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The stock market’s “systemic problem” is rearing its ugly head again.
The 10-year Treasury yield (^TNX) has surged nearly 50 basis points in the past month, reaching above 4.6% for the first time since May 2023.
Over this time period, the S&P 500 (^GSPC) is down more than 1%, and any signs of a broadening in the stock market have all but dissipated. Morgan Stanley chief investment officer Mike Wilson wrote in a note to clients on Sunday that the bad breadth is a symptom, not the cause, of the choppiness in markets.
It starts with the rates that have crossed a line.
Multiple strategists have been eyeing the 4.5% threshold as a key indicator for when the rising 10-year yield could weigh on equities. Similar rises in rates in April 2024 and the fall of 2023 coincided with some of the largest drawdowns seen in the current bull market.
“The correlation of equity returns to bond yields has flipped decisively into negative territory (yields up, stocks down and vice versa) — something we have not seen since last summer,” Wilson wrote.
On top of that, Wilson points out, better-than-expected economic data isn’t to blame for pushing yields higher.
“The combination of these factors makes rates the most important variable to watch in early 2025, in our view,” Wilson wrote.
Higher rates are seen as a headwind for equities, particularly in more speculative areas of the market like small caps where more companies could be forced to refinance at a higher borrowing rate. This helps feed the market’s recent large-cap bias and the status quo of Big Tech’s concentrated position in the market.
“The recent rise in rates provides yet another reason to stay up the quality curve as companies with stronger balance sheets/less leverage are likely to remain less rate sensitive,” Wilson wrote.
Wilson reasons that unless rates come lower, among other factors, the broadening of the stock market rally many have called for in 2025 could be on hold for now.
Rising rates are also typically joined by a rise in the dollar. The US dollar recently hit a two-year high and is also pressing toward levels that Wilson argues also have the potential to weigh on equities with more significant foreign sales exposure.
As our Chart of the Day showed last week, that could include quite a few companies that have been helping drive recent earnings growth for the S&P 500. S&P 500 companies with less than half of their revenue in the US grew earnings by nearly 14% over the year prior during the third quarter, per FactSet. That far outpaced the 1.8% earnings growth seen by companies with more than half of their revenue coming from within the US.