US stocks' surface prosperity belies internal weakness! S&P 500 less than 2% from record high, yet small caps, banks, and utilities sectors suffer heavy losses.

Title context: US stocks' surface prosperity belies internal weakness! S&P 500 less than 2% from record high, yet small caps, banks, and utilities sectors suffer heavy losses. Text: As the US 10-year Treasury yield climbed as high as 5.34%, a new high since 2002, Wall Street is fiercely debating when the bond market selloff will truly hit the seemingly resilient US stock market. However, judging from internal market performance, the pressure from high interest rates has already become apparent. Although the S&P 500 is still less than 2% from its record high, multiple sectors such as small caps, bank stocks, utility stocks, and high-risk tech stocks are already under clear pressure. At the same time, the S&P 500 Equal Weight Index is facing a seventh consecutive weekly decline, highlighting that the current US stock rally is increasingly dependent on a handful of large technology stocks. Dan Suzuki, global investment strategist at iCapital, said that most US equity sectors are currently down at least 5% from their respective highs, with some sectors falling more than 15%. He believes this is largely related to rising interest rates and the resulting tightening of financial conditions. The US stock market is currently in a peculiar situation: on the one hand, the artificial intelligence (AI) investment boom continues to support the major stock indices; on the other hand, rising political risk for GEO Group Inc, persistently climbing interest rates, and uncertainty brought by the US midterm elections are factors that could trigger market volatility. Eric Diton, president and managing director of The Wealth Alliance, said that as long as the US economy and corporate earnings remain strong, the stock market can still withstand higher bond yields for the time being. But he warned that if problems arise in AI infrastructure buildout, leading to downgrades in corporate earnings expectations, the market could face broader selling pressure. The following five aspects reveal the pressure building beneath the surface calm of the major US stock indices. S&P 500 Equal Weight Index on track for seventh straight weekly decline, market rally further concentrated An important measure of US market breadth, the S&P 500 Equal Weight Index, is at risk of a seventh consecutive weekly decline. Unlike the traditional S&P 500 index, which gives larger companies greater weight based on market capitalization, the equal-weight index gives each constituent stock the same weight, so it can more directly reflect the overall performance of ordinary constituent stocks. According to data, if the index fails to reverse its decline by Friday, it will be the third time in history that it has fallen for seven consecutive weeks. The previous two occurrences were during the market adjustment after the dot-com bubble burst in 2002 and during the US bear market in 2022. This phenomenon reflects that although the S&P 500 remains near a record high, the upward momentum is mainly concentrated in a few large technology companies, while most other stocks have clearly lagged. However, not everyone in the market believes that narrowing market breadth means this bull market is about to end. Michael Purves, chief executive officer of Tallbacken Capital Advisors, said in a Thursday report that he does not see the current imbalance in market breadth as a reason to be bearish on the S&P 500, but rather as a manifestation of a strong bull market driven by technological change. Purves has a year-end target of 8,500 for the S&P 500, implying nearly 11% potential upside from current levels. Small caps near correction territory, more than one-third of companies face debt repayment pressure As interest rates and bond yields rise, small-cap stocks have been hit particularly hard. Compared with large companies, small companies usually carry higher debt burdens and have relatively simpler business structures, making them more sensitive to rising financing costs and changes in the economic environment. Data show that the Russell 2000 Index significantly underperformed the S&P 500 in the just-ended third quarter, with a return gap of nearly 10 percentage points. This was the second-worst quarter for the Russell 2000 relative to the S&P 500 since 1999. As of now, the Russell 2000 has fallen 8.5% from its record high set on August 14, approaching the technical correction range typically defined as a cumulative decline of 10%. In terms of sector composition, financial and industrial companies account for a relatively high share of the Russell 2000, while the S&P 500 relies more on the technology giants that benefited from the AI boom this year. More notably, financial pressure within small caps is increasing. According to data, more than one-third of Russell 2000 constituents are so-called "zombie companies," meaning companies with weak operations that struggle to cover debt interest expenses from their own profits. As financing costs continue to rise, the financial burden on such companies may further intensify, also leaving small caps as a whole facing greater valuation and earnings pressure. Bank stocks enter technical correction as AI agents intensify market concerns Even though US consumer spending remains strong and corporate borrowing activity continues, providing some support for banking business, bank stocks have still been clearly sold off recently. The KBW Nasdaq Bank Index, covering 24 large banks, has fallen more than 12% from its mid-August