Summary of Key Points
Long-term government bond yields in major global economies (the United States, Japan, Europe, etc.) have continued to rise, reaching multi-year highs (for example, the yield on 30-year U.S. Treasury bonds has exceeded 5.3%, and the yield on 10-year Japanese bonds is approaching 3%), indicating that the "price of capital" is becoming more expensive. However, stock markets such as the U.S. market have continued to rise without experiencing significant adjustments, creating a contradiction where bond markets are signaling risks while stock markets are still ascending. Rising long-term interest rates will hit growth stocks (such as technology and AI companies) that rely on future profits, and overseas investors from countries like Japan may reduce their allocation of U.S. bonds, further driving up interest rates. The fact that stock markets have not yet declined is due to policy measures aimed at maintaining stability and expectations of AI-driven profits, but given the high cost associated with AI development and the pressure on cash flows, the market will eventually need a significant adjustment to deflate these bubbles.
1. Why are global long-term interest rates rising? Three factors are driving this trend
Long-term interest rates (such as those on 30-year Treasury bonds) can be considered the cost of borrowing over the next few decades. The current rise is mainly due to three reasons:
- High fiscal pressure in the United States: The U.S. government is accumulating increasing debt and needs to issue more bonds to fund its operations. With insufficient demand, it has to raise interest rates to attract investors (i.e., offering higher yields to encourage purchases).
- Inflation and geopolitical risks: Energy prices (such as oil prices) are rising again, along with geopolitical conflicts (such as the U.S.-Iran relationship), leading to concerns about future inflation and thus higher interest rates required to compensate for these risks.
- Other countries are also raising their rates: Japan's interest rates were previously near zero, but now the yield on 10-year bonds is approaching 3%; long-term interest rates in Europe (Germany, France) are also at high levels. Global funds are re-evaluating their investment strategies, further driving up interest rates.
2. Why are growth stocks most affected by rising long-term interest rates? Because the value of future money decreases
Growth stocks (such as AI and technology companies) are currently not generating much profit, but investors believe they will in the future. For example, if a company is currently earning $100 million and the market expects it to earn $1 billion in five years, it may be valued highly today. However, the value of that money in the future must be adjusted for inflation and other factors. For instance, at a 2% interest rate, $1 billion in five years would be equivalent to $820 million today; at a 5% interest rate, it would only be worth $780 million. The higher the interest rate, the less valuable future money becomes, which puts pressure on growth stock valuations.
3. Why does Japan's rising interest rate impact the U.S. stock market?
Japan is the largest overseas buyer of U.S. bonds (holding $1.14 trillion). Previously, Japanese banks and insurance companies would invest their funds in U.S. bonds to earn interest. Now that Japan's 10-year bond yield is approaching 3%, they can earn similar returns by investing domestically, leading them to reduce their purchases of U.S. bonds:
- They may choose not to renew existing bond holdings or buy fewer new U.S. bonds. This reduces the demand for U.S. bonds, causing their prices to fall and further increasing interest rates, which puts additional pressure on growth stock valuations.
4. Why haven't stock markets declined significantly? Policy support and AI-driven expectations are holding them up
There are two main reasons why stock markets have not dropped despite rising interest rates:
- Policy measures for stability: The U.S. government does not want the stock market to plummet, especially since AI companies (such as OpenAI and chip manufacturers) are in the midst of aggressive financing and expansion. A sharp market decline could disrupt their funding activities. Therefore, when stock markets fall significantly, the White House or the Federal Reserve may announce measures like potential interest rate cuts or improved geopolitical situations to stabilize market sentiment.
- Expectations of AI-driven profits: The market believes that AI will lead to substantial growth. Even if current valuations are high, as long as future profits grow fast enough, they can justify these high values. For example, a company with a 30x price-earnings ratio (PE) could maintain its stock price if it grows its earnings by 15% annually.
5. Stock markets will eventually need to adjust: AI's high cost of capital is becoming unsustainable
The current issue is that the promises made by AI companies are facing practical challenges:
- Tech giants are investing heavily in AI (e.g., Microsoft and Meta building data centers and purchasing chips), but their cash flows are becoming strained. For example, Alphabet (the parent company of Google) reported a negative free cash flow for the second quarter (-$590 million), and Meta's cash flow decreased by 91% year-over-year.
- With long-term interest rates at 5.3%, investors can earn 5% by investing in bonds rather than taking risks with AI companies that may not generate sufficient returns. If AI's growth fails to keep up with its high costs, valuations will likely collapse.
In summary, the stock market needs a significant adjustment to eliminate excessive valuation bubbles and allow funds to reallocate to more cost-effective assets, which will create a healthier market environment in the future.
Disclaimer: This article is for informational purposes only and does not constitute investment advice. Please make decisions with caution.