Equities are acting like they are the risk-free asset…
Executive Summary:
The Illusion of Market Breadth: While the headline S&P 500 hovers near all-time highs, underlying market internals have deteriorated to historic extremes; just four mega-cap tech stocks accounted for over 200% of the index's third-quarter gains, masking the reality that the median constituent is trading 17% below its 52-week high.
The Fixed Income Disconnect: Treasury yields and credit spreads are climbing relentlessly despite soft labor data and coordinated dovish signaling from the Federal Reserve, resulting in a tightening of financial conditions equivalent to more than +140 basis points in rate hikes.
A Structural Shift in Real Yields: Fiscally dominant government borrowing has fundamentally raised the clearing price for capital, offering investors a historically robust real yield of over 3% and providing a compelling, risk-free alternative to heavily concentrated equity portfolios.
Full Commentary:
Most of the major equity indices drifted higher last week, but the real story is the hemorrhaging occurring under the surface of an S&P 500 that’s been stubbornly consolidating around this 7,620 level since early June. Sure, the top-heavy index is within a rounding error (0.5%) of its August 13th all-time closing high of 7,798, but never before have investors experienced a market where this supposed "broad" benchmark tells you less about what the actual average stock is doing.
The S&P 500 Equal Weight Index is tied for its longest weekly losing streak in four years. It’s faltered for seven consecutive weeks now – surpassing the five-week plunge during the early-2020 COVID crash and matching the steep, Fed-induced drawdown of 2022.
A rhetorical question I’ve been batting around with colleagues lately is, “Could it be that the bull market actually ended on August 13th?” Now, barring an exogenous surprise, I still think stocks will be higher at year-end than they are today. But pop the hood on this market, and you'll find an engine that is far from firing on all cylinders. Over 40% of S&P 500 constituents (204 companies, to be exact) are trading more than 20% below their 52-week highs, with the median stock sitting in a -17% hole.
A majority of the index (311 stocks) actually fell in the third quarter—even as the headline index printed a +2% gain. Meanwhile, the small-cap Russell 2000 peeled back more than -7%. Continuing with this theme of ‘the few’ carrying ‘the many,’ the quants over at Citadel noted that just four mega-cap Tech darlings (MSFT, NVDA, AAPL, and META) unilaterally added about 300 points to the S&P 500 in Q3. That’s more than 200% of the index’s total gain, while the other 499-ish companies collectively dragged it down by about 150 points.
Outside of the idiosyncratic AI capex arms race, the price action over the last three months really boils down to the squeeze from a few key variables: the 10-year yield spiked +81 bps in Q3 to 5.28%, diesel jumped +32%, crude oil rallied +35%, and the 30-year mortgage rate climbed +72 bps to 7.30%. All of these are moving in the exact wrong direction if you enjoy loose financial conditions and comfortable consumer pocketbooks.
Liz Ann Sonders, Chief Strategist at Charles Schwab, aptly described the market last week as having a severe case of halitosis. Over the five months ending in September, the S&P 500 rose nearly 6%, but only 13% of its constituents managed to beat the benchmark. Over the past year, it’s up 14% with a measly 9% outperforming. They call this a "stock-picker’s market," which isn't wrong—but you’d better be dead right with your active choices, and you better pile into them, because beating a concentrated index right now requires hitching your wagon to the handful of names handling the heavy lifting. Frankly, the S&P 500 is becoming less and less relevant as a benchmark for actual investors to measure themselves against. When 20 companies make up 50% of the weight—and 15 of them are tech or tech-adjacent—it’s not a broad market index anymore.
This internal rot only worsened in September. Almost 80% of S&P 500 stocks were down for the month, the average stock shed -5%, and only two of eleven sectors were green (Tech, and Communication Services, the latter entirely thanks to Meta and Alphabet). Narrowness is one thing, but the breakdown in the 3-month realized correlation between the cap-weighted S&P and the equal-weight version is something else entirely. On September 22nd, it hit 0.5982. That’s the lowest print in the 15-year history of the data series, sitting an absurd 4.3 standard deviations below the 0.93 average. It’s a K-shaped economy, and we are getting a K-shaped stock market to match.
Now, to be fair, this extreme concentration at least mirrors the fundamentals. The top 10 mega-caps are projected to account for over two-thirds of aggregate S&P 500 earnings growth in Q3. So, you could argue the index is narrow simply because the earnings are narrow.
But it’s not as though several massive macro variables haven’t moved in a way that explains this breadth breakdown. The DXY dollar index is breaking out to a new two-year high above 102, which always causes chaotic pin action across other asset classes. Oil prices remain stubbornly elevated, but it’s the refined product markets (diesel and gasoline) that are really applying the screws to the global economy. And finally, interest rates are climbing back to multi-decade highs. Not even a weak jobs report—and plunging expectations of an October Fed hike (dropping from 70% to 20%)—could pry the upside pressure off rates.
