Shares challenged as bond yields rise and economic surprise fades

The near-term outlook for stocks appears to be challenging as US economic data ceases to exceed expectations and bond yields rise on Donald Trump’s policy promises.

In December the US S&P 500 fell 2.5 per cent while at home the ASX 200 lost 3.3 per cent. Picture: Getty Images

The year 2025 could well be another positive one for stocks if rate cuts broaden and China delivers major stimulus.

But in the short term, the market may struggle as it did in December.

China’s policy makers have indicated that interest rates will fall and fiscal stimulus is coming but they aren’t expected to announce any concrete plans to support growth until March.

Meanwhile, iron ore and copper are hitting multi-month lows due to demand worries.

Iron ore was one of the worst-performing commodities last year, down about 17 per cent amid concern that demand would buckle as China’s economic slowdown deepened and its ongoing property market crisis.

Potential tariffs on Chinese steel are a risk after Donald Trump’s inauguration on January 20, but China may announce stimulus plans at the Two Sessions meeting in March after the Central Economic Work Conference last month strongly hinted greater support was on the way.

In the US and Australia, stocks have recovered somewhat from the late December sell-off that followed a less dovish outlook on interest rates from the US Federal Reserve.

But stocks did poorly last month in what’s normally a bullish time of year.

In December the US S&P 500 fell 2.5 per cent while at home the ASX 200 lost 3.3 per cent.

The rise in stocks from August through November came from rising valuations as US rates cuts started and economic data surprised positively. The latter was more important than rate cuts as it gave hope that the sharemarket would “grow into” somewhat stretched PE multiples in 2025.

Unusually for the start of an interest rate cutting cycle, the US 10-year bond yield rose from 3.60 to 4.45 per cent from mid September to mid November. But the bullish economic outlook that lifted bond yields more than offset the increasing valuation hurdle for stocks from rising bond yields.

From lows near negative 45 points in July and August, the Citi US economic surprise index rose steadily to positive 43 points by mid November. However, thanks to US policy uncertainty and rising bond yields on the economy, the US CESI fell back to zero by the end of December.

But even as US economic data stopped surprising positively, bond yields kept rising on US inflation jitters and a less dovish interest rate outlook. The 10-year Treasury yield rose 40 basis points in December, hitting an eight-month high of 4.64 per cent by year end.

Five per cent may be more of a danger zone in terms of the impact on mortgage rates and the housing market, but the 100 basis points rise in the 10-year yield since mid September will raise eyebrows.

As well as the potential for soaring bond yields to crimp the US economic outlook, there’s also a lot of uncertainty about the inflationary impact of Trump’s policies.

Having spent the second half of 2025 reacting to US economic resilience, investors may be somewhat reserved before Trump’s inauguration. Until the market gets some clarity on his plans for US tariffs, fiscal stimulus and immigration policies, there may be potential for the 10-year bond yield to probe the 5 per cent level, restraining stocks.

Nvidia founder and chief executive Jensen Huang. Picture: Getty Images

Monday’s keynote speech by Nvidia chief executive Jensen Huang at CES 2025 in Las Vegas could be the main event at the start of the week. Mr Huang is due to start his talk at 1.30pm AEDT Tuesday Australian time. In focus are the latest trends in Nvidia’s customer demand and upcoming product rollouts, particularly the launch date for its GeForce RTX 5000 series of graphics cards.

Artificial intelligence, robotics, extended reality, and automotive technology as well as the risks around US tariffs are likely to be hot topics for the conference overall.

It’s also a big week for economic data with inflation readings due in Australia and China, and US non-manufacturing ISM and non-farm payrolls data due.

But despite some cooling of recently elevated bullish sentiment in stocks, Macquarie Equities sees no rush to pile into stocks at the start of the year.

“As we start 2025, sentiment has cooled a little, but investors are still bullish on the outlook,” said Macquarie’s Australian equity strategist, Matthew Brooks.

Even after December’s fall, the ASX posted a total return of 11.4 per cent in 2024. This follows a similar low double-digits percentage return in 2023.

Brooks notes that the 2024 return was largely driven by an expansion of the market’s PE valuations.

That accounted for 7 percentage points of the 11.4 per cent total shareholder return. Rising earnings per share added 0.5 percentage points to this return, while dividends added 4 percentage points.

But with the market PE ratio near record highs, a positive return in 2025 will likely need a stronger contribution from earnings. In other words, earnings expectations will need to rise.

“In our view, the yield spike in December will drive slower growth, particularly in housing, and this will add to the negative delta in economic surprises in early 2025,” he said. “When you add uncertainty heading into Trump’s inauguration, we still think a better time to buy risk will be near when surprises trough, likely delayed until March.”

Originally published as Shares challenged as bond yields rise and economic surprise fades