US Stocks May Face Unconscious Sell-Off

The U.S. stock market has experienced an extraordinary surge over the past few years, captivating global investors with its seemingly unstoppable rise. From the beginning of 2023 to the end of 2024, the S&P 500 index soared by more than 50%, adding a whopping $18 trillion to its market capitalization. This impressive performance has transformed the U.S. market into a magnet for capital, drawing investors from all corners of the globe who view it as a golden opportunity to accumulate wealth.

However, beneath this façade of prosperity lie potential risks that have been quietly lurking. For months now, while bond markets have been sending out warning signals, stock traders have largely remained oblivious. Their focus has been swayed by optimistic expectations stemming from U.S. tax cuts and the promising prospects within the realm of artificial intelligence. To them, these factors appeared sufficient to undergird the relentless upward march of the stock market, all while shunning looming threats.

Last week, however, everything took a dramatic turn. As U.S. Treasury yields skyrocketed, breaking through a troubling threshold, stock prices plummeted in a swift and alarming manner, jolting investors out of their complacency and forcing them to reckon with the considerable risks at hand. Specifically, the 20-year U.S. Treasury yield surged past the critical 5% mark midweek, reminiscent of a flood breach, setting off alarms across the market. By Friday, it reached its highest level since November 2, 2023, while the 30-year Treasury yield also had a brief stint above 5%, marking its peak since October 31, 2023. It was particularly perplexing that during this period, following the Federal Reserve's decision to lower its federal funds rate by 100 basis points since mid-September, bond yields defied expectations and increased by approximately 100 basis points, representing a striking anomaly.

"This is highly unusual," remarked Jeff Blazek, co-head of multi-asset strategy at Neuberger Berman, expressing his evident concern regarding the rapid rise in bond yields during the initial months of a loosening cycle. He expanded on this, stating that an analysis of market data from the past 30 years reveals that mid- and long-term yields typically remain relatively steady or exhibit only modest increases following a series of Fed rate cuts. This time, however, the steep upturn is both rare and unsettling.

Traders are now closely monitoring the 10-year Treasury yield, which is perched at its highest level since October 2023 and racing towards the 5% psychological barrier. The awareness is palpable among traders: breaching the 5% mark could unleash a wave of selling in the stock market. Matt Peron, head of global solutions at Janus Henderson, voiced his apprehension, stating, "If the 10-year yield actually hits 5%, investors would instinctively start selling off stocks. Once this selling spree begins, it often takes weeks or even months to stabilize. During this turbulent period, the S&P 500 could face significant headwinds, potentially dropping by as much as 10%."

The causality behind this apprehension is not complex. Rising bond yields render U.S. Treasury Bonds more attractive, prompting investors to prefer safer, low-risk assets. In contrast, higher yields translate into increased borrowing costs for businesses, which inevitably affects their operations and growth prospects. This negative impact will manifest in the stock market, putting downward pressure on equity prices.

Last Friday, the undercurrent of anxiety among investors seemed to break the surface. The S&P 500 index took a substantial hit, plunging by 1.5%, marking its worst single-day performance since mid-December. Following a period of optimism that had persisted since November 5, during which the market had been on a steady upward trend, this abrupt downturn wiped out nearly all the gains accrued during that bullish phase. The market's swift reversal felt like a tempest, extinguishing investors’ hopeful sentiments and bringing them to a frosty halt. The dramatic change prompted a poignant realization among investors about the capricious nature of market dynamics. What once was an optimistic outlook turned into dust as they faced the stark reality of potential losses. In response to this bewildering market landscape, investors were compelled to reassess their strategies to navigate these uncertain waters.