Wall Street’s artificial intelligence fixation is so strong that it’s overwhelming all risks, including soaring interest rates, as investors continue to plow money into the market’s largest technology stocks and push equity indexes toward record highs.

By Carmen Reinicke But even with all the euphoria, the risks looming on the horizon are becoming acute, particularly as yields on long-term Treasuries trade near their highest levels in decades.

“With these higher rates, all of us are on edge,” said Ken Mahoney, chief executive officer of Mahoney Asset Management.

Just last week, the long bond yield reached 5.69% and the 10-year rate topped 5.3%, something neither has done since 2002. But tech stocks have still managed to hold onto their gains. The Nasdaq 100 Index hit a fresh record on Friday and is up 22% this year, while the S&P 500 Index is less than 1% from the all-time high it reached in August. The largest point contributors to the S&P 500’s and tech-heavy Nasdaq 100’s gains over the last three months are AI giants Microsoft Corp., Nvidia Corp. and Apple Inc.

“I would’ve said 5% was the limit, but you know, that’s kind of in the rearview mirror already,” said Matt Stucky, chief portfolio manager at Northwestern Mutual.

Investors’ confidence in the durability of this rally largely rests on sky-high expectations for upcoming earnings from the tech giants that have driven the lion’s share of growth over the last few years.

Third-quarter earnings per share for the sector are expected to jump more than 65%, giving the group the second-fastest growth after energy, to help fuel the more than 24% rise in EPS anticipated for S&P 500 companies, according to Bloomberg Intelligence. If that happens, it will be the third straight quarter when the index’s EPS has climbed more than 20%.

“It’s hard to even put that in perspective,” said Rob Conzo, chief executive officer of the Wealth Alliance. “It’s historic.”AI has been the primary driver of gains in the stock market — and technology shares in particular — over the last three years, as companies spend hundreds of billions of dollars to build out the infrastructure needed to power the nascent technology. Those capital expenditures have created a virtuous circle for investors where the behemoths doing the spending rally because they’re making progress on AI, and the recipients of all that cash, from chipmakers to data center construction companies, also climb as their revenues take off.

Greed and Fear Still, sentiment around AI has oscillated between excitement and concern many times over the last few months as Wall Street pros question when and if they’ll see returns from all that cash being thrown around, and whether that will even matter considering the risks the technology could pose for humanity. At the same time, the market is grappling with the war in Iran, sticky inflation led by surging oil prices and the likelihood of another interest-rate hike by the Federal Reserve this year.

That back-and-forth has driven rotations from software to hardware and back to the Magnificent Seven tech giants, which lagged in the first half of the year but have outperformed the broader market since the end of July.

It all adds up to a complicated trading environment. You can’t dismiss the incredible momentum driving AI names higher, but the threat of a stock market selloff is real, especially with interest rates in the stratosphere and AI spenders needing to borrow increasing amounts of capital to fund their ambitions.

“The interest-rate sensitive stocks are feeling it at this level,” Mahoney said. “I think every stock would feel it if it keeps grinding higher.”The market appears to have accepted that rates will stay higher for longer than expected, at least for now. But it’s not clear how long that can last or at what level the pain would start to weigh on tech stocks, given their earnings strength.

“Historically it takes roughly a hundred basis point move or so in the 10-year to kind of impact valuations and earnings,” Northwestern Mutual’s Stuckey said. “So I guess it’s just higher, simply put.”With benchmark 10-year Treasuries at around 5.3%, there isn’t much more room to go. “If 10-year yields go to 6%, we’re going to have a different conversation,” said Chris Galipeau, head market strategist at the Franklin Templeton Institute.

The last time the 10-year hit 5% was briefly in 2023. The S&P 500 rose 24% that year, kicking off a three-year run of double-digit percentage gains. Back then, the theory was that rising yields didn’t kill the rally because the gains were being led by the Magnificent Seven, which had enormous piles of cash on their balance sheets and light debt loads, giving them the ability to withstand higher borrowing costs. ‘Forcing a Turn’That has changed this year as the massive AI infrastructure spending has prompted them to sell stock and issue bonds to raise the money they need.

Major AI spenders Alphabet Inc., Amazon.com Inc. and Meta Platforms Inc. have all seen free cash flow turn negative on an annual basis.

“These companies initially entered this AI build phase with maximum flexibility, holding pristine AA and AAA credit profiles, what we call the Mount Rushmore of corporate credits,” said Bloomberg Intelligence analyst Robert Schiffman. “Today, however, hyperscalers like Meta, Amazon, Alphabet, Microsoft and Oracle have cash needs that far exceed internal cash sources, forcing a turn to debt markets that will drive leverage up over the next two years.”But even with this challenging backdrop, the firms’ credit ratings haven’t been hurt yet, he added.

“This unique stability persists because surging EBITDA growth expectations continue to successfully offset the increased leverage,” Schiffman said.

Of course, higher yields have hit other parts of the market, leading to multiple compression in the S&P 500. The index now trades at less than 19 times forward earnings, down from more than 21 in May. ‘Paddling Like Crazy’“The S&P at the index level is like a duck on the surface of the water,” Galipeau said. “It looks fine, but under the surface the feet are paddling like crazy.”

Considering how tech stocks have driven gains over the past few years, the biggest concern for investors is that if they start to lose steam, does that put the strength of the entire market in jeopardy? “If technology loses it and technology corrects, then a lot more chips may fall,” Mahoney said.

For now, the strength is continuing because investors expect that the end of the US war with Iran will swiftly send oil prices lower, loosening inflation’s grip on the economy, Mahoney said. Should that happen, strong earnings would be expected to power Big Tech stocks higher.

However, that’s hardly a guarantee. Meanwhile, the war is dragging on and experts question whether oil prices will immediately drop if it ends. Between that, stubborn inflation and high interest rates, there are plenty of risks that could just as easily derail this ride.

“Growth is still strong and supported and elevated by tech-related activity,” said Magdalena Ocampo, market strategist at Principal Asset Management. “What’s changing now is this rising perception that there’s potentially more upside risk to inflation and a bit more downside risk to growth. And that’s perhaps what the markets are telling us underneath the surface.”