Equity markets may be hitting new highs, but bond investors remain unconvinced that the AI-fuelled growth story can overcome mounting fiscal and economic risks.
That is the view of Nuveen global investment strategist and head of macro credit Laura Cooper, who argues that investors are increasingly relying on a narrow group of companies and themes to justify elevated equity valuations.
Markets have shrugged off a series of headwinds this year, including geopolitical tensions, rising energy prices, fiscal concerns and expectations of higher-for-longer interest rates.
According to Cooper, investors are effectively betting that US economic growth, corporate earnings and the artificial intelligence investment boom will be powerful enough to offset almost everything else.
“The remarkable thing is not that markets remain resilient, but the lack of breadth beneath that resilience,” she said.
While the S&P 500 has gained around 11% year to date, the rally has become increasingly concentrated.
Nuveen estimates that roughly half of expected earnings growth is being driven by companies benefiting directly from AI infrastructure spending, while excluding the 10 largest contributors would reduce the index’s gains by more than half.
The concentration has created a growing divergence between equity and bond markets.
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Long-dated government bond yields continue to reflect concerns about fiscal deficits, rising sovereign debt issuance and the long-term cost of capital. Equity investors, by contrast, appear confident that earnings growth can outpace those pressures.
“Bond investors remain less convinced,” Cooper said.
The next phase of the AI investment cycle could prove critical.
The initial winners of the AI boom – including chipmakers, data-centre operators and networking companies – have benefited from a surge in spending that investors could easily quantify.
However, Nuveen argues that markets are now assuming that an estimated $750bn of AI investment this year will translate into broader productivity gains, revenue growth and higher corporate profits.
That assumption has yet to be fully tested.
“The first phase of the cycle rewarded infrastructure providers. The next will reward businesses that can demonstrate measurable revenue growth, productivity gains and margin expansion from AI adoption,” Cooper said.
The issue is particularly relevant for multi-asset investors seeking to balance opportunities in equities against risks emerging elsewhere in markets.
While US exceptionalism continues to support global equity performance, Europe remains more vulnerable to rising energy prices and geopolitical tensions. Nearly half of European companies have suffered earnings downgrades this year, according to Nuveen, with energy accounting for around one-third of earnings growth in the region.
At the same time, European investors have become increasingly reliant on US technology stocks, raising the potential for broader market repercussions if AI-related earnings fail to meet expectations.
For now, equity markets are winning the argument. However, Nuveen warns that the next stage of the rally will require earnings growth to broaden beyond a handful of AI beneficiaries and spread across the wider economy.
For multi-asset investors, the key question is whether AI-driven earnings growth can continue to outrun rising debt burdens, fiscal pressures and a structurally higher cost of capital.
The answer may determine whether equities continue their advance or whether bond markets are ultimately proved right.