high, entering technical correction territory. Year to date, the index has risen only 3.3%, clearly lagging the S&P 500's gain of about 12%. Pressure on bank stocks has mainly come from rising financing costs, climbing bond yields, and growing market concerns about credit risk, all of which have weakened investor confidence in banks' near-term earnings prospects. In addition, the Muse AI agent launched by Meta (META.US) has also brought new uncertainty to the financial sector. The market worries that AI agents may change consumers' long-standing habits in using bank accounts. For example, consumers may previously have kept funds in low-yield checking accounts for long periods because of cumbersome procedures, while AI agents are expected to help users more easily compare financial products and move funds, thereby eroding banks' traditional advantage of earning returns from low-cost deposits. In terms of individual stock performance, First Capital, Inc. Financial (COF.US), Wells Fargo & Company (WFC.US), and Huntington Bancshares (HBAN.US) are among the weakest constituents in the KBW Bank Index this year, down about 20%, 14%, and 12% year to date, respectively. Citigroup (C.US) fell as much as 4.6% intraday on Thursday, the largest intraday drop since July. Utility stocks down about 17% from highs as traditional defensive sector loses appeal Utility stocks, usually regarded as a defensive investment choice, have also become one of the sectors hardest hit by the recent rise in bond yields. Because utility companies usually provide relatively stable dividend income, their stocks have long been favored by investors seeking yield and stability. But as US Treasury yields continue to climb, the returns offered by bonds have become more attractive relative to utility dividends, weakening the appeal of the latter. Data show that the S&P 500 utilities sector has fallen about 17% from its record high set in February this year, gradually approaching the bear market range typically defined as a 20% decline. In the third quarter of this year, the US 10-year Treasury yield rose by nearly 1 percentage point cumulatively, while the utilities sector fell 13% over the same period. Among the sector's 31 constituents, only Constellation Energy (CEG.US) and AES Corporation (AES.US) posted gains. Broken down further, power generation companies and electric utility companies both fell more than 10% in the third quarter, underperforming other categories within the sector. In addition to rising bond yields, expectations of higher US natural gas inventories have also weighed on related stocks. At the same time, higher fuel costs may erode corporate profits, while sharply higher interest rates increase the financing costs of renewable energy projects. For utility companies that need to continuously invest large amounts of capital to build and maintain infrastructure, a high interest rate environment may simultaneously affect financing costs, earnings expectations, and stock valuations. High-risk tech stocks sold off, financially fragile companies clearly lag In addition to traditionally rate-sensitive sectors, more speculative stocks in the market are also under pressure. According to data, a basket of unprofitable technology company stocks tracked by Goldman Sachs Group, Inc. fell 11% cumulatively in the third quarter, the second-worst third-quarter performance since relevant data began in 2014. This stock portfolio includes companies such as streaming platform Roku Inc (ROKU.US) and interactive fitness equipment maker Peloton Interactive (PTON.US). For growth companies that have not yet achieved stable profitability, investors tend to rely more on expectations of future earnings for valuation. When bond yields rise, the present value of discounted future cash flows usually declines, putting pressure on the valuations of such companies. At the same time, companies with weaker financial conditions and higher debt burdens have also clearly lagged. According to data, a basket of stocks of companies with the weakest balance sheets and heavier debt burdens rose only 1.9% in the three months ended September, the smallest quarterly gain since early 2022. Early 2022 was when the Federal Reserve began its most aggressive rate-hiking cycle in decades, and a similar divergence has now reappeared in the market, showing that investors are paying more attention to financing costs and corporate financial health. Wall Street divisions widen as AI investment outlook becomes key variable Although several sectors have already seen clear adjustments, Wall Street remains divided on the overall outlook for US stocks. Diton of The Wealth Alliance remains cautious on the stock market and has increased holdings in energy stocks to hedge against risks from bond yields and crude oil prices remaining high. He believes that as long as economic growth and corporate earnings remain strong, the major stock indices can still withstand higher rates, but if AI infrastructure investment runs into problems, it could trigger broader downgrades in earnings expectations. On the other hand, Jimmy Lee, chief executive officer of Wealth Consulting Group, believes that the rise in bond yields may not necessarily spiral out of control. He said investors may currently just be selling rate-sensitive stocks and rotating back into technology after tech stocks experienced a sharp correction earlier this year. Lee is using the pullback in valuations as an opportunity to add to financial and industrial stocks, but he also pointed out that an unexpected reversal in the AI investment boom would pose the main risk to the S&P 500.