, businesses and the Fed’s inflation fight.
The Economy Remains Strong but Inflation Is Still Sticky
Monday’s economic data reinforced the same mixed message investors have been hearing for several weeks. The September ISM services index came in at 54.9, indicating that the service economy continues to expand at a healthy pace.
Employment improved as well, returning to expansion for the first time in three months. But the inflation picture was less encouraging. The ISM prices index climbed to 74.0, its highest level since July 2022, with businesses continuing to cite fuel costs and tariffs as major pressures.
That leaves the Fed facing a familiar problem: economic activity remains healthy, but inflation is still running hotter than policymakers would like. The good news for markets is that falling oil prices could eventually ease some of those pressures. But Monday’s data offered little evidence that the underlying inflation problem has disappeared.
AI Remains a Tailwind, but the Story Keeps Broadening
AI stocks weren’t the dominant driver Monday, but the investment theme continues to broaden. Microsoft gained after an analyst upgrade highlighted the company’s position in enterprise AI, while Cerebras rallied after OpenAI CEO Sam Altman described the chipmaker as a close partner.
Tesla also confirmed preliminary discussions with TSMC about a potential role in its planned Texas semiconductor project, highlighting the enormous amount of advanced manufacturing capacity companies expect AI and automation to require.
At the same time, reports suggested Microsoft and Meta are reducing some spending on Anthropic’s Claude models. That is another reminder that rapid overall growth in AI doesn’t mean every company, or every model, will benefit equally. As the industry matures, competition among models, chips, cloud providers and infrastructure companies is likely to intensify even as overall AI spending continues growing.
Here’s Our Take
Monday’s rally highlights an interesting change in the market’s behavior.
A few weeks ago, another increase in long-term Treasury yields might have been enough to send technology stocks sharply lower. Today, the Nasdaq reached another record despite higher long-term yields.
That doesn’t mean interest rates no longer matter. Instead, investors appear increasingly willing to tolerate higher rates as long as the economic and corporate earnings backdrop remains strong. And that may become the central question for the fourth quarter.
The economy continues to expand, business investment remains healthy and the AI spending cycle is still providing a powerful tailwind. Falling oil prices are also helping offset some of the inflation concerns that dominated September.
But inflation remains stubborn, Treasury yields remain elevated and stock valuations leave less room for disappointment. That puts greater importance on the upcoming earnings season.
If companies can continue delivering strong profit growth and demonstrating that AI investment is translating into real revenue and productivity gains, stocks may be able to withstand higher interest rates. If earnings begin disappointing, however, those same elevated yields could quickly become a much bigger problem. For now, investors appear willing to give corporate America the benefit of the doubt.
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