Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.

THE disconnect between shares and bonds is getting harder to justify. As interest rate expectations keep pushing higher, bonds are feeling the squeeze while shares seem determined to shrug off tighter financial conditions. Can it last?

Glass half full

Shares are holding up remarkably well, despite last week’s slight wobble on the back of the Federal Reserve’s latest minutes pointing to an all but certain rate hike later this month. In fact, the equal weighted index of US shares is on the cusp of breaking upwards from the sideways channel it’s been stuck in for a year or so now.

That is at odds with expectations of higher for longer interest rates which threaten higher costs for companies and less disposable income for consumers with mortgages. What’s going on?

One thing seems likely. The economy is less susceptible to interest rate hikes than feared. This is good news and bad. It’s good because it means the recession we all expected has been at the very least postponed. It’s bad news, though, because it could mean that central banks like the Federal Reserve and Bank of England will have to push rates even higher for even longer to hit their inflation targets.

For now, the glass is half full. How long it remains so will depend a lot on what happens on the corporate earnings front.

Results season looms

We won’t have long to wait because this week, as usual, the banks will kick off the second quarter reporting season. At the moment the expectation is that earnings will decline around 9% year on year. But that is exactly what was forecast three months ago, and the first quarter season delivered a much smaller drop in profits of around 3%. A repeat of that positive surprise would be good for share prices.

The banks, specifically, face a mixed bag of influences. On the one hand, rising interest rates are good for profits. They widen the gap between what a bank can earn on its reserves and what it is obliged to pay out to depositors. This is a key driver of profitability in the sector.

However, the counterpoint to that good news is that rising interest rates will also lead to greater provisions against bad loans. The balance between the good and bad news will determine whether earnings season gets off to an encouraging or worrying start next week.

Nifty Fifty all over again?

Meanwhile, the outperformance by a handful of big tech stocks continues. Is this a re-run of the early 1970s when a group of big, reliable earners (dubbed the Nifty Fifty) saw their valuations rise to twice that of the market as a whole. If investors continue to see safety in the likes of Apple and Microsoft this disconnect could have a way to run yet. And because they dominate the market, they could drag the market higher even as rising interest rates make recession more likely. The relative case for bonds over shares looks stronger than ever. For more on this, check out our latest quarterly Investment Outlook, published today.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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