<div id="readability-page-1">PROVIDENCE, Rhode Island, May 17 (Reuters) - Investors are warning that lofty U.S. stock markets have not yet priced in the risk of rocketing inflation and are vulnerable to a sharp spike in bond yields. Equity markets have been propelled by robust first-quarter earnings and expectations of boosts from artificial intelligence, overshadowing the risk of high energy prices and the lack of a conclusion to the war with Iran. But a spike in bond market yields over the past week - which took the 30-year Treasury bond above 5% and benchmark 10-year bonds above 4.5% - could change the picture for investors. That caused stock market caution on Friday. Paul Karger, co-founder and managing partner of TwinFocus, who manages money for ultra-high net worth families, said his clients are bombarding him with questions every time he meets with them about how to make sense of the apparent market paradox. &#34;Breakfast, lunch and dinner: the question is always about how to make sense of the fact that this is such a divided outlook,&#34; with earnings telling a positive story but oil prices and inflation emerging as a negative for companies, Karger said. Karger has what he calls a &#34;barbell&#34; approach to assets he manages: accumulating big overweight positions in cash, gold and other commodities, while maintaining positions in the market-leading mega-cap growth stocks. After an initial swoon following the start of the U.S.-Israeli war with Iran in late February, U.S. stock indexes have mounted a sharp rebound. The benchmark S&amp;P 500 was last up more than 17% since its low for the year in late March, giving it a year-to-date gain of over 8% - even with Friday's pullback of nearly 1%. Rising benchmark yields tend to put pressure on equity valuations, as companies and consumers will face higher borrowing costs. This can also weigh on economic growth and corporate profits, while possibly making bond returns more competitive with stocks. That may especially be the case now with the stock market at elevated levels. The benchmark S&amp;P 500 as of Thursday was trading at 21.3 times earnings estimates for the next 12 months, according to LSEG Datastream. That is well above the index's long-term average forward P/E ratio of 16, although it is below the 23.5 level it reached in October, as the strengthening U.S. earnings outlook has helped to keep valuations somewhat in check. &#34;I do think there is a real fear that inflation is kind of embedded in the economy going forward,&#34; said Peter Tuz, president, Chase Investment Counsel, in Charlottesville, Virginia. &#34;You don't see any signs of it going down right now, and that is a real fear, and it will drive the market down if it continues.&#34; Jack Ablin, chief market strategist at Cresset Capital, said if there is a delay of even a few months in reopening the Strait of Hormuz to both oil and liquefied natural gas (LNG) tankers as well as other commercial shipping, the result could be &#34;a brand new inflation regime for which investors just aren't prepared.&#34; EARNINGS ROSY The reason equity markets remain robust, portfolio managers say, is earnings. U.S. publicly traded corporations are delivering first-quarter profits that are significantly above expectations and on track to be some 28% higher than a year ago, the largest jump seen since late 2021. &#34;We're seeing the impact of the AI spending boom and (a related) increase in productivity,&#34; said Jeremiah Buckley, a portfolio manager at Janus Henderson, which could extend into 2027, he added. The latest wave of artificial-intelligence market enthusiasm has buoyed stocks including semiconductors. Massive capital spending on data centers and other AI-related infrastructure boosted chip demand. Still, lofty valuations in AI-related sectors are also causing some to forecast a pullback. Also underpinning equity markets is fear of being left on the sidelines. &#34;Traders don't want to turn bearish if there is a possibility -- as many think -- that the Strait of Hormuz situation could be cleared up in just a few weeks' time,&#34; said Tim Murray, capital markets strategist at T. Rowe Price. RISKS SKEWED However, investors are becoming increasingly aware of the risks - and the potential shock to equities. The surge in the price of crude oil, still trading above $100 as uncertainty swirls around the temporary ceasefire between Iran and the United States, has propelled inflation fears. Producer prices saw their largest gain in four years in April. &#34;Markets aren't braced for an 'extreme' scenario in the Iran war&#34; of a prolonged Hormuz shutdown, John Higgins, chief economic adviser, financial markets at consultancy Capital Economics, warned his clients in a report published on Thursday. While Treasury markets are pricing in the inflation risk, equity markets are not doing the same with the prospect that a prolonged shutdown may take a toll on the growth that has supported profits. The geopolitical crisis in the Persian Gulf and the inflation it may be causing has the potential for long-term damage. &#34;The Iran crisis has the potential to reshape the trajectory of the markets&#34; for the rest of the year, said Matthew Gertken, chief geopolitical strategist at BCA, a market analysis firm. (Reporting by Suzanne McGee in Providence, Rhode Island; additional reporting by Caroline Valetkevitch and Lewis Krauskopf; editing by Megan Davies and Nick Zieminski)</div>

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Analysts caution that the U.S. stock market may be underestimating risks from inflation and geopolitical instability, particularly with rising bond yields. While strong corporate earnings and AI-driven growth support equities, concerns about high energy prices and the ongoing conflict in Iran pose significant risks. Investors are increasingly aware of potential shocks to the market, especially if the Strait of Hormuz remains closed, which could lead to a new inflation regime. The S&P 500 is currently trading at elevated valuations, raising concerns about future growth.

- Investors are concerned that U.S. stock markets have not accounted for rising inflation and increasing bond yields, which could negatively impact equity valuations.  
- Despite a rebound in U.S. stock indexes due to strong earnings and AI-driven optimism, there are fears that persistent inflation and geopolitical issues, particularly the ongoing conflict in Iran, may lead to economic slowdown.  
- The current market conditions highlight a potential risk as the prices of oil and other commodities remain high, suggesting that the economy could face long-term challenges if inflation persists.

Analysis-Bond yield spike is risk to unprepared equities market, investors warn