A "Calm on the Surface" US Stock Market: Indexes Are "One Step Away" from New Highs, but Almost All Sectors Have Been Hit Hard

The US stock market is currently witnessing a rare 'two-faced market': The S&P 500 index is less than 2% away from its all-time high, yet beneath the surface, almost all interest rate-sensitive sectors have suffered heavy losses. The 10-year US Treasury yield has climbed to 5.34%, the highest since 2002, quietly undermining stocks that have missed the artificial intelligence narrative.

This surface-level calm is highly deceptive. Over the past month, the median stock within the S&P 500 has fallen by 5%, while the index itself hasn't budged — its sole support coming from the semiconductor sector's approximate 6% gain in the past month. Meanwhile, the ratio of the Equal Weight S&P 500 ETF (RSP) to the S&P 500 index just hit a historic low, with the equal-weight S&P 500 index recording its seventh consecutive weekly decline, a phenomenon previously seen only during the bursting of the internet bubble in 2002 and the bear market of 2022.

An even more cautionary signal: In the past 18 trading days, 17 days saw more S&P 500 components hitting new 52-week lows than new highs, a streak now extending to 12 consecutive days. According to Bloomberg data, in previous episodes like this, the US stock market had been hovering near a low after sell-offs before subsequently rising — but this time, the S&P 500 index remains near all-time highs.

Dan Suzuki, global investment strategist at iCapital, pointed out:

"Most sectors in the market are at least 5% off their highs, with some down over 15%. This is largely due to rising interest rates and the subsequent tightening of financial conditions."

Tech giants prop up a 'hollow' index, breadth hits historical extremes

The steady facade of the S&P 500 is almost entirely reliant on the strong performance of a handful of AI-related tech giants. The equal-weight S&P 500 index—which assigns the same weight to each component—is facing its seventh straight week of declines. According to Bloomberg data, this has only happened twice before: after the internet bubble burst in 2002 and in the 2022 bear market.

Michael Purves, CEO of Tallbacken Capital Advisors, wrote in a research note:

"We don’t view the current distorted market breadth as a reason to be bearish on the S&P 500, but rather as a manifestation of a strong bull market, partly because major technological disruption is underway."

He set a year-end target price of 8,500 points for the S&P 500, which would represent an approximately 11% gain from its current level.

However, this optimistic view hinges on the continued fulfillment of the AI narrative. Eric Diton, President and Managing Director of The Wealth Alliance, stated:

"The stock market can currently withstand higher yields—provided economic and profit growth remain robust. But the biggest risk to the market is if the pace of AI development is derailed. Should earnings expectations be significantly lowered, this will trigger broader stock market pain."

Small caps approach correction territory, 'zombie companies' make up over one-third

Rising interest rates hit small-cap stocks particularly hard. The Russell 2000 index just suffered its second-worst quarter relative to the S&P 500 since 1999, underperforming by nearly 10 percentage points and falling 8.5% from its August 14 all-time high, nearing technical correction territory.

According to Bloomberg data, among the Russell 2000 components, 'zombie stocks'—companies unable or struggling to cover debt interest with operating profits—account for over one-third. These companies face much greater debt-servicing pressure in a high-interest rate environment than larger firms, and if financing costs continue to rise, their survival space will shrink further.

Small-cap indices are weighted more heavily toward cyclical sectors such as financials and industrials, which are currently under pressure, in sharp contrast to the tech-driven structure of the S&P 500.

Bank stocks fall into correction, AI rivalry compounds pressure

Despite robust consumer spending and active corporate borrowing in the US, bank stocks have not benefited. The KBW Nasdaq Bank Index—which tracks 24 major banks—has fallen more than 12% from its mid-August peak, entering technical correction, and is up only 3.3% year-to-date, far behind the S&P 500’s 12% gain.

Capital One Financial, Wells Fargo, and Huntington Bancshares have been the worst performers in the KBW index this year, down 20%, 14%, and 12% respectively. Citigroup plunged as much as 4.6% intraday on Thursday, marking its largest one-day drop since July.

Beyond rate and credit pressures, Meta’s Muse AI Agent is also seen as a new threat to financial stocks — this product could end the 'inertia behavior' of consumers keeping funds in low-yield savings accounts for long periods, thus eroding banks' low-cost funding sources.

Utilities near bear territory, 'safe haven' status eroded by rates

Utilities are among the sectors most deeply hurt by this round of rate increases. The S&P 500 Utilities sector has fallen about 17% from its February peak, approaching bear market territory.

High yields have fundamentally undermined the appeal of utility stocks: When short-term US Treasury yields vastly surpass the dividend yields of utilities, the logic of treating them as a 'stable income alternative' no longer holds. In Q3, both electric companies and electric utilities sub-industry fell over 10%, the biggest losers within the sector; only Constellation Energy and AES delivered positive returns.

Meanwhile, surging rates have also raised financing costs for the renewable energy transition, further suppressing the sector's long-term investment thesis.

High-risk assets retreat across the board, AI narrative is the last line of defense

The most speculative corners of the market haven't escaped the pressure either. According to Bloomberg data, Goldman Sachs’s basket of loss-making tech companies—including Roku and Peloton Interactive—dropped 11% in Q3, marking the second-worst third quarter since records began in 2014.

Goldman Sachs and Bloomberg data show that companies with the weakest balance sheets and heaviest debt burdens rose only 1.9% in the third quarter, the smallest quarterly gain since the Federal Reserve began its current rate-hiking cycle in early 2022.

Jimmy Lee, CEO of Wealth Consulting Group, said he is buying financial and industrial shares as valuations fall, and believes the spike in bond yields won't spiral out of control. However, he also warns:

"The biggest risk to the S&P 500 is an unexpected collapse in AI trades."

The current vulnerability in the market lies in the highly concentrated logic underpinning the index — if cracks appear in AI earnings expectations, the widespread damage masked by the tech giants’ halo will surface even more violently.