What higher interest rates could mean for stocks and bonds

Higher Treasury yields reflect economic resilience, not an imminent crisis. Capital Group managers see rates normalizing toward historical averages, with stocks historically performing well even in rising rate environments. Bonds now offer attractive income and diversification at current yields of around 5%.

While inflation may settle above pre-pandemic lows, near 2% to 2.5%, it poses a risk if capital expenditures accelerate growth before AI productivity gains materialize. This could pressure the Fed to hike rates, pushing the 10-year Treasury above 5%. Uncertainty around the Fed's communication strategy, a return to pre-2008 playbook, will require markets to learn its reaction function.

Equity managers suggest diversifying away from high-growth, high-valuation stocks. Instead, they recommend sectors like financials, insurance, and energy, which often trade at more reasonable valuations and offer strong cash flows. The AI boom remains a long-term growth driver, with potential to impact nearly every sector.