Stock and Bond Expectations in "Big Fight": Stock Market Bets on Slowing Growth, Bond Market Defends Against Soaring Inflation

Under the impact of the Iran war, European and American financial markets are experiencing a rare internal struggle. Bond markets are pricing in inflation risk at multi-year highs, anticipating an imminent interest rate hike cycle, while stock markets are signaling an economic slowdown that will suppress interest rates and even trigger rate cuts. In Europe, the interest rate swap market has priced in three rate hikes by the European Central Bank this year. Germany's 10-year benchmark bund yield hit a 15-year high on March 27, and major institutional investors like BlackRock are still betting on further bond declines. However, the pricing logic in European equities is entirely different: the price-to-earnings ratio of the STOXX Europe 600 components is still around 15 times expected earnings, far above the average of the past two decades. Analysts even predict that corporate earnings will grow by 11% in 2027. In the US stock market, the S&P 500's cyclically adjusted price-to-earnings ratio has recently remained above 38 times, in the upper range of historical highs over more than 150 years of data. The divergence between stocks and bonds has now spread to the two core global markets, presenting investors with a directional choice. Bond Markets Expect an Aggressive Interest Rate Hike Cycle to Begin The sharp reaction in the bond market stems from a direct mapping of historical scenarios. According to Bloomberg, Amélie Derambure, a senior multi-asset portfolio manager at AXA Investment Managers in Paris, stated that the fixed income market is pricing the inflationary impact of the current conflict similarly to the consequences triggered by Russia's invasion of Ukraine four years ago. "I think the price reaction in fixed income markets is particularly violent," she said. "While the stock market remains uncertain about the economic consequences of this conflict, the bond market is already pricing in a scenario similar to 2022." At that time, soaring energy prices pushed inflation in the Eurozone to record highs, forcing the European Central Bank to embark on its most aggressive rate hike cycle in history. The renewed concerns over energy supply due to the situation in Iran, coupled with Europe's already high inflation base, have prompted bond investors to react defensively. Institutions like BlackRock are betting on further yield increases, resonating with the interest rate swap market's expectation of three rate hikes. Stock Markets Believe: Worsening Growth Will Curb Rate Hike Potential The logic of the stock market mirrors that of the bond market. Investors generally believe that if geopolitical conflicts persist, the substantial drag on economic activity will leave central banks unable to significantly tighten policy, making interest rate hike expectations ultimately unachievable. Karen Georges, a stock fund manager at Ecofi in Paris, described this divergence as "market schizophrenia," stating: "We clearly don't think there will be two rate hikes, let alone three – considering how a protracted crisis will hit economic activity. If growth is substantially impacted, we might even see a rate cut by the end of the year." Analysts' forecasts of 11% growth in European corporate earnings by 2027 are also based on assumptions of a mild economic environment and loose financing conditions, which fundamentally contradict the aggressive rate hike path priced by the bond market. Once economic slowdown leads to earnings disappointment and central bank easing expectations are dashed, the current high stock valuations will face significant downward pressure. US Stock Investors Continue Experientialism of "Geopolitical Shocks Will Pass" US stock investors are continuing a repeatedly validated experiential strategy: viewing geopolitical shocks as temporary disruptions and holding positions through periods of volatility. According to Bloomberg, George Nadda, a portfolio manager at Altana Wealth in London, said, "Recent history has taught investors to view geopolitical disturbances as temporary phenomena, as the actual economic impact of such events is relatively limited." Historical data supports this judgment: during the Gulf War and the Iraq War, oil prices surged, but stock markets recorded gains within six months after the conflicts began. The same occurred in the early stages of the war in Ukraine in 2022 and during the "Liberation Day" tariff shock in April 2025. Under this logic, sell-side analysts in the US are generally reluctant to lower earnings forecasts, with per-share earnings estimates showing an upward trend before the April earnings season. Investors also continue the optimistic expectation of strong US economic growth that preceded the conflict. Two Assets, Two Genomes Behind the stock-bond divergence lies a fundamental difference in the thinking of investors in these two asset classes. Kevin Thozet, a member of the Carmignac investment committee in Paris, stated that the gap between the stock and bond markets can be partly explained by their respective fundamental stances: "By definition, stock investors are optimists, focused on future profits; while bond investors are entirely focused on protecting themselves from inflation erosion." The arbiter of this divergence will ultimately be the direction of economic data and central bank policy. If inflationary pressures continue to rise as feared by the bond market, stock valuations will face dual pressure from both interest rates and earnings; if growth becomes the primary concern as expected by the stock market, the aggressive pricing in bonds will gradually correct. Currently, both markets are waiting for the other to be proven wrong.