A combination of elevated oil prices and surging bond yields has derailed a broadening in the rally that was supposed to propel stocks to new records.

Bulls are confronting a harsh reality: adding major positioning isn’t worth it right now. The bond selloff is capping the appeal of equities, a strengthening dollar is hampering liquidity, and the threat of Iran war re-escalation has kept US benchmark crude oil prices around $90 a barrel. The deteriorating picture leaves investors, reluctant to cash out more than they have already, wondering what’s next.

“It’s risk-off until the dollar peaks,” said Bank of America Corp. strategists led by Michael Hartnett, noting the greenback is spiking on credit event risk, while tighter financial conditions are crushing equity breadth.

After reducing risk during the summer, investors seem to have little appetite to pull back further. Take hedge funds: they spent most of September adding hedges and short positions, rather than cutting their long exposure, according to Goldman Sachs Group Inc. prime brokerage data.

It’s evidence that investors are far from complacent and are evaluating threats ranging from inflation, rates, oil and the midterms without any panic. They appear willing to maintain fairly concentrated exposure to a narrow number of themes or stocks, especially AI-related trades, while selling anything that may suffer from the crumbling macro-economic backdrop. For BofA’s Hartnett, it’s a “long artificial intelligence” (Nasdaq 100), “short artificial irrelevance” (S&P 500 Equal Weight) approach.

While breadth has been in free fall, this has had almost zero impact at the index level. Nearly 60% of S&P 500 members are trading below their 200-day moving average, while about 75% are below their 50-day equivalent. These tend to be the sorts of levels where breadth produced a bounce over the past five years, staging a rally that often drove further index gains. But for this to happen, the market needs a catalyst, something it lacks for now.

There are some offsets. The economy is still growing, the latest services and manufacturing numbers have been strong, the job market is resilient, and earnings growth shows no sign of weakness. This reporting season now shapes up as a crucial test in reassuring investors that corporate robustness in the face of high oil and rising rates is still a thing.

“While a spike in bond yields leaves stocks looking relatively expensive, the continued rise in corporate earnings should see equities add to their gains over the coming months,” said Pictet Asset Management chief strategist Luca Paolini.

Companies in the MSCI World index should deliver earnings growth exceeding 30% this year, Paolini said. He expects price pressures to ease in the coming months, even if oil briefly pushed headline US inflation to almost double the target level. Until then, the risk is a spike in volatility.

Bond-market jitters are back, but equities are so far disregarding them. The MOVE Index, which tracks implied volatility in Treasury options, has climbed to about 108, almost seven times the level of the VIX. That ratio is in the 91st percentile of readings since 2000 and the widest since the term-premium scare of late 2024. The last time the gap ran this wide for an extended stretch, in 2023 and early 2024, it took a sharp rise in long-end yields to drag equity volatility up with it.

Ranking each index against its own history makes the divergence even starker. MOVE is in the top quarter of all its data since 2000; the VIX, at around 16, is below its long-run median. That rare elevated spread has always resolved in the same way — not with rates vol collapsing to meet equity vol, but with equity vol eventually catching up.

Whether that’s the template for this episode depends on what’s driving the Treasury move: a repricing of the Federal Reserve path that stocks can absorb, or a term-premium shock that they can’t. The gap itself doesn’t show which it will be, but the two markets can’t both be right for long.