Early last week, equity markets began to take another breather, partly due to the continued rise in long-term yields. The U.S. 10-year Treasury yield touched 5.3% before receding slightly:
There are multiple drivers behind this action. However, there are also investor dynamics at play affecting rising rates on longer-term Treasurys.
Without getting too technical, there's now a record amount of commercial shorts of bonds, which naturally pushes up yields artificially. Also, short bonds, long equities are asymmetric. The more shorts there are on bonds, when yields fall, stocks then rise like a coiled spring being unleashed.
So, institutional fund investors currently view short bonds as a natural hedge to being long equities. In our view at Cornerstone, this dynamic ultimately supports an overall positive risk/reward in equities into the end of the year.
After all, the U.S. economy remains extraordinarily resilient, even with the Federal Reserve raising interest rates. Plus, the biggest return on capital in corporate America is with AI/technology, which is largely immune to higher rates (which we’ll exhibit later).
Additionally, did we learned anything new from the September Fed minutes released last week? Not really. Our overall impression remains the same.
To summarize, the Fed “suddenly” got impatient with inflation and members got on board with losing patience.
Though somewhat in conflict, Fed governors acknowledge continued progress on inflation and supply distortions like AI memory prices. They also said supply shocks will begin to roll off.
The Fed thinks the labor market is close to maximum employment, allowing it to focus on inflation. But we know the recent extraordinarily weak jobs report is in significant conflict with that assessment.
Somewhat contradictory, the Fed is raising rates to attack inflation, but said policy isn’t restrictive but the entire point of raising rates would be to be restrictive in the first place.
In perhaps the most confusing contradiction, despite increasing rates to fight inflation, the Fed said inflation compensation remains consistent with expectations of personal consumption expenditures (PCE) returning to 2%.
Time will tell if the Fed hikes in 2026 were for the correct policy or if our arguments against these hikes were right.
Earnings Season Preview
We expect the record earnings growth we have seen thus far to continue through the end of the year. The market's resilience has created a tightly coiled spring, especially as we enter this earnings season, which is expected to be just as strong as the previous two quarters.
We know analysts and companies have once again been more optimistic than usual. As a result, current estimates for the S&P 500 for the third quarter are higher today compared to the start of the quarter. Estimated per-share earnings for the third quarter increased by 1.4% from June 30 to Sept. 30:
Remember, analysts typically lower their estimates.
Reviewing guidance, both the number and percentage of S&P 500 companies issuing positive EPS guidance are higher than average:
The 72 companies issuing positive EPS guidance is well above the five- and 10-year averages. More importantly, the markets growth driving tech sector accounts for 44 of the 72 positive guidance reports (61%):
Also, 62% of companies issued positive EPS guidance (the five-year average is 40%).
Analysts’ upward revisions to earnings estimates and the guidance by companies now indicates S&P 500 earnings will grow by 29.5%. That’s a significant increase over the original estimate of 26.7% on June 30:
If the 29.5% rate occurs, it will be the third consecutive quarter of over 25% earnings growth. And there doesn’t seem to be an end in sight.
Importantly, S&P 500 companies are expected to report revenue growth of 12.3% (versus an expected 10.9% on June 30):
Looking forward, analysts expect earnings growth of 27.6% for Q4 2026. That would lead to calendar year earnings growth of 32.4%, which is an increase of 6.2% since June 30:
What about valuations? Based on last Wednesday's closing price for EPS, the forward 12-month price-earnings ratio for the S&P 500 is now 19x. That’s below the five-year average of 19.8 and the 10-year average of 19.1. More significantly, this P/E ratio is well below the 20.4 recorded at the end of the second quarter.
This is earnings growth shrinking valuations. Clearly, corporate fundamental earnings growth and strength is far outpacing the positive market moves already realized in 2026.
Rising Rate Rally
Let’s turn to interest rates a final time, specifically the market reaction following the first rate hike in a cycle. Many investors have scars from 2022. But data debunks the 2022 analogy and proves the comparison is a mistake. The data supports buying quality growth stocks into this rate-hiking environment.
Remember why the Fed raised rates on Sept. 16, in the face of extraordinarily strong growth (as identified above) and arguably supply-shock-driven core inflation.
Understanding this dynamic directs us to three important macro reasons why best-in-class growth stocks can and should thrive into this specific rate hiking regime.
1. Investors care more about why the Fed is raising rates. Historically, the biggest stock market corrections happen when the Fed finds itself significantly behind the curve on inflation and is forced into an aggressive rate hiking cycle to get high prices under control.
Just look at non-transitory 2022. Inflation rose to 9% and the Fed hiked quickly by over 400 basis points after former Chair Jerome Powell finally admitted inflation wasn’t transitory.
But today, monetary policy primarily reflects stronger economic growth, resilient AI infrastructure, consumer demand, and record corporate earnings. The latest Federal Reserve Bank of Atlanta “GDP Now” forecast is 3.7%:
Also, 2026 EPS growth is running well north of 30% expectations. That's why quality stocks have been holding up in the face of uncertain rates across the yield curve.
2. While some argue core PCE inflation remains sticky, not surprisingly to some (us), the most recent reading came in much lighter than expected. Yet, the bond market is currently pricing in four additional hikes:
The current economic data trend indicates hawkishness is likely to peak, especially as the supply-side surge in oil, semiconductor prices, asset management fees, and tariff costs inevitably eases. Thus, pricing pressures should cool significantly by March 2027.
Those areas are the four biggest drivers of today's inflation and they’re all transitory in nature. We are already seeing this dynamic come into play on 10- and 30-year Treasurys as the two-year Treasury yield levels off.
3. Cutting into the conventional crowd “wisdom,” historically equities have done better after rate hikes versus rate cuts:
This is because most rate hike cycles are done in the face of a growing and strengthening economy. This is why the why matters more than the what. If the Fed is hiking because of strong growth, stocks can do just fine.
This growth strength can also be seen in the overall S&P 500 resilience at the macro level, which is hidden in the stealth correction across the broader smaller-cap stock market.
Quality growth matters the most going into the rate hiking cycle and coming out of seasonal weakness because mega-cap tech’s interest coverage ratio of 31.9% powers over everybody else: 
It’s why huge tech stocks have driven much of the sector's alpha in the back half of Q3.
Both the current and historical data continues to converge as expected and aligns with where MoneyFlows’ trusty Big Money Index (BMI) currently sits, as it just crossed into oversold territory right on schedule:
History tells us not to wait because when buyers vanish, the S&P 500 climbs quickly. In 12 oversold episodes since 1990, the S&P 500's low came within a week of the BMI's low. In all 12, the S&P 500 bottomed first and bounced about 2% before the BMI bottomed.
That puts the likely low for the market underneath sometime this week, historically speaking. This also lines up with the midterm election calendar, where midterm year lows have historically landed between Oct. 2 and 15.
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