How long can the U.S. stock market continue to celebrate as U.S. Treasury yields soar?

Since the U.S. election day, the S&P 500 index has risen by about 300 points, with a cumulative increase of over 30% in the past year. However, as 2025 approaches, can the U.S. stock market's celebration continue?

Bank of America Merrill Lynch pointed out in a research report on November 15 that although there are currently no signs of a bear market in U.S. stocks, signals that could change the situation are still worth discussing—such as the soaring U.S. Treasury yields.

Typically, when the yield on the 10-year U.S. Treasury bond rises to 5%, investors tend to shift funds from stocks to bonds. Currently, the yield on the 10-year U.S. Treasury bond has risen by 80 basis points since mid-September and is expected to hit 5%.

Bank of America Merrill Lynch has set a target price of 6,000 points for the S&P 500 index by the end of 2024 (currently at 5,870 points) and expects the index's earnings per share (EPS) to rise by 13% to $275 in 2025.

The bank also noted that when the 10-year U.S. Treasury yield exceeds 5%, investors will turn to the bond market, which will limit the rise of U.S. stocks, but the current interest rate risk is generally controllable. The uncertainty of tariffs and policies during the "Trump 2.0" period will also impact U.S. stocks.

Will the situation in U.S. stocks reverse when Treasury yields reach 5%?

Since mid-September, the yield on the 10-year U.S. Treasury bond has continued to climb by about 80 basis points, and the soaring bond yields seem to have begun to exert pressure on U.S. stocks. The rise in U.S. stocks may collapse when Treasury yields reach 5%.

Bank of America Merrill Lynch pointed out that when the yield on the 10-year Treasury bond exceeds 5%, investors may shift from stocks to bonds, and Wall Street's stock allocation will typically decline.

Last week, the yield on the 10-year benchmark U.S. Treasury bond was about 4.44%, rising approximately 14 basis points over the week, currently reported at 4.451.

However, the bank believes that the current interest rate risk is controllable because 80% of the debt of S&P 500 constituent companies is long-term fixed-rate debt, compared to less than 50% in 2008. At the same time, the current real yield is about 2%, which is basically in line with the average level since 1950.

Real interest rates may be more comparable to the stock market. Although real interest rates may rise further, this process does not necessarily have a negative impact on the stock market, as similar situations have occurred in history. For example, during the productivity boom from 1985 to 2005, the average real interest rate was 3.5%, while the annual return of the S&P 500 index was 15%.

Trump 2.0 Impact on US Stocks

Bank of America Merrill Lynch predicts that by 2025, the earnings per share (EPS) of the S&P 500 index will grow by 13%, reaching $275. It is expected that under the "Trump 2.0" policy, tax cuts, deregulation, and industrial repatriation will drive cyclical growth in the stock market. However, Trump's tariff and immigration policies may also pose potential risks. Specifically:

• Tariff policies could lead to a decline of more than 10% in the S&P 500 index's earnings per share (EPS).
• Policy uncertainty may push the global economy into recession, resulting in a 20% drop in earnings per share (EPS).
• Tightening tariff and immigration policies could trigger inflation shocks, causing the 10-year Treasury yield to soar, which would lead to a 10% decline in earnings per share (EPS).

Additionally, the report points out that at least five indicators currently show that sentiment and positioning in the US stock market have become overly optimistic, limiting the market's upside potential.

The bank has observed some signs of euphoria among large-cap tech stocks, especially the "Seven Giants" of US stocks, where sell-side analysts' long-term growth expectations for these companies have reached historic highs, despite their large scale and fierce competition in AI investments. Meanwhile, US cyclical stocks and high-dividend stocks remain overlooked by the market. Bank of America Merrill Lynch believes that these neglected sectors may see rotation opportunities driven by the Trump 2.0 policy.