All of this is just a long-winded way of me trying to describe a capital market setup where every asset class is telling a different story. Bonds are screaming about excess supply and sticky inflation. Interest rates are screaming about Fed credibility and above-trend growth. Oil is hyper-focused on global shipping disruptions today and a supply tsunami tomorrow. Sentiment is completely bifurcated (investors are euphoric while consumers are miserable). And all the while, the S&P 500 couldn't care less, happily consolidating within a whisper of its all-time high.
Bottom line: the S&P 500 has effectively become a referendum on about twenty AI stocks, while the market's other gauges—bonds, credit, oil, breadth, sentiment—are flashing the kind of stress you'd normally expect to see priced into the VIX. It’s a genuine headscratcher for us humble analysts tasked with prudently allocating capital on a timeline longer than a few weeks, while trying to strike the right balance between risk and reward.
For now, AI is keeping the equity market propped up. But unless interest rates calm down, the dollar breakout proves to be a head-fake, credit stabilizes, and energy finds a durable solution, the question is no longer how much more equities can absorb — the question is how long they can keep pretending the stress everywhere else just doesn’t matter.
Not to be hyperbolic, but if you are excessively overweighted to risk in your portfolio, you probably should be feeling a little uncomfortable.
After all, we have a Shiller CAPE ratio flirting with territory seen only around the turn of the millennium, equity concentration at modern extremes, and an earnings narrative that—while undeniably strong—carries a hint of artificiality that may struggle to sustain its current pace. This isn’t a signal to dramatically de-risk or head for the hills, but rather a gentle nudge to take a step back and objectively evaluate the board.
I’m directing this line of thinking particularly toward the nearly 70 million Baby Boomers, whose median age is now 70. This demographic currently holds roughly 55% of their asset mix in equities and less than 5% in fixed income. For fifteen years, many in this generation hoped for the day they could lock in a 5% yield on their nest egg with minimal risk. The bond market has finally delivered that opportunity. Yet, having watched their savings compound beyond expectations, many are sitting on portfolios that need to fund the next fifteen years of retirement—without a whole lot of time to weather a potential bear market—while still leaning heavily into equities.
Macro strategist Jim Bianco recently framed the reality of a bear market better than anyone I’ve heard lately:
"A bear market is time, not price. Everybody says the stock market always comes back—and it does. But is it going to be 2000, where the market peaks and takes 13 years to reclaim a new all-time high, or 2020 during COVID, where it plunges and makes a new high five months later?
What if it takes 13 years? If you're 68 years old, you don't want to hear that. That's not good. If you're 38, you might actually cheer it on: you get to dollar-cost average at discounted valuations for over a decade so that by 50, you're sitting on a massive base for the next secular upswing.
Think of it always as time, not price. Ask yourself: if the market rolls over, how long will it take to claw back—and do you actually have the time to sit around and wait for it?"
To make sense of the current equity positioning, we have to look at the bond market. I must admit, Friday's price action in Treasuries was a bit of a head-scratcher following what was, by any objective standard, a remarkably soft jobs report.
Not only did nonfarm payrolls come in at a meager +29k against consensus expectations of +90k, but the Bureau of Labor Statistics quietly shaved another -60k off the prior two months. The unemployment rate ticked up to 4.2%, and perhaps the most notable data point was a muted +0.1% print on average hourly earnings (versus +0.3% expected), all but guaranteeing another negative reading for real wages.
Yet interest rates continued their steady climb anyway. This relentless march higher is especially interesting considering the relatively dovish commentary coming from nearly every prominent FOMC official not named Chair Warsh.
Fed Vice Chair Philip Jefferson made it abundantly clear that policymakers need more time before judging whether additional rate hikes are required:
“As we look ahead, my view is that any future adjustments in policy should be determined by carefully examining trends in the data, the evolving outlook and the balance of risks.[…] My colleagues and I will need to come to our own judgment, which may take more time.”
New York Fed President John Williams echoed that tone, planting his flag firmly in the "hike-and-hold" camp. Governor Michelle Bowman—traditionally an unyielding hawk—didn’t mince words either, stating outright that she sees no urgent need for additional rate moves this year. Lisa Cook struck a cautious tone on persistent supply shocks without offering an ounce of rate-hiking ammo, while Dallas Fed President Lorie Logan openly suggested that surging bond yields are doing the central bank’s heavy lifting for them.
The subtext here is notable: a shift in tone is in play. The Fed appears to be actively trying to dial back the market's hawkish expectations.
Why the sudden pivot? Because broader financial conditions—incorporating the spike in Treasury yields, the widening in credit spreads, and the DXY breaking above 102—have tightened so much that they represent an equivalent increase in the Fed funds rate of over +140 basis points. Roughly 40% of that tightening has hit since Warsh’s hawkish Jackson Hole address on August 28th. We haven't seen financial conditions this restrictive since the spring of 2025. The committee clearly recognizes that the bond market has moved too far and too fast relative to their true intentions. Warsh may be keeping his cards close to his chest, but his voting members are providing plenty of forward guidance.
