AI Stocks Defy Rising Rates but Risks Loom for Tech Investors

Wall Street’s focus on artificial intelligence is helping tech stocks weather a sharp rise in interest rates that typically pressures equity valuations. The 10-year Treasury yield recently hit 5.3%, and the 30-year yield reached 5.69%, the highest levels since 2002. Despite this, the Nasdaq 100 closed at a record high Friday, up 22% this year. The S&P 500 is also near its August peak, with Microsoft, Nvidia, and Apple leading the gains.

Investors are banking on strong earnings growth to justify high tech valuations. Third-quarter earnings per share for the tech sector are projected to rise over 65%, while overall S&P 500 earnings are expected to increase more than 24%. However, the market’s reliance on Big Tech earnings to offset high interest rates makes upcoming results from major AI companies crucial. Disappointing earnings or another spike in Treasury yields could pressure valuations.

The AI investment boom is reshaping the financial profiles of some tech giants. Alphabet, Amazon, and Meta have seen annual free cash flow turn negative due to heavy spending on data centers and AI infrastructure. These companies, along with Microsoft and Oracle, are increasingly relying on outside financing. Higher borrowing costs haven’t damaged their credit ratings yet, but greater debt reliance makes rising rates more relevant.

Elsewhere, higher rates are already impacting the market. The S&P 500 trades at less than 19 times projected earnings, down from over 21 times in May. Rate-sensitive stocks outside the AI trade are under pressure. Investors also face inflation risks from rising oil prices and geopolitical tensions. A 10-year Treasury yield nearing 6% could materially change the outlook for equities.