With US Treasury yields continuing to rise and the breadth of US stocks deteriorating, yet US stock indices remain resilient, what's next?

With US Treasury yields continuing to rise and the breadth of US stocks deteriorating, yet US stock indices remain resilient, what's next?

U.S. stocks are in the midst of a rare internal rift. Yields are soaring, market breadth continues to deteriorate, and credit spreads are widening, but the S&P 500 is holding firm, with bulls and bears locked in a stalemate and market sentiment becoming increasingly anxious.

On Wednesday, Rich Privorotsky, head of Goldman Sachs' single delta trading desk, bluntly stated that the pace of the rise in US Treasury yields "has become too severe to ignore," with the monthly increase in real interest rates being one of the worst since 2013. He warned that the surge in interest rate volatility is compressing Wall Street's risk intermediation capabilities, and the pressure on the stock market is far more profound than the index suggests.

Meanwhile, quarter-end rebalancing pressures are looming – Goldman Sachs estimates pension funds will sell a record $33 billion in stocks by the end of this month, and CTA systematic strategies will also net sell over $5.3 billion in Russell 2000 futures in the coming week. The combined selling pressure from these two factors makes the market outlook even more unpredictable.

BTIG strategist Jonathan Krinsky said his conversations with clients have been "more or less the same over the past few weeks, but the frequency and level of anxiety are increasing daily." The core issue is singular: the divergence between market breadth and interest rate trends and the S&P 500 is unsustainable, but no one can be certain how it will converge.

Behind the seemingly resilient index lies a multitude of internal problems.

The S&P 500 has barely moved in the past month, but beneath this calm surface, structural damage is accumulating rapidly.

Krinsky points out that while the S&P 500 has been flat overall over the past month, the median number of stocks has fallen by 4.5%, with the index's stability entirely offset by a roughly 10% gain in the semiconductor sector. The Nasdaq 100 has also seen almost no growth since mid-August, but only 10 of its stocks have risen by more than 10%, while as many as 23 have fallen by more than 10%. The "buy on breakout, chase momentum" strategy is failing; instead, more stocks are experiencing larger and more sustained declines.

The performance of mid-cap stocks is particularly alarming. Mid-cap stocks have quietly fallen below their 200-day moving average, accumulating a decline of over 8% from recent highs. Meanwhile, the number of stocks hitting new lows on the NYSE has exceeded the number hitting new highs for ten consecutive trading days, a signal that historically often foreshadows broader market pressure.

Goldman Sachs' Privorotsky corroborated this assessment: "The pain beneath the surface is clearly visible—the pressure on small-cap stocks, financial stocks, and other interest rate-sensitive sectors far exceeds the apparent calm presented by technology leaders."

Goldman Sachs: Interest rates have risen faster than the critical threshold.

Goldman Sachs' assessment is particularly crucial in the current market debate. Privorotsky explicitly stated that the stock market had previously "impressively shown resilience," but the pace of increase in real interest rates has triggered alarm bells.

Goldman Sachs' analytical framework shows that the stock market typically reacts when interest rates rise by more than two standard deviations—the key is not the absolute level of interest rates, but the speed of the rise. Currently, this threshold has been breached. The monthly increase in real interest rates has entered its worst range since 2013.

Privorotsky also observed a peculiar asymmetry in price behavior: when oil prices and interest rates improve in tandem, interest rate risk shows almost no reaction; but once oil prices rise, interest rates immediately come under pressure. He believes that 5-year and 10-year inflation expectations are still fluctuating in line with energy prices, but a significant proportion of the current interest rate shock comes from rising real interest rates rather than inflation expectations.

His conclusion is concise and powerful: " I can remain extremely optimistic about artificial intelligence and its pace of development, but at present, such optimism is almost meaningless unless the energy and interest rate issues are resolved. " The logical chain is clear: suppressing oil prices helps to lower interest rates, and stable interest rates can open up broader room for stock market recovery.

End-of-quarter rebalancing and CTA selling pressure: Double selling pressure looming.

In addition to fundamental pressures, technical selling pressure is being released in a concentrated manner at the end of the quarter.

Goldman Sachs estimates that pension funds will need to sell approximately $33 billion in stocks at the end of the month and quarter (approximately $11 billion at the end of the month and $22 billion at the end of the quarter) and buy an equivalent amount of bonds. This amount ranks 97th in all estimated transactions over the past three years, and 98th in January 2000, close to historical extremes.

Meanwhile, Goldman Sachs' CTA model shows that, under a flat price scenario, systematic strategy managers will net sell approximately $5.3 billion of Russell 2000 futures in the coming week, one of the largest sell estimates in the past six years.

Privorotsky is "tactically tempted" by this, believing that quarter-end and month-end factors should provide support for duration assets. However, he also admits that the core contradiction in the current situation is: which will "blink out" first before the end of the quarter: the bond buying by pension rebalancing and the stock index selling by CTAs?

In Krinsky's view, the current market is essentially a standoff between bulls and bears, and neither side has yet been proven right.

The bulls argue that market breadth is being thoroughly shaken out and a significant upward correction is imminent; interest rates will also fall sharply at some point. The bears counter that with continued deterioration in market breadth, rising yields, and widening credit spreads, the S&P 500 cannot remain unaffected indefinitely.

Krinsky himself leans towards a bearish stance, but he adds a tactical exception – the Utilities sector (XLU). He points out that after the RSI falls below 35, XLU has a 100% probability of rising within the next 5 trading days, with an average increase of 2.7%, making the current risk-reward ratio attractive.

His final assessment was that this divergence would not subside gently as the bulls had hoped. "We believe this will not end until the last resistance finally yields and the price breaks down."

The credit market is beginning to show cracks that stock volatility is refusing to price – high-yield credit default swaps (HY CDX) have risen to their highest level since April, when the VIX was 19.23, far higher than the current 16.35. This divergence may be the clearest warning sign of what's to come.

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