Rising Treasury yields are the biggest challenge to Trump’s bull market

Wall Street investors hoping for a traditional Santa Rally to close out the year have been left disappointed so far. Stock index futures suggest continued struggles for equities, following a 1.1% drop in the S&P 500 at the end of last week.

According to economists, 2024 has been a record-setting year for Wall Street. The S&P 500 reached 57 record highs, placing it among the top five years for all-time records. Over the past year, the Nasdaq Composite has gained over 31%, the S&P 500 has climbed 25%, and the Dow Jones Industrial Average has risen a more modest 14%.

However, rising bond yields are presenting challenges for equities. The benchmark 10-year Treasury yield closed last week at its highest level in seven months. Since September, yields have jumped nearly a full percentage point, even after the Federal Reserve cut its benchmark interest rate. 

Treasury yields could pressure stocks

Analysts attribute the rising bond yields to concerns over President-elect Donald Trump’s tariff and tax policies. These policies could fuel inflation and expand the federal deficit, increasing bond supply and suppressing prices.

Julian Emanuel, a strategist at Evercore ISI, warns that long-term yields could continue to exert medium-term pressure on equities, even if broader economic conditions remain favorable. 

“Rising long-term bond yields pose the biggest challenge to the bull market as 2025 begins,” Emanuel wrote in a recent note, pointing to increased equity market volatility following the Federal Reserve’s December meeting.

The bond market is reaching a peak while the crude oil market finds a bottom, both driven largely by inflation. Bitcoin positions itself as a key player due to its decentralized nature and limited supply, offering an alternative to the depreciation of traditional assets. As…

— GG (@LuillyDRR) December 27, 2024

Emanuel emphasized that while bond yields may pull back slightly in the short term due to elevated Treasury short positions and easing geopolitical tensions, the medium-term outlook remains challenging. The interplay between rising bond yields and equity valuations will be crucial in determining market trends in early 2025.

The strategist also predicts that a 10-year Treasury yield of 4.5% is manageable for equities, but a breach of 4.75% could trigger a deeper correction. Notably, stocks have shown resilience in periods of rising yields, advancing 117% since the bond market trough in 2020. 

However, during periods when yields surpassed 4.5% or 4.75%, equities posted negative returns of -2.1% and -3.7%, respectively.

Corporate earnings bolstered by economic resilience

In 2024, earnings growth extended beyond the “Magnificent Seven” tech giants, with the other 493 S&P 500 companies exiting their earnings recession. According to FactSet data, S&P 500 earnings are projected to grow 15% year over year in 2025.

Keith Lerner, co-chief investment officer at Truist, notes that this earnings growth will likely sustain the bull market. “The weight of evidence suggests the primary market trend remains higher, driven by earnings growth in 2025,” Lerner stated in his market outlook.

The broader U.S. economy has also demonstrated resilience. November retail sales exceeded expectations, GDP growth remains above trend at 3%, and the unemployment rate continues to hover around 4%. While still elevated, inflation has shown signs of moderation, giving investors hope for a “soft landing” where prices stabilize without significant job losses.

Market tailwinds and headwinds into 2025

Several tailwinds are supporting market Optimism heading into 2025. Record corporate profits are expected for a second consecutive year, with net profit margins projected to remain nearly 12%. Sectors beyond technology, including health care, industrials, and materials, are anticipated to see profit increases in the high teens.

However, headwinds are where economists are expressing little to no optimism. Federal Reserve officials now project the federal funds rate to fall to 3.9% in 2025, an increase from their earlier September estimate of 3.4%. 

While the Fed delivered a substantial 50 basis point rate cut in September, most adjustments over the past year have been in smaller 25 basis point increments. The latest projections suggest the central bank anticipates two more rate cuts in 2025, down from the four cuts previously forecast in September.

BREAKING: Fed projections imply 50 basis points of rate cuts in 2025, another 50 bps in 2026.

— unusual_whales (@unusual_whales) December 18, 2024

If interest rates are not accordingly cut in 2025, given the Federal Reserve’s commitment to combating inflation, it may risk a policy error that could potentially harm the labor market.

Additionally, analysts reckon that the Trump administration’s policies, while business-friendly, could introduce growth challenges through higher tariffs.

Tech stocks, which have driven much of the market’s gains, face potential stagnation as investors grow wary of excessive spending on artificial intelligence without corresponding earnings growth. While a collapse in tech valuations is unlikely, a moderation in valuations could shift investor focus toward undervalued sectors like health care and materials.

From Zero to Web3 Pro: Your 90-Day Career Launch Plan