There’s something interesting happening in the stock market right now. Major indices have continued to show strength even as higher borrowing costs create challenges for businesses and consumers.
Ordinarily, we would expect elevated interest rates to weigh on stock prices. Companies pay more to finance expansion, consumers become more cautious about large purchases, and investors have more attractive alternatives when government bonds offer higher yields.
Yet stocks have continued climbing, largely because the companies driving the market aren’t experiencing the same financial pressures as everyone else.
Much of the strength has come from large technology companies investing heavily in artificial intelligence. These businesses are spending billions of dollars building data centers, purchasing advanced computer chips, and developing the infrastructure needed to support AI.
Investors anticipate substantial future profits from those investments. When a company expects an exceptionally high return, a modest increase in financing costs may not be enough to discourage spending.
The calculation is different for a business that needs to refinance existing debt or borrow money to maintain ordinary operations. Higher interest expenses can reduce profitability, particularly when a company has limited opportunities to increase revenue.
This helps explain why higher interest rates have affected some industries far more than others.
There is another interesting consequence of the AI boom: the enormous investments being made by technology companies are adding to the demand for capital at a time when governments around the world are also borrowing heavily.
Interest rates are not determined by Federal Reserve policy alone. Government financing needs, inflation expectations, and demand from private borrowers all influence the yields investors require in order to be able to lend money.
Competition between governments and businesses for capital can push up borrowing costs. We have seen pressure on government bond yields in several major economies, including Japan, Germany, France, and the United Kingdom.
Businesses that have become accustomed to inexpensive financing, now face a difficult adjustment. Companies that borrowed when interest rates were historically low may now need to refinance at higher rates. Unless earnings have increased enough to offset those expenses, more money goes toward servicing debt and less remains available for growth.
But you would not necessarily recognize these pressures by looking at the S&P 500, which is weighted by market capitalization—so its largest companies have the greatest influence on performance. Strong gains from a small group of technology stocks can offset weaknesses across many other businesses.
As a result, the S&P 500 can reach new highs even when a substantial portion of its constituent stocks are not participating in the rally.
That is worth understanding because investors sometimes interpret rising indices as evidence that the broader economy is doing well. The companies benefiting from AI investment may have quite different financial prospects from businesses facing weaker consumer demand and higher financing costs.
There is also an important question about how much future success investors have already reflected in technology stock prices.
Artificial intelligence has enormous potential to improve productivity and change how businesses operate. But technology can be successful without every company investing in it earning the returns that shareholders expect.
Building and maintaining AI infrastructure is expensive. Companies need to generate enough additional revenue or cost savings to justify those investments, and the financial benefits may take years to develop.
During the internet boom of the late 1990s, investors correctly recognized that the internet would transform the economy. What proved much harder was determining which companies would profit, and how much those future earnings were worth.
Today’s leading technology companies are financially different from many of the speculative businesses of that era. Still, the underlying question is familiar: will future profits justify current valuations?
This is not to say technology stocks are bound to fall. Continued strong earnings growth could keep pushing prices higher. But because the major indices are so heavily concentrated in a handful of companies, any shift in expectations for those businesses can have an outsized effect on the overall market.
For investors, understanding these economic forces is useful. Predicting exactly how and when the market will respond is another matter entirely.
A company can report excellent earnings and watch its stock decline because investors expected even better results. Another can report disappointing earnings and rally because the news wasn’t as bad as anticipated.
That’s one reason I’ve always preferred focusing on what individual stocks are doing, rather than trying to predict every move in the broader market.
My Income Trader Volatility (ITV) indicator is designed to identify periods when selling pressure in individual stocks has become unusually intense. I look for conditions suggesting that fear may have pushed prices too far and that selling pressure is beginning to fade.
Not every decline represents an opportunity, and not every signal becomes a trade. I still evaluate each stock, their upcoming earnings announcements, and the risks involved before making any recommendations.
But what is encouraging is that ITV continues to identify opportunities that have produced winning trades for us, even in this environment.
We have not needed the entire market to rally or interest rates to move in a particular direction. We’ve been able to focus on individual stocks and where the conditions fit our strategy.
I don’t know exactly where the S&P 500 will be a month from now, and I wouldn’t trust anyone who claims to know with certainty. There are simply too many variables affecting the market, from interest rates and corporate earnings to changing expectations surrounding AI.
Fortunately, I don’t need to make those predictions to find opportunities.
As long as investors continue reacting to uncertainty, individual stocks will experience periods of excessive selling pressure and recovery. My goal is to identify those situations, evaluate the risks, and act when the signals support a trade.
That is a process I can continue using regardless of which direction the major indices move next.
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