(Bloomberg) — For years it seemed like nothing could stop the stock market’s relentless march higher, as the S&P 500 rose more than 50% from the start of 2023 to the end of 2024, adding $18 trillion of value in the process. However, Wall Street is now seeing what could ultimately derail this rally: Treasury yields above 5%.
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Stock traders ignored bond market warnings for months, focusing instead on the windfall from the tax cuts promised by President-elect Donald Trump and the seemingly limitless possibilities of artificial intelligence. But the risks came into focus last week as Treasury yields rose toward their ominous milestones and stock prices fell in response.
The yield on the 20-year US Treasury note broke 5% on Wednesday and jumped again on Friday, hitting the highest level since November 2, 2023. Meanwhile, the yield on the 30-year US Treasury note briefly exceeded 5% on Friday to the highest level Since October 31st. , 2023. Those yields have risen by about 100 basis points since mid-September, when the Fed began cutting the federal funds rate, which fell 100 basis points at the same time.
“It’s extraordinary,” Jeff Blazek, co-chief executive of multi-asset strategies at Neuberger Berman, said of the large and rapid jump in bond yields in the first months of the easing cycle. He added that over the past 30 years, medium- and long-term yields have been relatively flat or modestly higher in the months after the Fed began a series of interest rate cuts.
Traders are watching the policy-sensitive 10-year Treasury yield, which is the highest since October 2023 and rapidly approaching 5%, a level they fear could trigger a stock market correction. It last briefly crossed the threshold in October 2023, and before that you have to go back to July 2007.
“If the 10-year interest rate gets to 5%, there will be a knee-jerk reaction to selling stocks,” said Matt Perron, head of global solutions at Janus Henderson. “Events like this take weeks or perhaps a few months, and over the course of that the S&P 500 could fall by 10%.”
The reason is fairly simple. Rising bond yields make yields on Treasury bonds more attractive, while also increasing the cost of raising capital for companies.
The spillover into the stock market was evident on Friday, as the S&P 500 fell 1.5% on its worst day since mid-December, turning negative for 2025, and coming close to erasing all gains from the November euphoria sparked by Trump’s election.
While there is no “magic” in focusing on 5% beyond the psychology of round numbers, perceived barriers can create “technical barriers,” said Christy Akulian, head of investment strategy at BlackRock iShares. This means that a rapid move in yields can make it difficult for stocks to rise.
Investors are already seeing how this works. The S&P 500’s dividend yield is just one percentage point lower than what the 10-year Treasury bond offers, a development last seen in 2002. In other words, the return on owning assets much less risky than the U.S. stock index was not. That’s good in a long time.
“Once yields rise, it becomes more and more 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.”
Not surprisingly, strategists and portfolio managers expect a bumpy road ahead 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 prompted economists to lower their expectations for interest rate cuts this year. But this isn’t just about the Fed. The bond sell-off is global and based on flat inflation, hawkish central banks, ballooning government debt, and extreme uncertainties presented by the incoming Trump administration.
“When you’re in hostile waters, returns above 5% are the point 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 will step in.
“The real question is where we go from there,” said Rick de los Reyes, portfolio manager at T. Rowe Price. “If the rate gets to 5% on its way to 6%, that will worry people, and if it gets to 5% before it stabilizes and eventually comes down, things will be OK.”
Market professionals say it’s not the high returns, it’s the why. A slow increase as the US economy improves could help stocks. But a rapid jump due to concerns about inflation, the federal deficit and policy uncertainty is a red flag.
In recent years, the faster returns rise, the more stocks are sold. The difference this time seems to be investor satisfaction, as we saw in the bullish stances in the face of superficial assessments and doubts about Trump’s policies. This puts the stock in a weak position.
“When you look at rising prices, a strong labor market and a generally strong economy, all of that points to a potential rise in inflation,” said Eric Deaton, president of the Wealth Alliance. “And that doesn’t even include Trump’s policies.”
One area that may be a refuge for stock investors is the group that has been driving most of the gains in the past few years: big technology companies. The companies called Magnificent Seven – Alphabet Inc. are still… and Amazon.com Inc. and Apple Inc. and Meta Platforms Inc. and Microsoft Corp. And Nvidia Corp. And Tesla Inc. – Achieve rapid profit growth and massive cash flows. Additionally, looking to the future, they are expected to be the biggest beneficiaries of the AI revolution.
“Investors typically seek high-quality stocks with strong balance sheets and strong cash flows during market turmoil,” said Eric Sterner, chief investment officer at Apollon Wealth. “Big tech has become part of that defensive game lately.”
This is the hope that many stock investors are clinging to, that Big Tech’s control over the broader market and their relative security will limit any weakness in the stock market. The Magnificent Seven has a weight of over 30% in the S&P 500.
Meanwhile, the Federal Reserve is in the midst of cutting interest rates, although the pace is likely to be slower than expected. That makes this situation very different from 2022, when the Fed was rapidly raising interest rates and indexes fell.
However, many Wall Street pros are urging investors to proceed with caution for now as interest rate risks arrive in various unexpected ways.
“Companies in the higher-cap S&P 500 are likely to be the most exposed – and that could include mag-seven companies – and some of the foam areas are likely to be exposed to mid-cap growth,” said Janos Henderson of Standard & Poor’s 500. And the small ones are under pressure.” Perun. “We have been steadfast in our company to continue to focus on quality and sensitivity to evaluation. This will be very important in the coming months.”
