High interest rates are not the "end" of US stocks? Is profitability the real key?

The market is treating "high interest rates" as the terminator of US stock valuations. The 30-year US Treasury yield has risen to around 5.40%, its highest in nearly 20 years; long-duration US Treasuries have fallen by about 10% over the past year, and the S&P 500's forward price-to-earnings ratio has compressed by about 3 multiples. Yet, the US stock market has still climbed by roughly 16% during the same period.

However, a report released by JPMorgan on September 14 draws a very different conclusion: This cycle of rising rates is still some distance from truly suppressing valuations. The key determinant of the valuation ceiling is not the yield itself, but earnings growth.

After the team segmented valuation data since 1950 by earnings growth rates, they found that the relationship between the 10-year US Treasury yield and the S&P 500 valuation multiple forms an "inverted U" pattern—when yields are rising moderately in the early stages, valuations may actually be supported; only when a certain threshold is breached will rising rates start to significantly compress valuations. Given current earnings levels, this threshold for the 10-year US Treasury yield corresponds to about 5% to 6%.

More broadly, Wall Street strategists have not seen the Fed's potential rate hikes as a bear market trigger. Strategists at Goldman Sachs, Morgan Stanley, and JPMorgan all believe that as long as economic growth and corporate earnings remain resilient, moderate rate-driven market pullbacks are likely to be short-term fluctuations.

Goldman Sachs' chief US equity strategist Ben Snider noted that the market has already priced in expectations for more than three hikes over the next year, while corporate earnings and balance sheets remain robust; Bloomberg's statistics also show that historically, what truly threatens bull markets is a full rate hike cycle, not a single hike.

The Real Threshold for Valuation Pressure: 5%–6%

The first segment is a super-growth environment with earnings growth above 20%, where valuation multiples can be supported up to about 24x, corresponding to a 10-year Treasury yield of around 6%. The second is a growth-above-trend environment with earnings growth of 10%–20%, where valuation multiples are about 20x, corresponding to a 5% yield. Overall, the lower the earnings growth, the lower the yield levels that the market can withstand.

Currently, the S&P 500 sits at about 22x 2026 EPS, which implies an adjusted 2026 earnings growth rate of about 28%; for 2027, the valuation is about 18x, suggesting an implied growth rate of about 21% (excluding one-off investment gains and losses). This means that as long as earnings growth remains above 15%, there is still potential for further revaluation in 2027.

There is another metric to measure whether valuations are expensive. Using the two-stage dividend discount model, the current implied equity risk premium is about 7.2%, at the 69th percentile in history; the long-term PEG is roughly 2x. In other words, as long as companies can deliver 13%–15% average annual earnings growth, the current valuation level is broadly still supported by fundamentals.

The AI Top 30 currently trades at about 30x forward earnings; the other 470 S&P 500 constituents average around 19x, and MSCI ACWI peers trade at about 14.3x. This premium in valuation mainly comes from stronger earnings visibility, lower leverage, and more stable shareholder returns.

Productivity acts as another buffer. If productivity remains within the 1.5%–2.5% range, current yields can still support about a 20x valuation; if AI further boosts productivity above 2.5%, the fundamental support for valuations will be even stronger.

How Interest Rates Affect Earnings: Start with Debt Structure, Then Cash Flow

The impact of rising interest expenses on corporate earnings is gradual, as most corporate debt consists of fixed-rate, longer-term financing.

In the short term, two forces are sufficient to partially offset the pressure from rising financing costs: first, improved earnings in the financial sector, and second, corporations still hold about $2.4 trillion in cash, which can now earn higher interest income. Meanwhile, the current borrowing costs for most companies remain below their 2023 peak: the 30-year fixed mortgage rate is around 6.8%, down from 8.1% in 2023; high-grade bond yields are around 6%, down from 6.5%; high-yield bonds are at about 7.7%, down from 9.6%.

The truly noteworthy pressure comes from structural divergence. A "higher for longer" rate environment is squeezing out consumer-related activities, residential and commercial real estate, as well as capital-intensive industries and highly-leveraged companies that don't directly benefit from AI development.

The report describes this process as an "invisible hand": limited capital is flowing toward the highest bidders and those with the best credit quality—governments and large multinational corporations. Therefore, higher interest rates may not necessarily mean an across-the-board hit to corporate earnings, but they will significantly increase internal market differentiation.

Yield Curve Shape Determines Sector Leadership: Steepening Favors Cyclicals, Flattening Favors Tech

Sector leadership also depends on the shape of the yield curve.

If there is a bear steepening (i.e., the long-short end spread widens), cyclical sectors such as energy and financials are likely to benefit more; if a bear flattening occurs, tech stocks are relatively favored. Meanwhile, bond substitutes and long-duration non-tech sectors—including utilities, real estate, communication services, and consumer staples—are most sensitive to rising interest rates.

In terms of style, the base case is still a shallow rate hike cycle, i.e., last year's "insurance cut" expectations have reversed, but aggressive tightening hasn't taken place. Under this scenario, growth and quality growth stocks are still expected to outperform; if inflation accelerates again and the market starts pricing in a broader hiking cycle (a further 4–5 hikes), then investment style may shift to low-volatility stocks.

From a market cap perspective, large caps are more resilient under pressure. In contrast, small caps rely more on short-term bank floating-rate financing, making them more directly impacted by monetary policy and subject to greater disruption.

The report also believes that the current round of rate hikes is mainly driven by fundamentals, rather than concerns about Fed independence or the credibility of US fiscal policy. Long-end swap spreads remain relatively stable, and long-term breakeven inflation rates have only risen modestly.