In recent weeks, the U.Sbond market experienced a notable uptick in the yield on the 10-year Treasury note, raising widespread concerns regarding the future trajectory of the stock marketThis surge has not only impacted investor sentiment but also led to a reconsideration of what many had anticipated as the traditional 'Santa Claus rally' phenomena that accompany the holiday seasonHowever, instead of festive optimism, market participants witnessed a downturn, with the S&P 500 plummeting by 1.1% last Friday and continuing its downward spiral into the opening of the week.

Experts suggest that the increasing bond yields are a crucial factor contributing to this pervasive sense of caution among investorsSince the Federal Reserve's recent interest rate cuts, the yield on 10-year Treasuries has surged close to a full percentage point since September, culminating in a seven-month peak recorded just last Friday

This striking change has inevitably brought forth apprehensions regarding the performance of equities moving forward.

An added layer of worry lies in the possibility that the United States' tariff and tax reduction policies may further exacerbate inflationary pressuresCoupled with an anticipated increase in government deficits, these factors might lead to a heightened supply of bonds, thereby driving prices down and yields up even moreThe overall market has been struggling with these potentially harmful dynamics.

Renowned strategist Julian Emanuel, leading Evercore ISI's team, analyzed these conditions over the weekend and shared some pivotal insightsHe notes, “In the long run, corporate earnings remain the primary engine of the stock market; however, despite an overall favorable environment, rising long-term yields could exert medium-term pressure on equitiesBy 2025, increasing bond yields may pose the most significant challenge for the bull market in U.S

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stocks.”

In the short term, Emanuel anticipates a possible retracement in benchmark yields as there is an existing high volume of short positions in the Treasury market, which could trigger some unwinding actionsAdditionally, easing geopolitical tensions in oil-sensitive regions may help alleviate inflation concernsNevertheless, persistent issues such as U.Spolicy stances, mounting fiscal deficits, and expectations that Japan might reduce its purchase of U.STreasury securities are likely to further propel bond yields upward in the medium termEmanuel projects that a spike in volatility within both the bond and stock markets is a basic expectation as early as next year.

Emanuel elaborates that the pressure from rising bond yields remains a constant concern, irrespective of whether the stock market valuations are perceived as inflatedHe illustrates his point by referencing previous market conditions — whether in 2018, when stock market valuations were comparatively lower, or during 1994 and 2022, when they were at elevated levels — an increase in bond yields has historically strained the stock market.

Moreover, he stresses that there hasn't been a fixed threshold over the past few decades for the 10-year Treasury yield that definitively triggers a stock market correction

The 'trigger level' has varied significantly across different periodsFor instance, a 3% yield in 2018 pressured the markets, while back in 1994, the same point was registered at a whopping 6%.

At present, Emanuel posits that if the 10-year yield remains below 4.5%, the stock market might still navigate through pressures without derailing its upward momentumHowever, should yields break beyond 4.75%, a more severe and prolonged adjustment in the stock market could manifest.

With a keen eye on the evolving landscape since the end of the monumental bond bull market in 2020, Emanuel notes that the stock market embarked on a rollercoaster journey over the span of 1,754 days, achieving an astonishing cumulative increase of 117%, thereby becoming a much-coveted prize for investorsYet, beneath this apparent tranquility, a significant undercurrent of turbulence persistsRecent data shows that during the 89 days when the 10-year yield quietly edged past the 4.5% mark, the stock market faced headwinds, resulting in a 2.1% decline

Additionally, if yields were to rise further to 4.75% or beyond, the market could see an even more substantial downturn, with losses potentially steepening to 3.7% within just 20 daysEmanuel’s foresight serves as a serious warning: should the 10-year yield decisively breach the critical 5% threshold, it could spell significant trouble for the ongoing bull market, reminiscent of the chaotic market fluctuations triggered by a 3% yield in 2018.

Amid these intricacies characterizing the financial environment, a multitude of uncertainties loom, with the relentless climb of bond yields casting a shadow over the broader marketHowever, Emanuel and his seasoned team appear as contrarians in this financial narrativeMaintaining a resolute optimism towards the stock market's future beyond 2025, their expectations are grounded in extensive market analysis and sophisticated modelingDespite recognizing a likely volatility “baptism” the stock market is poised to undergo at the start of the next year, they view this as a temporary disturbance rather than a full-blown crisis