ORLANDO, Florida, July 28 (Reuters) - The U.S. economy

appears to be in a new era of higher-for-longer bond yields. In

theory, this should be a more challenging environment for equity

investors, but Wall Street's stellar performance in recent years

suggests that is not necessarily the case.

Treasury yields have hit new multi-year highs in recent weeks,

with the 30-year yield reaching the highest level since the

mid-2000s.

Yields, which were floored after the global financial crisis of

2008, rose when the Federal Reserve began aggressively raising

interest rates in 2022 to fight inflation. They have remained

elevated ever since, even as the policy rate was gradually

lowered in 2024 and 2025, and are rising now as bond investors

anticipate a resumption of Fed tightening.

So what does this mean for equity investors?

Intuitively, higher borrowing costs should be a headwind for

stocks.

From a macro perspective, they make it more expensive for

consumers and businesses to borrow, spend and invest. All else

being equal, this should weigh on economic growth and corporate

profits. Higher borrowing costs are a particular concern for

U.S. hyperscalers like Alphabet, Microsoft ( MSFT ),

Meta and Amazon ( AMZN ), which are burning through

their free cash flows and increasingly turning to the debt

markets to help fund the trillion-dollar AI capex boom.

Looked at through an investment lens, higher bond yields

make fixed-income assets more attractive relative to equities,

shrinking the so-called equity risk premium. More importantly,

higher yields translate into a higher discount rate, which

reduces the present value of future earnings - a particular

concern for tech and other growth-sensitive sectors.

Of course, strong earnings can offset rising bond yields, as

the "Magnificent Seven" U.S. tech giants showed in recent years.

But some of these firms' shares, notably Tesla,

Microsoft ( MSFT ) and Meta have fallen sharply this year and are in

technical bear markets. Even the high-flying Philadelphia

semiconductor "SOX" chip index has slipped into bear

market territory. These slumps could simply indicate investors'

growing concerns about the durability - and profitability - of

the AI spending spree, but they could also be a signal that

higher bond yields are starting to weigh on equity performance

for all the reasons noted above.

EARNINGS AND GDP GROWTH

But you don't have to zoom out far to see the other side of

this argument. The S&P 500, Dow Jones Industrials

and Russell 2000 small cap indexes are all just 3% off

their all-time highs. Granted, the Nasdaq is down 8%

from its June 1 peak, but the tech-heavy index has notably

outperformed the other three benchmarks in recent years. This

hardly looks like an equity market under stress.

All things considered, Wall Street still appears to be

taking higher bond yields in stride, an indication that equity

investors are focusing more on stronger growth rather than

fiscal or inflation fears.

There are good reasons why buyers might be tempted to

continue ploughing cash into equities despite the

higher-for-longer bond outlook.

Rising yields are not automatically bearish if they are

being driven by strong nominal growth and earnings, which

currently appears to be the case.

Nominal annualized GDP growth in the first quarter was just

under 6% - and real GDP growth of around 2% this year would keep

nominal growth near that level, perhaps even higher. True,

inflation is above target and sticky, but it's not spiralling

out of control.

Meanwhile, earnings growth expectations are running at an

extraordinary pace - close to 40% for the second quarter and

nearly 30% for the calendar year. However, one should note that

these hopes rest largely on AI, with almost 75% of earnings

growth in the April-June period expected to come from the tech

and communications services sectors.

BACK TO NORMAL?

Perhaps what we're seeing is a return to an equity

environment that is less dependent on multiple expansion than in

recent decades. As Jim Caron at Morgan Stanley Investment

Management notes, the bond market repricing following the

zero-rate "anomaly" of the pre-pandemic years shows investors

are being weaned off their "obsession" with dovish Fed policy

and putting greater faith in the durable growth story.

"What is the biggest market misunderstanding? In my view, it

is the idea that higher rates automatically mean recession,"

Caron wrote last month, adding that a "disorderly" rise in

long-dated yields is a worry, but only if it is driven by

deficits rather than growth.

Of course, the underlying U.S. fiscal picture is hardly

encouraging, and it's safe to say investors are not banking on a

sudden outbreak of fiscal discipline in Washington. With defense

spending and interest payments soaring, the federal deficit

isn't shrinking any time soon. This should put a floor - or

perhaps a springboard - under the term premium and longer-dated

yields. If this becomes the main driver of higher bond yields

over time - rather than a scramble for capital to fuel a

technological boom - then equities could be in trouble.

But, for now, strong earnings and solid, steady growth

appear to be helping stocks learn to live with rising bond

yields. We may soon discover whether that's the new normal or

merely a calm before the storm.

(The opinions expressed here are those of the author, a

columnist for Reuters)

Enjoying this column? Check out Reuters Open Interest (ROI),

your essential new source for global financial commentary.

Follow ROI on LinkedIn, and X.

And listen to the Morning Bid daily podcast on Apple,

Spotify ( SPOT ), or the Reuters app. Subscribe to hear Reuters

journalists discuss the biggest news in markets and finance

seven days a week.