By Lewis Krauskopf and Laura Matthews
NEW YORK, May 18 (Reuters) - As the spike in bond yields re-emerges as a risk for equities, some corners of the U.S. stock market are particularly vulnerable.
Shares of smaller companies, especially those that are unprofitable or reliant on debt, are in the crosshairs. Economically sensitive sectors such as consumer or housing-related companies could falter, while dividend-paying stocks may lose appeal, undercut by more attractive Treasury payouts. Technology,
the largest part of the U.S. stock market based on weighting, could see pressure, particularly among shares that gained significantly during the market's recent rally, such as semiconductors.
"If most of the value depends on future cash flows, cheap debt, private-market marks, or a resilient consumer, higher yields do real damage," said Joshua Barone, wealth manager at Savvy Advisors in Reno, Nevada.
A global bond rout continued to cloud markets on Monday, as rising energy prices stemming from the Middle East war drove inflation worries and the potential for interest-rate hikes around the world.
The benchmark 10-year Treasury yield hit 4.631% during the session - its highest level since February 2025 - although it had pulled back as of Monday morning and was last around 4.59%. Yields move in the opposite direction to the price of bonds.
Rising benchmark yields tend to pressure equity valuations, and U.S. stocks could be particularly exposed with major indexes around record highs.
Companies and consumers face higher borrowing costs, which can weigh on economic growth and corporate profits. Higher yields can also make fixed income returns more competitive.
SMALL CAPS IN THE SPOTLIGHT
Many smaller companies rely on debt financing, which becomes more expensive as yields rise.
The prospect of higher rates hurting the U.S. economy could also be a harsher blow for smaller companies, which tend to be more domestically focused, investors said.
"Small caps rely more on the consumer and more on the capital markets," said Matthew Miskin, co-chief investment strategist at Manulife John Hancock Investments. "And both of those can be strained with higher rates."
Many smaller companies have yet to turn a profit, meaning their values are heavily linked to expected future cash flows. As yields rise, those cash flows lose luster as investors can more immediately realize a higher return from safer Treasuries.
As yield-spike fears took hold on Friday, the small-cap Russell 2000 slumped 2.4%, its biggest one-day drop since November, and was moving lower again on Monday morning.
CONSUMER, HOUSING STOCKS COULD FACE YIELD HEADWINDS
Consumer discretionary and retail stocks face a "double whammy," said Keith Lerner, chief investment officer at Truist Advisory Services.
"Lending rates are moving up and oil prices are moving up, which are two things that are negative ... for the consumer," Lerner said.
An exchange-traded fund that weighs retail and consumer stocks similarly - the Invesco S&P 500 equal-weight consumer discretionary ETF - fell 1.3% on Friday, and is down 8% on the year.
Housing stocks were hit hard on Friday, with the PHLX Housing index dropping 3.3%.
"With sticky inflation, higher rates are going to be here for longer just as we step into the busiest time of the year for home purchases," said Seth Hickle, portfolio manager at Mindset Wealth Management in Indianapolis. "This could have homebuyers rethinking that purchase."
Stocks that investors rely on for their strong dividends could face pressure, as the income available from holding safe-haven Treasuries increases.
That includes the utilities sector, whose dividend yield of 2.9% is more than twice the level of the broader S&P 500, according to LSEG data. But utilities, which have been considered a safe-haven group, could see their appeal rise if the economic backdrop weakens.
"For utilities, higher interest rates do compete with dividends," said Ed Clissold, chief U.S. strategist at Ned Davis Research. "If interest rates rise so much that the broad market comes under pressure, then utilities’ (relatively low market volatility has) tended to outweigh the competition for yield."
CAN TECH WEATHER RISING YIELDS?
Technology stocks have faced turbulence when yields rise, as many tech and other growth companies with high expected profits have market values that depend more on future cash flows. The tech-heavy Nasdaq Composite fell 1.5% on Friday and was lower again on Monday.
Such pressure this time could have an outsized impact on the market due to its heavy weights in indexes such as the Nasdaq and S&P 500.
"The swift rise in bond yields if sustained could threaten the tech sector's leadership in the stock market, especially at a time when things have been frothy in this market," said Richard Reyle, chief investment officer at Questar Capital Partners, in written commentary.
However, other investors said impressive earnings growth by large tech companies may help buffer the stocks from yield-related pressure.
"With tech, it's overbought and it almost just needs to cool down after such a run," Miskin said. However, he said, "fundamentally, I think they are more insulated."
(Reporting by Lewis Krauskopf and Laura Matthews; editing by Megan Davies, Rod Nickel)
