Large-cap US equities have achieved their independence from bond yields.

Not entirely, of course. Risk-free rates will always matter for equity valuations even if, from time to time, multiples ignore yields in favor of today’s narrative du jour (AI or whatever else).

In 2024, US large-cap benchmarks have hit record after record. Small-caps, on the other hand, remain some 16% below the November 2021 “everything bubble” peaks.

On Monday, as the S&P hit yet another fresh all-time high, Morgan Stanley’s Mike Wilson highlighted the notable chart below.

So, that’s exactly what it says it is: The correlation between equities and 10-year US yields, both for the S&P and for the Russell.

Note that the correlation turned negative beginning with the late-summer long-end selloff as the inexorable rise in the term premium and accompanying bear steepener torpedoed stocks (yields up, stocks down), only for bonds to rally sharply into year-end, bolstering equities in the process (yields down, stocks up).

In 2024, Wilson noted, benchmark US yields have generally stabilized, and are meaningfully higher (~35bps) versus the December lows. But large-cap stocks are perched at new records anyway, hence the climb out of negative territory for the blue line in the figure above.

“The rolling two-month correlation of equity returns and change in interest rates is now modestly positive for large-caps, while it remains decidedly negative for small-caps — in other words, small-caps are exhibiting greater interest rate sensitivity than large-caps,” Wilson wrote, on the way to suggesting that’s evidence that “the market is becoming increasingly considerate of balance sheet quality.”

If you’re waiting for small-caps to outperform, Wilson said it’ll take “more confirmation that we’re entering a higher nominal growth environment that can drive pricing power for these companies and offset profit margin and leverage overhangs.”

The figure above makes the same general point, but in a more nuanced way. It shows the correlation of relative performance for industry groups with higher net debt/EBITDA to rates.

There again we see “increasing rate sensitivity,” Wilson remarked, adding that the trends illustrated by the visualizes “reinforce” the bank’s “preference for large-cap, high quality stocks.”