As inflation expectations rise following the Iran conflict, bond yields have surged significantly. The deep divergence between stock and bond markets has prompted multiple institutions to issue correction warnings this week.

Year-to-date, the S&P 500 has gained 7.4%, with both it and the Nasdaq Composite reaching record highs last week. Concurrently, the yield on the 30-year U.S. Treasury note touched a high of 5.20% on Wednesday, a level not seen since 2007, while the 10-year yield has climbed approximately 70 basis points since the onset of the Iran war. The persistent rise in bond yields has recently pulled both major U.S. stock indices down from their peaks.

These concerns weighed on global markets. The Euro Stoxx 50 opened down 0.2% Tuesday, Germany's DAX fell 0.4%, and the MSCI World Index dropped 0.2%, marking its fourth consecutive day of declines—its longest losing streak in over two months. The MSCI Asia Pacific Index fell 1%. Brent crude oil held steady around $111 per barrel as the Iran conflict showed no signs of abating.

Several institutions have sounded alarms. Barclays analysts noted that U.S. equity funds have seen net inflows of $70 billion over the past seven weeks, a robust figure at the 97th percentile since 2000, but warned "the pendulum may now swing the other way." The latest Bank of America fund manager survey showed a dramatic jump in net equity overweight positions to 50% this month from 13% in April, the largest monthly increase on record. The bank also cautioned that its Bull & Bear Indicator is nearing a "sell signal." Paul Skinner, Chief Investment Officer at Wellington Management, stated the stock-bond divergence "makes the equity market vulnerable to a correction."

In Europe, the Euro Stoxx 50 opened down 0.2%, Germany's DAX fell 0.4%, the UK's FTSE 100 dropped 0.3%, and France's CAC 40 declined 0.3%. Japan's Nikkei 225 closed down 1.5% at 59,804.41. The Topix index fell 1.2% to 3,791.65. South Korea's KOSPI closed 0.9% lower at 7,208.95. The U.S. Dollar Index was little changed. Sterling fell about 10 pips against the dollar to 1.3386. The yield on the 10-year U.S. Treasury note was largely steady at 4.67%. The yield on the 10-year UK Gilt fell 6 basis points to 5.07%. Japan's 30-year government bond yield dropped 11 basis points to 4.045%. Brent crude held around $111 per barrel, while WTI crude fell 0.3% to $103.81 per barrel. Spot gold edged down 0.2% to $4,471.54 per ounce. Spot silver gained 2% intraday to $75.17 per ounce. Bitcoin rose 0.2% to $77,129.2.

**Stock-Bond Divergence Reaches Extreme Levels**

The scale of the current stock-bond divergence is notable in recent years. Since the Iran war began in late February, the S&P 500 has gained nearly 7%, while the yield on the 10-year U.S. Treasury has soared approximately 70 basis points. The inverse movement of bond prices and yields indicates significant investor selling of U.S. Treasuries.

Outside the U.S., the MSCI World ex USA Index has recovered substantially from its war lows, now down only about 3% from pre-conflict levels after a peak drawdown of nearly 9%. The FTSE World Government Bond Index, tracking sovereign debt from over 20 countries, has seen its aggregate yield rise about 55 basis points over the same period. The Bloomberg Bond Index, tracking government bonds with maturities of 10 years and above, is down 4.6% year-to-date, with long-end government bond yields reaching their highest levels in nearly two decades.

Bank of America's May fund manager survey, released Tuesday, further highlights crowded equity positioning. Fund managers overseeing $517 billion in assets increased their net equity overweight stance to 50% from 13% in April, the largest monthly jump on record. However, the bank's analysts warned its Bull & Bear Indicator is approaching "sell signal" territory, suggesting early June is a "ripe time to take profits" and that the trajectory of bond yields will determine the extent of any pullback.

**Barclays: "Pendulum May Swing the Other Way"**

Barclays analysts painted a picture of extreme crowding in equity positions in a Tuesday morning report. U.S. equity funds have seen net inflows of $70 billion over the past seven weeks, a 97th percentile record since 2000, with year-to-date inflows reaching $180 billion—more than double the median of the past five years.

"Driven by persistently high oil prices, foreign capital has accelerated into U.S. equities. However, with portfolios already fully allocated and macro headwinds building, the risk of near-term position unwinding has risen materially," the Barclays analysts wrote. The bank noted portfolio managers have begun reducing equity exposure in recent days, and Commodity Trading Advisors (CTAs)—key drivers of the recent rally—are now near the upper limits of their long U.S. equity positions. "The aftermath of the Iran conflict and the surprising April CPI data have prompted a repricing of central bank policy expectations. We believe positioning has further room to retrench in the near term," the report stated.

Barclays also raised the question of whether rising yields will "end the AI party." "Rising yields and inflation concerns continue to anchor short positions in U.S. Treasuries, but U.S. equity longs remain vulnerable as yields approach key historical inflection points that have started to weigh on stocks," the analysts wrote. The report also noted the Iran conflict has pushed stock-bond correlation back into negative territory, reminiscent of the COVID-19 period—where equities reacted negatively to inflation surprises and positively to growth surprises.

**Correction or Bear Market? Diverging Views**

Wellington Management's Paul Skinner told CNBC the stock-bond divergence poses risks to equity portfolios. "We do think this makes the equity market vulnerable to a correction," he said, but added Wellington does not believe inflation is permanently embedded in the global economy. "This could just be a correction, not the start of an equity bear market, but there will be huge dispersion between global markets due to differing central bank responses."

Skinner warned that if central banks respond too slowly to inflation, it could trigger a stagflationary environment similar to the early 1970s in the UK, which would be "catastrophic" for risk assets. He expressed a preference for a scenario like the 1979 oil shock, where central banks maintained high rates to avoid stagflation—"even then, risk assets performed far better than expected."

Neil Birrell, Chief Investment Officer at Premier Miton Investors, stated in an email to CNBC that bond and equity markets hold starkly different views on the macro outlook. "The bond market reflects underlying pessimism and a flight to safety, while the equity market is priced on optimism—that the Iran war will be resolved relatively quickly and macro risks will dissipate," he said, noting corporate earnings currently provide support for stocks. Birrell warned that elevated bond yields, combined with rising inflation, slowing growth, an escalation or prolongation of the Iran war, weaker corporate earnings, or further geopolitical shocks, will eventually negatively impact equities. "The question is how deep and for how long before buyers step back in—or they may step aside for a while," he said.

**Deutsche Bank: Fundamentals Not Yet Shaken**

Deutsche Bank analysts offered a more optimistic view on the current resilience of equity markets. "Despite a modest pullback in risk assets in recent sessions, the conditions historically required for a more significant sell-off are not yet in place," the bank stated in a Tuesday report.

Based on its historical analysis, Deutsche Bank noted that triggering a larger equity market correction typically requires one or a combination of the following: a sustained oil price shock, economic data clearly pointing to contraction, and aggressive central bank rate hikes. "At present, it is hard to argue that any of these conditions are firmly in place," the report stated. "The closest is the 'sustained' oil price shock, as the market increasingly prices in a scenario of elevated oil prices for longer."

The bank also pointed out that the six-month Brent crude futures contract remains only slightly above $90 per barrel, emphasizing that "declining energy intensity means the same oil price level no longer creates the economic shock it once did." "Therefore, unless fundamentals change decisively, the resilience of risk assets is not particularly surprising and aligns with historical patterns over recent decades," Deutsche Bank analysts concluded.