Global long-term bond yields remain high, with most stock markets under pressure and declining, while spot silver is up 2% on the day.

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As the Iran war raises inflation expectations and bond yields surge, the deep divergence between stock and bond markets has prompted multiple institutions to issue correction warnings this week.

The S&P 500 index has risen 7.4% year-to-date, and together with the Nasdaq Composite it set historic highs last week. Meanwhile, the yield on the US 30-year Treasury bond hit 5.20% on Wednesday, the highest since 2007, and the 10-year Treasury yield has climbed about 70 basis points since the outbreak of the Iran war. Driven by the continued rise in bond yields, both major stock indices have pulled back from their highs recently.

Due to these concerns, the Euro Stoxx 50 index opened down 0.2% on Tuesday, Germany’s DAX lost 0.4%, and the MSCI global index declined 0.2%, falling for the fourth consecutive day in the longest losing streak in over two months; the MSCI Asia Pacific index fell 1%. Brent crude remained around $111 per barrel, with no signs of easing in the Iran conflict.

Multiple institutions have issued warnings. Barclays analysts noted that US equity funds saw net inflows of $70 billion over the past seven weeks, among the top 3% since 2000, but warned that “the pendulum may now swing the other way.” Bank of America’s latest fund manager survey showed the net overweight in equities jumped from 13% last month to 50% this month, the biggest single-month surge ever. The bank also warned its bull-bear indicator is approaching a “sell signal.” Wellington's Chief Investment Officer Paul Skinner stated that the equity-bond divergence “makes the stock market vulnerable to correction shocks.”

Euro Stoxx 50 index opened down 0.2%, Germany’s DAX fell 0.4%, UK FTSE 100 down 0.3%, France’s CAC 40 down 0.3%.Nikkei 225 closed 1.5% lower at 59,804.41. Japan's TOPIX closed down 1.2% at 3,791.65. Korea’s KOSPI finished down 0.9% at 7,208.95.Dollar spot index was little changed.Pound-dollar dropped about 10 pips intraday, now at 1.3386.US 10-year Treasury yield was little changed at 4.67%.UK 10-year Treasury yield fell 6 basis points to 5.07%. Japan’s 30-year yield down 11 basis points to 4.045%.Brent crude held around $111/barrel, WTI fell 0.3% to $103.81/barrel.Spot gold fell 0.2% to $4471.54/oz.Spot silver gained 2% intraday to $75.17/oz.Bitcoin rose 0.2% to $77,129.2.

Stock-bond divergence hits recent extremes

This round of stock-bond divergence is particularly prominent in recent years.

The S&P 500 index has risen nearly 7% since the Iran war broke out at the end of February this year, while the US 10-year Treasury yield surged about 70 basis points in the same period. The inverse movement of bond prices and yields signals large-scale selling of US Treasuries by investors.

Outside the US, the MSCI World (ex-US) index has rebounded strongly from war lows, now down only about 3% from the onset of the conflict, though the deepest war-time pullback approached 9%. The FTSE World Government Bond Index, tracking over 20 countries’ sovereign debt, saw yields climb about 55 basis points in the same period. The Bloomberg index, tracking government bonds with maturities of 10 years and longer, is down 4.6% year-to-date, and long government bond yields have risen to their highest in nearly two decades.

Bank of America’s fund manager survey further revealed the current crowded positioning in equities. Surveyed managers, with $517 billion in assets under management, saw their net overweight in stocks surge from 13% in April to 50% in May, the biggest monthly jump in history. However, analysts at the bank warned its bull-bear indicator neared “sell signal” territory, saying early June is a “good time to take profit,” and that the direction of bond yields will determine the scale of this correction.

Barclays: "The pendulum may swing the other way"

Barclays analysts painted an extremely crowded picture of equity positioning in a Tuesday morning report. US equity funds have seen net inflows of $70 billion in the past seven weeks, ranking in the top 3% since 2000, with total inflows year-to-date at $180 billion, more than double the five-year median.

"Driven by persistently high oil prices, foreign funds have accelerated inflows into US equities. But as portfolios are fully positioned and macro headwinds build, the risks of short-term unwinding have risen materially," Barclays wrote. The bank noted portfolio managers have begun to trim equity exposure in recent days, while Commodity Trading Advisors (CTAs)—key drivers of this rally—are near their US equity long position limit. "Aftershocks from the Iran conflict and a surprise in April CPI data have prompted markets to reprice central bank policy expectations. We believe that there is further room for a position pullback in the near term," the report said.

Barclays also questioned whether bond yields will "end the AI feast." "Rising yields and inflation concerns continue to anchor Treasury shorts, but as yields approach historical turning points that drag on equities, US stock bulls remain vulnerable," analysts wrote. The report also noted the Iran conflict has pushed stock-bond correlation back into negative territory, recreating the pattern of the pandemic—stocks react strongly negatively to inflation surprises and positively to growth surprises.

Correction or bear market? Divergent views among institutions

Wellington’s Chief Investment Officer Paul Skinner told CNBC that the stock-bond divergence is exposing equity portfolios to risks. "We do believe this makes the stock market vulnerable to correction shocks," he said, but noted Wellington does not believe inflation is entrenched in the global economy. "This could well be a correction rather than the beginning of a bear market, but with central banks reacting differently, there will be tremendous fragmentation between global markets."

Skinner warned that a sluggish central bank response to inflation may cause a stagflation environment like the UK in the early 1970s, bringing "catastrophic" shocks to risk assets. He added that he prefers a scenario resembling the 1979 oil shock, where central banks maintain high rates to avoid stagflation—even then, risk asset performance far exceeded expectations.

Neil Birrell, Chief Investment Officer at Premier Miton Investors, said in an email statement to CNBC that the bond and equity markets are pricing macro conditions very differently. "The bond market reflects underlying pessimism and risk aversion, while equities are based on optimism—the belief the Iran war will resolve quickly and macro risks will fade," he said, adding corporate earnings are still supporting equities. Birrell warned that high bond yields, combined with rising inflation, slowing growth, escalation or prolongation of the Iran war, weakening earnings, or additional geopolitical shocks, will ultimately negatively impact equities. "The only question is how deep and how long the shock will last before buyers return—or they may just step aside temporarily to watch," he said.

Deutsche Bank: Fundamentals remain intact

Deutsche Bank analysts have a more optimistic interpretation of the current resilience in equities. "Despite a slight pullback in risk assets in recent sessions, the conditions that have historically led to broader sell-offs are not present," the bank wrote in a Tuesday report.

According to historical analysis by Deutsche Bank, triggering larger stock market corrections typically requires one or a combination of: persistent oil price shocks, economic data entering contraction, or aggressive central bank rate hikes. "Currently, it’s hard to say any of these conditions have been met," the report said. "The closest is ‘persistent’ oil price shock, and the market increasingly prices for higher oil prices to persist longer."

The bank also noted that six-month futures for Brent crude are only slightly above $90/barrel and emphasized: "The intensity of energy consumption has declined, meaning that the same oil price levels no longer cause the same economic shocks as in the past." "Therefore, unless fundamentals change clearly, the resilience of risk assets is not surprising and is consistent with historic patterns in recent decades," Deutsche Bank analysts concluded.

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