Where higher rates matter most for equities
As interest rates remain structurally higher, differences in debt and profitability are becoming more important, with small caps appearing particularly exposed to rising financing costs
Interest rates have shifted significantly higher across major developed markets. US, UK, and Eurozone 10- year yields are near their highest levels in more than a decade and a half, while Japanese yields are at multi-decade highs. Persistent inflation and resilient growth have contributed to the move, while rising government borrowing worldwide has expanded the global supply of sovereign debt, pushing yields higher to attract investors. As financing costs rise, differences in debt levels across equity markets may become increasingly important for investors.
Weekly highlights
Source: FactSet. Average of month-end yields from 12/2009-12/2019.
Source: FactSet. Average of month-end yields from 12/2009-12/2019.
Source: CME Group. As of 11/4/2026.
Where higher rates matter most
For much of the period following the Global Financial Crisis, companies benefited from an exceptionally low cost of debt. That environment looks unlikely to return anytime soon. Markets are currently pricing in further rate hikes over the next year, and we expect rates to remain structurally higher than they were through much of the 2010s.
Higher borrowing costs will not affect companies uniformly or all at once. Much depends on the amount of debt companies carry, the rates at which that debt is financed, and the profitability available to support it. This puts renewed focus on corporate balance sheets, particularly during a period of heightened AI spending.
The key question for equity investors is therefore not simply whether rates remain elevated, but which parts of the market are best positioned to absorb them, and what that may mean for corporate earnings and, ultimately, equity performance. One place to start is debt levels relative to operating earnings, which vary significantly across equity markets.
Debt levels alone tell only part of the story; what matters is companies’ ability to service that debt. Debt-to-EBITDA captures both, measuring debt against the operating earnings available to support it, with lower ratios generally indicating a greater capacity to cover debt costs. On this measure, the contrast is most pronounced at the ends of the spectrum. US large caps and emerging markets currently sit at the lower end of the range, while Europe and Japan carry somewhat higher ratios. Small caps remain the clear outlier, with debt levels that are substantially higher relative to earnings.
Emerging markets are particularly notable given how much the picture has changed. MSCI EM debt-to-EBITDA has declined from roughly 2.6x in June 2024 to 1.9x today (FactSet, as of 10/30/26), bringing it roughly in line with the S&P 500, as profitability has improved meaningfully over that time period. The improvement has coincided with the growing influence of large technology companies tied to the AI investment cycle. Their strong earnings growth has increasingly shaped the profitability profile of the broader EM index, similar to the dynamic seen among US large caps.
Small caps present a different picture. Higher debt levels relative to earnings leave smaller companies more exposed to rising financing costs. Moreover, thinner earnings provide less of a cushion as those costs rise. These characteristics may help explain why small-cap relative performance has been particularly sensitive to moves in interest rates.
Recent market performance reflects that exposure. Over the past year, rising US 10-year Treasury yields have tended to coincide with periods of small-cap underperformance relative to the S&P 500, most clearly in September and early October.
The shift is notable because small caps had built a meaningful lead over large caps for much of the last year. As Treasury yields moved sharply higher in September, that lead was fully erased, with the Russell 2000 briefly trailing the S&P 500 (FactSet, as of 10/30/26). While rates are not the only driver of equity returns, the reversal highlights how different areas of the market can respond differently to changes in financing conditions.
For investors, we believe a structurally higher-rate environment will place a greater premium on companies’ ability to support their debt. Markets with stronger profitability and more manageable debt levels should be better positioned as financing costs remain elevated. More rate-sensitive areas could benefit if yields decline, but the reason rates are moving will matter. A decline driven by moderating inflation would have very different implications than one driven by weaker economic growth.
Source: FactSet, Russell, S&P, MSCI, CME Group, State Street Investment Management. Data as of 10/30/2026 unless otherwise stated.
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