Market Warning Signs: The Looming Threat of Rising Treasury Yields
For years, the stock market has been on an unstoppable upward trajectory, with the S&P 500 Index surging over 50% from 2023 to 2024, adding a staggering $18 trillion in value. However, Wall Street is now facing a daunting reality: Treasury yields above 5%. This ominous milestone has the potential to derail the market’s rally, and investors are taking notice.
The Bond Market’s Warning Signals
Equities traders have long ignored the bond market’s warnings, focusing instead on the promise of President-elect Donald Trump’s tax cuts and the limitless possibilities of artificial intelligence. But the risk is now coming into sharp focus. Treasury yields have risen roughly 100 basis points since mid-September, with the 20-year US Treasuries breaching 5% and the 30-year US Treasuries briefly crossing 5%. This rapid jump in bond yields is unprecedented in the early months of an easing cycle.
The Impact on Stocks
Rising bond yields make returns on Treasuries more attractive, increasing the cost of raising capital for companies. This spillover into the stock market was evident on Friday, as the S&P 500 tumbled 1.5%, wiping out all the gains from the November euphoria sparked by Trump’s election. The earnings yield for the S&P 500 is now sitting 1 percentage point below what’s offered by 10-year Treasuries, a development last seen in 2002.
A Bumpy Road Ahead
Strategists and portfolio managers predict a tumultuous road ahead for stocks. Morgan Stanley’s Mike Wilson anticipates a tough six months for equities, while Citigroup’s wealth division sees a buying opportunity in bonds. The path to 5% on the 10-year Treasury became more realistic on Friday after strong jobs data caused economists to reduce expectations for rate cuts this year.
Global Factors at Play
This isn’t just about the Fed. The selloff in bonds is global, driven by sticky inflation, hawkish central banks, ballooning government debts, and extreme uncertainties presented by the incoming Trump administration. “When you’re in hostile waters, yields above 5% is where all bets are off,” said Mark Malek, chief investment officer at Siebert.
Seeking Shelter in Big Tech
One area that may prove to be a haven for equity investors is the group that’s been driving most of the gains these past few years: Big Tech. The so-called Magnificent Seven companies — Alphabet Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp., and Tesla Inc. — are still posting rapid earnings growth and massive cash flows. They’re expected to be the biggest beneficiaries of the artificial intelligence revolution.
Proceed with Caution
Wall Street pros are urging investors to proceed cautiously, as rate risk hits in various unexpected ways. “The companies in the S&P 500 that are up the most will probably be the most vulnerable — and that could include the Mag Seven — and some frothy areas of mid-cap and small-cap growth will likely be under pressure,” said Janus Henderson’s Peron. “We’ve been consistent across our firm on staying focused on quality and being valuation sensitive. That will be very important in the coming months.”
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