(Bloomberg) — For years it seemed like nothing could stop the stock market’s inexorable march higher, as the S&P 500 index soared more than 50% from the beginning of 2023 to the end of 2024, adding $18 trillion in value in the process. Now, however, Wall Street is looking at what may ultimately derail this rally: Treasury yields above 5%.
Bloomberg’s Most Read
Stock traders have ignored warnings from the bond market for months, focusing instead on the windfall from President-elect Donald Trump’s promised tax cuts and the seemingly limitless possibilities of artificial intelligence. But the risk came into view last week as Treasury yields rose toward their ominous milestones and stock prices sank in response.
The yield on the 20-year US Treasury bond surpassed 5% on Wednesday and rose above it again on Friday, hitting the highest level since November 2, 2023. Meanwhile, the 30-year US Treasury bond They briefly crossed 5% on Friday to reach the highest level since October 31. , 2023. Those yields have risen about 100 basis points since mid-September, when the Federal Reserve began reducing the federal funds rate, which has fallen. 100 basis points during the same time.
“It’s unusual,” Jeff Blazek, co-CIO of multi-asset strategies at Neuberger Berman, said of the dramatic and rapid jump in bond yields in the early months of an easing cycle. Over the past 30 years, medium- and long-term yields have remained relatively stable or slightly higher in the months after the Federal Reserve initiated a series of rate cuts, he added.
Traders are watching the policy-sensitive 10-year Treasury yield, which is the highest since October 2023 and quickly approaching 5%, a level they fear could trigger a stock market correction. . The last time it briefly exceeded the threshold was in October 2023, and before that we have to go back to July 2007.
“If the 10-year goes to 5%, there will be a knee-jerk reaction to sell stocks,” said Matt Peron, global head of solutions at Janus Henderson. “Episodes like this take weeks or maybe a few months to develop, and over the course of that, the S&P 500 could drop 10%.”
The reason is quite simple. Rising bond yields make Treasury yields more attractive, while increasing the cost of raising capital for companies.
The effect on the stock market was evident on Friday, when the S&P 500 fell 1.5% in its worst day since mid-December, turned negative by 2025 and came close to erasing all gains from the November euphoria. caused by Trump’s election.
While there is “no magic” to pegging 5% beyond the psychology of round numbers, perceived barriers can create “technical barriers,” said Kristy Akullian, director of investment strategy at Blackrock’s iShares. That is, a rapid movement in yields can make it difficult for stocks to rise.
Investors are already seeing how. The S&P 500’s earnings yield is 1 percentage point below what 10-year Treasuries offer, a development that was last seen in 2002. In other words, the return on owning a significantly less risky asset that the US stock benchmark has not been as high. It’s fine in a long time.
“Once yields rise, it becomes increasingly difficult to rationalize valuation levels,” said Mike Reynolds, vice president of investment strategy at Glenmede Trust. “And if earnings growth starts to falter, there could be problems.”
It’s no surprise that strategists and portfolio managers are predicting a bumpy road for stocks. Morgan Stanley’s Mike Wilson expects a tough six months for stocks, while Citigroup’s wealth division told clients there is a buying opportunity in bonds.
The path to 5% on 10-year Treasuries became more realistic on Friday after strong jobs data caused economists to scale back expectations for rate cuts this year. But this isn’t just about the Federal Reserve. The bond selloff is global and based on persistent inflation, hawkish central banks, rising government debts, and extreme uncertainties presented by the incoming Trump administration.
“When you’re in hostile waters, returns above 5% are where all bets are off,” said Mark Malek, chief investment officer at Siebert.
What stock investors need to know now is if and when serious buyers are stepping in.
“The real question is where do we go from there,” said Rick de los Reyes, portfolio manager at T. Rowe Price. “If it’s 5% on the way to 6% then that will worry people, if it’s 5% before stabilizing and eventually going down then things will be fine.”
The key is not so much that yields are rising, but why, market professionals say. A slow rise as the U.S. economy improves may help stocks. But a rapid jump due to concerns about inflation, the federal deficit and political uncertainty is a red flag.
In recent years, whenever yields have risen rapidly, stocks have sold off. The difference this time appears to be investor complacency, as seen in bullish positioning in the face of frothy valuations and uncertainties over Trump’s policies. And that’s putting stocks in a vulnerable position.
“When you look at rising prices, a strong labor market and a strong economy overall, everything points to a potential rebound in inflation,” said Eric Diton, president of the Wealth Alliance. “And that’s not including Trump’s policies.”
One area that may prove a haven for stock investors is the group that has driven most of the gains in recent years: large technology companies. The so-called Magnificent Seven companies (Alphabet Inc., Amazon.com Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp. and Tesla Inc.) continue to see rapid earnings growth and huge cash flows of cash. Furthermore, going forward, they are expected to be the biggest beneficiaries of the artificial intelligence revolution.
“Investors typically look for high-quality stocks with strong balance sheets and strong cash flows during market turmoil,” said Eric Sterner, chief investment officer at Apollon Wealth. “Megatechnologies have recently become part of that defensive game.”
That’s the hope many stock investors are clinging to: that the influence of large-cap technology companies on the broader market and their relative safety will limit any weakness in the stock market. The Magnificent Seven have a weighting of more than 30% in the S&P 500.
At the same time, the Federal Reserve is on the verge of cutting interest rates, although the pace is likely to be slower than expected. That makes this a very different situation than 2022, when the Federal Reserve was raising rates rapidly and indices were plunging.
Still, many Wall Street professionals are urging investors to proceed with caution for now as rate risk hits in several unexpected ways.
“The S&P 500 companies that rise the most will likely be the most vulnerable – and that could include Mag Seven – and some frothy areas of mid- and small-cap growth will likely be under pressure,” Janus Henderson said. Peron. “We have been consistent across our business in staying focused on quality and being sensitive to valuation. “That will be very important in the coming months.”
