A market correction may be looming as equities face off against bonds

Global stock markets have tumbled in 2026, extending last year’s rally as traders look to geopolitical turmoil and inflation fears.

But bond markets paint a different picture, and the growing divergence is ringing alarm bells for some investors.

While many major stock indexes erased losses incurred at the beginning of the Iran war, government bonds largely took a more cautious approach, continuing to price in higher inflation and widespread interest rate increases.

For example, in the USA, S&P 500 – up 7.4% year-to-date – up almost 7% since the end of February when the conflict began.

S&P 500 and Nasdaq Composite It hit all-time highs last week, but rising bond yields have weighed on stocks in recent days, causing both indexes to pull back from gains.

But the bond market looks much less optimistic as the US benchmark bond yield 10 year Treasury It rose by about 70 basis points as the value of banknotes fell throughout the war.

This divergence is also seen in markets outside the U.S. The MSCI World Ex USA index has clawed back most of its wartime losses and is now down about 3% since the beginning of the conflict. The index, which reached its lowest level about a month after the war, lost almost 9% of its value.

At the same time, yields on the FTSE World Government Bond index, a measure of government debt of more than 20 countries, saw a total increase of around 55 basis points. Bond yields and prices move in opposite directions.

While various developed economy markets are showing a similar optimistic trend in stock markets, macroeconomic concerns are putting pressure on government bonds.

Bank of America found record growth in equity allocations in May in its latest fund manager survey, results of which were released Tuesday. The survey, which included responses from panelists who collectively manage $517 billion worth of assets, showed fund managers were a net 50% overweight on equities this month, up from a net 13% overweight in April.

But BofA’s analysts warned that with the Bull and Bear Indicators approaching the “sell signal” level, June is “ripe for profit taking” and bond yields will determine the extent of any pullback.

In a note published Tuesday morning, analysts at Barclays said stocks are seeing the fastest recovery in decades and U.S. stock funds have seen net new inflows totaling $70 billion in the past 7 weeks. They said this marked a 97 per cent mark since 2000, but warned that “the pendulum could now swing back”.

“Foreign demand for U.S. stocks [the rest of the world] “It is accelerating in an environment where oil prices are persistently high,” Barclays analysts said, noting that the inflow into US stock funds since the beginning of the year has been at the level of 180 billion dollars, more than twice the five-year average.

“However, with portfolios becoming fully invested and macro volatility increasing, the risk of unwinding in the short term has increased significantly,” they added.

Barclays said its analysis showed portfolio managers had reduced their exposure to equities in recent days, with Commodity Trading Advisors (the main drivers of the recent recovery) now approaching maximum long US equity positions.

“Aftershocks in Iran and the April CPI surprise have led markets to reprice central bank assumptions; we see room for positioning to pull back further in the near term,” bank analysts said, before raising the question of whether bonds would “crash the AI ​​party” in equity markets.

“Specifically, rising yields and inflation concerns continue to anchor large shorts in U.S. Treasuries, but U.S. equity long positions remain fragile as U.S. equity longs approach a critical turning point where historically high rates begin to weigh on equities,” they said.

““The risk of higher yields spilling over into equities has re-emerged as the Iran conflict has already pushed stock-bond correlations into negative territory, reviving a Covid-era regime in which equities reacted negatively to inflation surprises and positively to growth surprises.”

Paul Skinner, investment director at asset management giant Wellington, also said on Tuesday that the divergence between bond and equity markets was putting equity portfolios at risk.

“We think you’re gone [equities] vulnerable to correction,” he told CNBC’s “Squawk Box Europe.”

But he said Wellington no longer believes inflation is embedded in the global economy over the long term.

“This might just be a fix [the] “It’s the beginning of a bear market in stocks,” he said, and continued: “But there will be huge inequalities around the world due to the reactions of central banks.”

If central banks take too long to respond to rising inflation, it could lead to a stagflationary environment that is “catastrophic for risk assets,” Skinner told CNBC, pointing to Britain in the early 1970s.

“We would like [this] “It will be more like the ’79 oil shock, where central banks kept interest rates high and we prevented stagflation,” he said. “Risky assets performed much better despite keeping rates high. So depending on how your central bank responds to that, there will be a difference in how markets respond.”

Neil Birrell, Chief Investment Officer at Premier Miton Investors, told CNBC in an email that it’s only a matter of time before bond market sentiment and trading patterns put pressure on stocks.

“Bond and equity markets adopted different views of the macro environment, with bonds reflecting underlying pessimism and risk aversion, while equity markets operated on an optimistic basis that the Iran war would sooner or later be resolved and macro risks would disappear.” he said, noting that corporate earnings supported the upward trend for stocks.

“The sell-off is being followed by buyers taking advantage of lower prices, but ultimately persistently higher bond yields, combined with higher inflation, slowing growth, an escalation or prolongation of the Iran war, weak corporate earnings, tensions caused by artificial intelligence or further geopolitical stress, will likely have a negative impact on equity markets,” Birrell said. he warned. “It’s a matter of how long and how long it takes for buyers to re-emerge, but it’s also possible they may fall by the wayside.”