The apparent boom in US stocks masks underlying weakness! The S&P 500 is less than 2% from its all-time high, yet small-cap stocks, banks, and utilities sectors suffer heavy losses.

According to Zhitong Finance APP, as the U.S. 10-year Treasury yield once soared to 5.34%, marking a new high since 2002, Wall Street is intensely debating when the bond market sell-off will truly impact the seemingly resilient U.S. stock market. However, market internals already show that the pressure from high interest rates is becoming evident.

Although the S&P 500 is less than 2% away from its all-time high, multiple sectors such as small caps, banking, utilities, and high-risk technology stocks are already under noticeable pressure. Meanwhile, the S&P 500 Equal Weight Index is facing the prospect of its seventh consecutive week of declines, highlighting that the current U.S. stock rally is increasingly reliant on a handful of large technology companies.

Dan Suzuki, global investment strategist at iCapital, said that most sectors in the U.S. stock market are down at least 5% from their respective highs, with some sectors dropping more than 15%. He believes this is largely due to rising interest rates and the resulting tightening of financial conditions.

The current U.S. stock market is in a unique situation: on one hand, the AI investment frenzy continues to support key indexes; on the other, rising geopolitical risks, persistently high interest rates, and uncertainties brought by the U.S. mid-term elections are potential sources of volatility.

Eric Diton, President and Managing Director of The Wealth Alliance, commented that as long as the U.S. economy and corporate earnings remain strong, the stock market can temporarily withstand higher bond yields. However, he warned that if AI infrastructure construction encounters problems, leading to a downward revision in corporate earnings expectations, the market could face broader selling pressure.

The following five aspects reveal the pressure building beneath the seemingly calm surface of major U.S. stock indexes.

S&P 500 Equal Weight Index Risks Seven Consecutive Weeks of Decline—Rally Further Concentrated

The S&P 500 Equal Weight Index, an important indicator of U.S. stock market breadth, is at risk of falling for the seventh week in a row. Unlike the traditional S&P 500 Index, which gives heavier weighting to large-cap companies based on market cap, the equal weight index assigns each constituent equal weight, reflecting the overall performance of average constituents more intuitively.

According to data, if the index fails to reverse its decline by Friday, this will mark only the third instance in history of a seven-week losing streak. The previous two occurred during the post-dot-com bubble market correction in 2002 and the 2022 U.S. bear market.

This phenomenon indicates that, despite the S&P 500 Index remaining near record highs, the upward momentum is mainly concentrated in a few large technology companies, while the majority of stocks are significantly lagging behind.

However, not all market participants see the narrowing market breadth as a sign that the bull market is nearing its end. Michael Purves, CEO of Tallbacken Capital Advisors, stated in a Thursday report that he does not view the current breadth imbalance as a reason to be bearish on the S&P 500, but rather as a reflection of a strong bull market driven by technological transformation.

Purves set a year-end target of 8,500 points for the S&P 500, implying a potential near-11% upside from current levels.

Small Caps Near Correction Territory—Over a Third Face Repayment Pressure

With rising interest rates and bond yields, small-cap stocks are taking a particularly hard hit. Compared to large companies, small firms typically shoulder higher debt burdens and possess more concentrated business structures, making them more sensitive to increasing financing costs and changes in the economic environment.

Data shows that the Russell 2000 Index significantly lagged behind the S&P 500 throughout the recently concluded third quarter, with a performance gap close to 10 percentage points. This is the second-worst quarter for the Russell 2000 relative to the S&P 500 since 1999.

As of now, the Russell 2000 Index has dropped 8.5% from its record high set on August 14, approaching the technical correction range typically defined as a cumulative 10% drop. Sector-wise, financial and industrial companies make up a larger share of the Russell 2000, whereas the S&P 500 relies more on technology giants that benefited from this year’s AI frenzy.

More notably, internal financial pressure is rising among small-cap stocks. According to data, over one-third of the Russell 2000 components are considered “zombie companies”—firms with weak operations and insufficient profits to cover interest expenses on their debts.

As financing costs continue to rise, these companies may face even heavier financial burdens, further increasing valuation and profitability pressures across the small-cap sector.

Bank Stocks Enter Technical Correction—AI Agents Heighten Market Concerns

Even though U.S. consumer spending remains strong and corporate lending activity continues, providing some support to banking operations, bank stocks have still seen a clear wave of selling recently. The KBW Nasdaq Bank Index, which tracks 24 major banks, has dropped over 12% from its mid-August peak, entering a technical correction zone.

