Bond yields rise, market concentration intensifies! Schroders reveals two potential risks in the US stock market

According to Zhitong Finance APP, on February 11, Johanna Kyrklund, Chief Investment Officer of Schroders Investment Group, stated that as we enter 2025, despite the high valuations in the U.S. stock market, she maintains a positive stance on nominal economic growth and interest rate cuts being beneficial for the stock market, as corporate earnings are expected to remain robust and inflation is still moving in the right direction. As major stock indices no longer provide the diversification benefits they once did, and the shift in political consensus is changing the correlations between asset classes, investors need to work harder to build resilient portfolios.

However, she pointed out that there are two risks that concern her. First, whether rising bond yields will jeopardize stocks. The 2010s were characterized by tightening fiscal policies and a zero interest rate environment, which led to excessive income inequality and subsequently sparked support for populist policies and a new consensus focused on loose fiscal policies, protectionism, and higher interest rates.

Loose fiscal policies represent higher borrowing costs. In many regions, an aging population combined with other spending demands will lead to rising debt levels. Ultimately, these factors will limit the potential returns in the investment market.

Government spending around the world helps support the economy, but this may lay hidden dangers for the stock market in the future, as excessive spending in the system is often only addressed during economic downturns.

Johanna Kyrklund noted that as long as bond yields do not rise too much, stock valuations can be maintained at current levels. The yield on the U.S. 10-year government bond is currently about 4.8%, and stock valuations relative to bonds have begun to enter a more precarious territory. Rising bond yields may attract funds out of the stock market and increase borrowing costs for companies.

Like most market commentators, she has predicted in recent years that the U.S. economy may enter a slowdown or recession, but the current forecast is for positive development. This may indicate that from a contrarian perspective, bond yields will experience some relief in the short term, especially as the market has digested the prediction that the U.S. may cut interest rates in 2025. However, high bond yields are a risk that investors need to pay attention to in 2025.

The second challenge is the concentration of market capitalization-weighted indices. The strong earnings growth brought by large tech stocks in this cycle is markedly different from the "dot-com bubble" of 1999/2000. At that time, valuations had no substantial support or explanation, but now many large U.S. tech companies' earnings can support their valuations. However, given the dominant position of these companies in major indices, any misstep by one of them poses a risk to overall investment market returns.

In fact, the current concentration of stock market indices far exceeds that of the late 1990s. From a portfolio perspective, maintaining high positions in a few stocks does not seem wise. More importantly, the driving forces behind the stocks of the "seven giants" in the U.S. stock market vary, and viewing them as a single entity underestimates the different business drivers among individual companies. Given the concentration in the stock market, now is not the time to place bets.

The U.S. shares these common risks with other markets. The concentration in European and Japanese stock markets is also very high. Investors relying on past winners to drive performance have begun to miss opportunities. Since the summer of 2024, the development paths of investments and the stock market have become more interesting, with different industry sectors recording varying performances at different times