Investors should exercise “extreme caution” as global bond yields rise and the traditional relationship between stocks and bonds becomes less favorable, according to Larry McDonald, founder of the Bear Traps Report and a market commentator who recently appeared on Fox Business.

McDonald's warning comes at a particularly sensitive moment for Wall Street. The 30-year U.S. Treasury yield has climbed to roughly 5.3%, while bond yields in other major markets, including Japan, Britain and France, are also elevated. The move is changing the relative attractiveness of fixed-income investments and raising questions about whether the stock market's strong run can continue without a meaningful correction.

McDonald has compared the current environment with the period before the 1987 stock-market crash, while emphasizing that he is not predicting that history will repeat itself exactly. His argument is instead that investors should recognize the combination of high valuations, expensive money and deteriorating bond-market conditions as a reason to reduce complacency.

For much of the post-financial-crisis period, investors had few attractive alternatives to stocks.

Interest rates were exceptionally low, meaning high-quality bonds generated relatively modest returns.

That pushed investors toward equities and riskier assets.

The environment has changed dramatically.

With long-term Treasury yields above 5%, bonds can now provide a substantially larger income stream while carrying much less price volatility than individual stocks.

That does not make bonds risk-free.

Long-duration government securities can lose value when yields rise further.

But the risk-reward calculation is different from the one investors faced when Treasury yields were near historic lows.

Higher bond yields affect stocks through several channels.

The first is valuation.

Investors compare the expected return from equities with the return available from relatively low-risk government bonds.

As Treasury yields rise, stocks have to offer a sufficient premium to remain attractive.

The second is the discount rate applied to future corporate earnings.

A higher risk-free rate reduces the present value of profits expected years into the future, putting particular pressure on technology and growth stocks.

The third is corporate financing.

Companies face higher borrowing costs when benchmark Treasury yields increase, making investment and refinancing more expensive.

All three forces can work against richly valued stocks at the same time.

McDonald's concern is partly about investor positioning.

After a strong equity-market rally, investors can become heavily exposed to the same popular trades.

That creates vulnerability when market conditions change.

If Treasury yields rise unexpectedly, some investors may decide that the potential return from stocks is no longer sufficient relative to bonds.

A rotation into fixed income can then put additional pressure on equities.

That does not necessarily require a recession.

A change in relative valuation can be enough.

Seasonality adds to the concern.

Late summer and early autumn have historically been periods of greater volatility in U.S. stocks.

September, in particular, has a reputation for weak average performance, although historical averages are not a reliable prediction for any individual year.

McDonald has advised investors to be especially careful rather than chase the momentum of crowded trades.

That message is consistent with a broader shift taking place across financial markets.

Investors who were comfortable accepting high equity valuations when cash and bonds yielded less are now being offered more competitive alternatives.

McDonald has pointed to Warren Buffett's large cash holdings as an example of patience in an uncertain environment.

Buffett's strategy has long emphasized maintaining liquidity when attractive opportunities are scarce.

Holding cash does not generate the highest return during a strong bull market.

But it gives investors the ability to deploy capital rapidly when valuations become more attractive.

That is particularly valuable during periods of market stress, when high-quality assets can become available at significant discounts.

The rise in yields is not simply a Federal Reserve story.

Long-term Treasury rates are also influenced by government borrowing and investor concerns about fiscal sustainability.

With the U.S. national debt approaching $40 trillion, Treasury issuance remains enormous. Investors may demand higher yields to absorb that supply, particularly if inflation remains above the central bank's target.

This creates an uncomfortable combination for markets.

Higher government borrowing can push yields higher, while higher yields increase the government's interest costs and can make future borrowing more expensive.

McDonald's warning is not limited to the United States.

He has pointed to rising yields in Japan, Britain and France as evidence that the global bond market is undergoing a broader repricing.

That matters because global capital is mobile.

Investors compare returns across countries.

If Japanese or European government bonds suddenly become more attractive, some global capital may move away from U.S. equities or lower-yielding assets.

Japan's bond market is particularly important because the country's investors have historically been significant buyers of foreign bonds.

The current market is heavily influenced by artificial intelligence.

Technology companies are spending enormous sums on data centers, semiconductors and other AI infrastructure, creating expectations for rapid future earnings growth.

But many AI-related stocks also trade at high valuations.

That makes them sensitive to changes in interest rates.

If bond yields continue climbing, investors may demand stronger evidence that AI spending will translate into profits.

Companies that cannot demonstrate a convincing return on capital could be punished even if the long-term technology story remains intact.

McDonald's warning should not be interpreted as a definitive prediction of an imminent market crash.

Comparisons with 1987 are attention-grabbing, but markets rarely repeat past crises in identical ways.

The relevant lesson is the combination of conditions rather than the specific historical outcome.

In 1987, investors confronted rapid increases in interest rates, valuation concerns, changing market structure and a sudden deterioration in confidence.

Today's market has very different underlying economic and technological characteristics.

The comparison is therefore better understood as a warning against complacency.

A number of developments could ease the pressure.

If inflation falls convincingly, Treasury yields could decline.

If the Federal Reserve signals greater willingness to cut rates, equity valuations could receive support.

If corporate earnings continue to grow rapidly, stocks may be able to absorb higher interest rates.

And if geopolitical tensions ease and energy prices fall, some of the current inflation premium could disappear.

Those developments would weaken the case for an aggressive defensive posture.

For investors, the key message is not that stocks must fall.

It is that the opportunity cost of owning stocks has changed.

When safe bonds yielded very little, investors had a strong incentive to accept equity risk.

Now that long-term government bonds offer yields above 5%, investors can earn meaningful income without relying on stock-price appreciation.

That changes portfolio construction.

Institutional investors may demand a higher earnings yield from stocks.

Individual investors may reconsider how much risk they need to take.

And companies may find that raising capital becomes more expensive.

The current market can still rise.

Strong earnings, AI-driven productivity and resilient consumer spending can continue to support equities.

But the margin for error may be narrowing.

When bond yields were low, investors could tolerate high equity valuations because alternatives were limited.

With yields now materially higher, every stock-market rally faces a more competitive fixed-income market.

That is the central reason behind McDonald's call for “extreme caution.”

The warning is less about predicting a specific crash than recognizing that the investment landscape has changed.

Treasury bonds are no longer yielding near-zero returns, long-term government borrowing costs are climbing and global fixed-income markets are repricing simultaneously.

For investors, the lesson is straightforward: a hot stock market can remain strong, but when bonds begin offering a much more compelling alternative, chasing momentum becomes a considerably more difficult proposition.