The Federal Reserve is widely expected to raise interest rates Wednesday. The 10-year Treasury yield is flirting with 5% and crude is north of $100 a barrel. When you hear those three headlines together, you picture Wall Street sinking and tech getting dumped.

That is not what is happening. The S&P 500 — tracked by the SPDR S&P 500 ETF Trust (NYSE:SPY) — remains just 1.8% below its record close of 7,798.99 set Aug. 13 and is up 11.85% year-to-date.

The gap between tightening financial conditions and an equity market that refuses to break comes down to one thing, and it is visible in the data rather than in sentiment.

Earnings Are Outrunning The Macro Shock

"Either development would normally be enough to break a global bull market in stocks. Neither has so far. That’s because corporate earnings keep climbing," Ed Yardeni, president of Yardeni Research, wrote Sunday.

Higher bond yields reduce the present value of future corporate profits and make government debt more attractive relative to stocks. But that valuation pressure becomes less damaging when the earnings being discounted are increasing rapidly.

Analysts expect S&P 500 earnings to grow 28.7% year over year in the third quarter and 26.3% in the fourth, according to FactSet.

This would mark the third consecutive quarter above 25% and the eighth straight quarter of double-digit growth.

Full-year earnings are projected to rise 32%.

The strength is not limited to America.

Yardeni noted that forward earnings for the MSCI All Country World ex-U.S. Index have increased 40.4% over the past year, compared with 10.5% revenue growth. Its forward profit margin has reached a record 12.6%.

Why A Fed Hike May Not Break The Rally

Fed-funds futures have already incorporated most of the move, allowing Treasury yields and equity valuations to adjust before Wednesday’s announcement.

The CME FedWatch Tool put the probability of a 25-basis-point hike at 85.5% as of Sept. 12, which would lift the target range off its current 3.50%-3.75%.

A second hike is almost fully priced in by year-end.

The Market Absorbs Higher Rates, But Isn’t Immune To Them

A sustained move in the 10-year yield above 5%, another surge in oil or unexpectedly hawkish guidance from Fed Chair Kevin Warsh could force investors to reconsider the valuation maths.

Wednesday is a Summary of Economic Projections meeting, so the dot plot lands alongside the decision. A hike is priced; a dot plot pointing to several more is not.

The market can absorb a higher discount rate while earnings grow 28%.

It cannot absorb a higher discount rate while earnings estimates start falling. The third-quarter reporting season, which begins in three weeks, will test that.

For now, however, earnings growth is winning the tug-of-war.

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