It’s not just the run-up in nominal yields; the recent widening in global credit spreads bears watching. Investment-Grade spreads have widened to 88 bps (levels we haven't seen since early April), while High-Yield spreads have gapped out +60 bps over the past month to 320 bps. Tighter conditions in corporate credit are something the Fed always pays close attention to—often even more than the equity market. We saw shades of this in late 2018: spreads blew out under a hawkish Fed dot plot calling for two more hikes in 2019, which eventually unraveled into three cuts and an unwind of a cyclical bear market in bonds.
Meanwhile, mortgage rates have ripped from 6.34% a year ago to 7.28% today—jumping +25 bps in just the past week—forcing everyday homebuyers back toward adjustable-rate credit.
Any industry or sector in the equity market sensitive to interest rates has been under heavy pressure. In one sense, the Fed's tightening approach is working, but the math is still hard to square: how deep of a contraction do these industries need to endure to offset an AI capex boom that will push forward regardless of the cost of capital? Using short-term interest rates to cool down a secular tech buildout is a bit like trying to put out an electrical fire with a garden hose—it’s the wrong tool for the job, but that isn't stopping them from trying.
We are witnessing a historic balance sheet bifurcation. The Fed's sledgehammer is crushing small-cap companies that rely on floating-rate debt, while the mega-cap tech giants locked in long-term debt years ago and are now earning 5% on tens of billions in cash. For the heaviest weights in the S&P 500, high interest rates are actually functioning as an easing cycle.
Nevertheless, this move in yields is starting to look overextended to the upside. Calls for 6% on the 10-year and 30-year Treasuries are growing louder, but we heard those same experts pounding the table at these exact levels in the fall of 2023 and the summer of 2007. Look at what happened next.
The immediate problem for bonds is that while the deteriorating jobs print wiped an October hike off the table, the December contract is still pricing in an 84% probability of a hike. The futures market stubbornly continues to discount nearly four Fed moves by next summer, keeping the peak terminal rate around 4.75% (roughly 60 bps above the Fed’s own median projection).
Money and bond markets have, for whatever reason, chosen to downplay the dovish rhetoric pouring out of key FOMC members. But looking at the broader picture, it’s hard not to feel that the bond market is still mispriced.
This brings us to what is arguably the most important observation for asset allocators right now. Why is the bond market actively ignoring a dovish Federal Reserve and pushing yields higher?
Because investors may need to entertain a considerably more structural explanation. Rather than being merely another bout of cyclical market indigestion, today's elevated real yields likely represent the clearing price demanded by private investors to absorb the extraordinary quantities of debt being issued by the government.
As Goldman Sachs macro strategist Alex Privorotsky recently noted, "At some point that is simply the clearing price for fiscally dominant economies trying to attract enough private capital to fund enormous sovereign borrowing."
That observation has profound implications for the equity market.
For the better part of fifteen years, the financial market's framework was defined by financial repression. Investors were systematically pushed out along the risk curve as suppressed real yields made cash and government bonds entirely unattractive. But what we are witnessing today is the very real possibility of that mechanism operating in reverse. If sovereigns need capital badly enough, the "risk-free" asset eventually has to become attractive enough to pull money away from equities.
Or, stated even more starkly: "At some point private savings need to be incentivized to be pulled from risky assets toward risk-free assets to finance government spending."
This isn't a temporary market dislocation; it is a permanent structural reality. With neither side of the political aisle campaigning on austerity or deficit reduction, the supply of Treasury issuance is guaranteed to remain immense. The bond market must offer high real yields to attract the necessary capital. This isn't just a theoretical concept; it is happening right now in the data. Look at the current state of the Bloomberg U.S. Aggregate Bond Index.
As of September 30th, the index is offering a nominal yield of 5.56%. While that sits slightly below the long-term historical average of 6.17% (dating back to 1976), the nominal yield is only half the story.
What actually matters for an investor's purchasing power is real yield—your return after inflation. With inflation running at roughly 2.45%, the real yield on the U.S. Aggregate sits at a robust 3.12%. For context, the historical average real yield over the last five decades is just 2.48%.
Once risk-free real yields are high enough, the hurdle rate for equities rises materially. Risky assets must now compete directly for the exact same pool of savings.
Which brings me right back to our 70-year-old investor holding 55% of their net worth in equities (which is appropriate for some and perhaps not for others). I’m not making a value judgement on what the right number is for any household, but rather trying to raise the following question: Why take historically extreme concentration risk in a narrow S&P 500 – and expose yourself to the potential unforgiving "time" element of a bear market – when you are finally being compensated to do the exact opposite?
Just a few short years ago, investors were suffocating under deeply negative real yields, forced to crowd into volatile equities just to keep their heads above water. Today, the script has flipped. You can lock in a real, inflation-adjusted return of over 3% in high-quality fixed income, well above historical norms.
Investors don't need to chase the last few percentage points of a top-heavy equity rally when the bond market is practically handing them the exact income and capital preservation solution they've spent the last decade searching for. The goal isn't to out-benchmark a broken S&P 500; it's to construct a resilient portfolio that ensures you actually have the capital to fund the next fifteen to twenty-five years of your life.
The structural tide is shifting. Capital is being incentivized to leave risk behind. It might be time to start listening to the clearing price.
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