(Bloomberg) -- For years it’s seemed like nothing could stop the stock market’s inexorable march higher, as the S&P 500 Index soared more than 50% from the start of 2023 to the end of 2024, adding $18 trillion in value in the process. Now, however, Wall Street is seeing what can ultimately derail this rally: Treasury yields above 5%.
Equities traders have shrugged off the bond market’s warnings 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 focus last week as Treasury yields climbed toward their ominous milestones and share prices sank in response.
The yield on 20-year US Treasuries breached 5% on Wednesday and jumped back above on Friday, reaching the highest since Nov. 2, 2023. Meanwhile, 30-year US Treasuries briefly crossed 5% on Friday to the highest since Oct. 31, 2023. Those yields have risen roughly 100 basis points since mid-September, when the Federal Reserve started reducing the fed funds rate, which has come down 100 basis points over the same time.
“It is 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, intermediate and longer-term yields have been relatively flat or modestly higher in the months after the Fed initiated a string of rate cuts, he added.
Traders are watching the policy-sensitive 10-year Treasury yield, which is the highest it’s been since October 2023 and is rapidly approaching 5%, a level they fear could spark a stock market correction. It last passed the threshold briefly in October 2023, and before that you have to go back to July 2007.
“If the 10-year hits 5% there will be a knee-jerk reaction to sell stocks,” said Matt Peron, Janus Henderson’s global head of solutions. “Episodes like this take weeks or maybe a few months to play out, and over the course of that the S&P 500 could get to down 10%.”
The reason is fairly simple. Rising bond yields make returns on Treasuries more attractive, while also increasing the cost of raising capital for companies.
The spillover into the stock market was apparent on Friday, as the S&P 500 tumbled 1.5% for its worst day since mid-December, turned negative for 2025, and came close to wiping out all the gains from the November euphoria sparked by Trump’s election.
Building Barriers
While there’s “no magic” to the fixation on 5% beyond round-number psychology, perceived barriers can create “technical barriers,” said Kristy Akullian, Blackrock’s head of iShares investment strategy. Meaning, a swift move in yields can make it difficult for stocks to rise.
Investors are already seeing how. The earnings yield for the S&P 500 is sitting 1 percentage point below what’s offered by 10-year Treasuries, a development last seen in 2002. In other words, the return on owning a significantly less risky asset than the US equities benchmark hasn’t been this good in a long time.
“Once yields get higher it becomes harder and harder to rationalize valuation levels,” said Mike Reynolds, vice president of investment strategy at Glenmede Trust. “And if earnings growth starts to falter, there can be issues.”
Not surprisingly, strategists and portfolio managers predict a bumpy road ahead for stocks. Morgan Stanley’s Mike Wilson anticipates a tough six months for equities, while Citigroup’s wealth division told clients there’s 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. But this isn’t just about the Fed. The selloff in bonds is global and based on 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,” Mark Malek, chief investment officer at Siebert, said.
What equity investors need to know now is if, and when, serious buyers step in.
“The real question is where we go from there,” said Rick de los Reyes, a portfolio manager at T. Rowe Price. “If it’s 5% on its way to 6% then that’s going to get people concerned, if it’s 5% before stabilizing and ultimately going lower then things will be fine.”
Red Flags
The key isn’t so much that yields are rising, but why, market pros say. A slow increase as the US economy improves can help stocks. But a quick jump due to concerns about inflation, the federal deficit and policy uncertainty is a red flag.
In recent years, whenever yields have risen quickly, stocks have sold off. The difference this time appears to be complacent investors, as seen in bullish positioning in the face of frothy valuations and uncertainties about Trump’s policies. And that’s putting equities in a vulnerable position.
“When you look at rising prices, a strong job market and an overall strong economy, it all points to a possible uptick in inflation,” said Eric Diton, president of the Wealth Alliance. “And that’s not even including Trump’s policies.”
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., Amazon.com Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp. and Tesla Inc. — are still posting rapid earnings growth and massive cash flows. Plus, looking to the future, they’re expected to be the biggest beneficiaries of the artificial intelligence 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. “The mega techs have become part of that defensive play recently.”
That’s the hope many equity investors are hanging on, that mega-cap tech companies’ sway over the broader market and their relative security will limit any weakness in the stock market. The Magnificent Seven have a more than 30% weighting in the S&P 500.
At the same time, the Fed is in the midst of lowering interest rates, although the pace is likely going to be slower than expected. That makes this a very different situation than 2022, when the Fed was hiking rates rapidly and indexes plunged.
Still, many Wall Street pros are urging investors to proceed cautiously for the time being 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.”