Since the start of the year, the index has only risen 3.3%, well behind the S&P 500’s approximate 12% gain. Bank stocks have been weighed down mainly by higher financing costs, rising bond yields, and growing concerns about credit risk, all of which have undermined investor confidence in the short-term earnings prospects for banks.

In addition, the launch of Muse, an AI agent by Meta (META.US), brings new uncertainties to the financial sector.

The market is concerned that AI agents could alter consumers’ longstanding banking habits. For example, consumers who previously left funds in low-yield checking accounts due to cumbersome operations could now use AI agents to more easily compare financial products and transfer funds, eroding banks’ traditional advantage of earning returns from low-cost deposits.

At the individual stock level, Capital One Financial (COF.US), Wells Fargo (WFC.US), and Huntington Bancshares (HBAN.US) are among the worst performers in the KBW Bank Index this year, recording drops of about 20%, 14%, and 12% respectively. Citigroup (C.US) fell as much as 4.6% intraday on Thursday—the largest intraday drop since July.

Utility Stocks Fall About 17% from Highs—Traditional Defensive Sectors Lose Appeal

Utility stocks, usually considered defensive investments, have also become one of the worst-hit sectors amid rising bond yields. With their relatively stable dividend income, utility companies’ stocks have long been favored by investors seeking yield and stability.

But as U.S. Treasury yields continue to rise, bonds have become increasingly attractive compared to utility stock dividends, diminishing the latter’s investment appeal. Data shows the S&P 500 utilities sector is down around 17% from its February record high, inching closer to the 20% drop that typically defines a bear market.

In Q3 of this year, the U.S. 10-year Treasury yield rose by nearly 1 percentage point, while the utilities sector dropped 13%. Among the sector’s 31 components, only Constellation Energy (CEG.US) and AES (AES.US) posted gains. More specifically, both power generation and electric utility companies fell by more than 10% in Q3, underperforming other sector segments.

Besides higher bond yields, expectations of increased U.S. natural gas inventories are also putting pressure on related stocks. At the same time, rising fuel costs may erode corporate profits, and sharply higher interest rates drive up financing costs for renewable energy projects.

For utility companies requiring continuous and significant capital investments in infrastructure construction and maintenance, a high interest rate environment could simultaneously impact their financing costs, earnings outlook, and stock valuations.

High-Risk Tech Stocks Sold Off—Financially Fragile Firms Clearly Trail

Beyond traditional interest rate-sensitive sectors, speculative stocks in the market are also under pressure. According to data, Goldman Sachs' basket of unprofitable tech companies dropped 11% in the third quarter, marking its second-worst third-quarter performance on record since 2014.

This group includes firms like streaming platform Roku Inc (ROKU.US) and interactive fitness equipment maker Peloton Interactive (PTON.US). For growth companies that have yet to turn a steady profit, investors often rely on expectations of future earnings to determine valuations.

When bond yields rise, the present value of forecasted future cash flows typically falls, putting pressure on these companies’ valuations. Meanwhile, companies with weak financials and heavier debt burdens are also clearly lagging the market.

Data shows that a basket of the most financially fragile, highly leveraged stocks rose just 1.9% in the three months to the end of September, the smallest quarterly gain since early 2022. Early 2022 marked the start of the most aggressive Fed rate hike cycle in decades, and the current similar divergence in the market signals investors are once again focused on financing costs and corporate financial health.

Wider Wall Street Disagreement—AI Investment Outlook Becomes Decisive Variable

Even as several sectors have undergone significant corrections, Wall Street remains divided on the overall outlook for U.S. stocks.

Diton of The Wealth Alliance remains cautious on equities and has increased his energy sector holdings to hedge against risks from persistently high bond yields and oil prices. He believes that as long as economic growth and corporate earnings stay strong, major indexes can withstand higher rates—but if AI infrastructure investments hit trouble, it could trigger broader downward revisions in earnings forecasts.

On the other hand, Wealth Consulting Group CEO Jimmy Lee thinks rising bond yields may not spiral out of control. He said investors may simply be selling interest rate-sensitive stocks and, after the significant tech pullback earlier this year, are rotating back into the tech sector.

Lee is seizing the opportunity of lower valuations to add to positions in financial and industrial stocks, but he also noted that if the AI investment frenzy unexpectedly reverses, it would pose a major risk for the S&P 500.