So far, investors who were looking for a Santa Rally have been let down. Futures for stock indexes show that Wall Street will have a hard time getting back on track on Monday after the S&P 500 SPX -1.11% dropped 1.1% at the end of last week.
One reason to be careful is that bond rates are going up. The standard 10-year Treasury yield TMUBMUSD10Y +4.593% hit its highest level in seven months on Friday. It has gone up almost a full percentage point since September, even though the Federal Reserve lowered its benchmark interest rate. Concerns that President-elect Donald Trump’s policies on tariffs and tax cuts may make inflation worse have pushed down bond prices. At the same time, a growing government deficit has made more bonds available.
A group of Evercore ISI analysts led by Julian Emanuel say this could continue to be a problem for stocks in the coming months. “In the long term, earnings drive stocks. However, rising long-term yields can put pressure on stocks in the medium term even when the overall environment is still favorable,” Emanuel writes in a note released on Sunday.
He goes on to say, “As 2025 starts, rising long-term bond yields are the biggest threat to the bull market.” The most recent rise in the 10-year yield did cause some instability in the stock market after the Federal Open Market Committee meeting on December 18.
Emanuel thinks that benchmark yields may pull back a bit in the coming days after their strong rise higher. These include people getting out of high-risk Treasury short positions and the possibility of lessening geopolitical tensions in oil-sensitive areas, which would make people less worried about inflation.
But the above-mentioned Trump policies, the budget deficit, and the possibility that China and Japan will buy fewer Treasuries will push yields higher in the medium term. As a result, Emanuel expects bond and stock market volatility to rise at the start of the year.
What’s also important to know is that “yield pressure doesn’t care about stock prices; it happens when valuations aren’t stretched (2018) and when they are (1994, 2022).”
Importantly, Emanuel says that stocks have gone down because “there isn’t a uniform ‘threshold’ over the decades for 10-year yields.” In fact, “trigger levels” in the past have been anywhere from 3% in 2018 to 6% in 1994.
He believes that the stock market can beat a 10-year Treasury yield of 4.5%, which it was above early Monday. But if the benchmark yield goes above 4.75 percent, Emanuel sees “a longer and deeper equity correction.”
He points out that stocks have gone up 117% over 1,754 days since the low point of yields in 2020, when the bond bull market ended. However, stocks have gone down 2.1% on the 89 days when the 10-year yield was above 4.5% and down 3.7% on the 20 days when it was 4.75% or higher.
And 5% is “a level that, like 3% in Trump’s highly charged first term in 2018, second year poses a greater threat to the cyclical bull market.”
Still, it’s important to note that Emanuel and his colleagues think the S&P 500 index will reach 6,800 next year, after some early choppy trading in 2025. This means they don’t think those upper yield bounds will be broken.
