What Could Trigger the Next Stock Market Selloff? Here’s What History Tells Us.

The S&P 500 has surged by nearly 30% over the past five months, prompting even bullish market strategists to contemplate, if not embrace, the possibility of a "healthy" correction.

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However, market corrections typically don't occur spontaneously; they usually require a catalyst to initiate them. In an attempt to forecast potential triggers for the next double-digit pullback, a group of investment strategists led by Michael Kantrowitz from Piper Sandler examined the 27 corrections of 10% or more for the S&P 500 that have transpired since 1964.

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Their analysis revealed a consistent pattern: every one of these market downturns was primarily driven by one of three factors—rising unemployment, increasing bond yields, or some form of global external shock. Occasionally, it was a combination of these factors, as witnessed during the two equity-market corrections in 1980.

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So, which factor is most likely to instigate the next 10% correction? According to Kantrowitz and his team, the greatest threat to serene markets is posed by rising bond yields. It's worth noting that the most recent correction, which concluded on October 27 with the S&P 500 down 10.3%, was also triggered by surging yields.

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In the past two years, equities have demonstrated heightened sensitivity to rising yields, approaching levels last observed near the zenith of the dot-com bubble on a rolling 26-week basis. This indicates that stocks could still react negatively if long-term bond yields continue to ascend, notwithstanding the fact that equities have been largely impervious to the rebound in yields since the onset of 2024.

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"We've extensively discussed the current rate sensitivity of equity markets. Consequently, the most significant risk we foresee for equities in 2024 would be an upsurge in rates," remarked Kantrowitz and his team.

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Paradoxically, a modest uptick in unemployment could potentially prolong the market rally by acting as a buffer against higher yields. Historically, bond yields, which move inversely to prices, tend to decline when the economy weakens, as demand for defensive assets like bonds surges.

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Last year, stocks experienced a three-month sell-off from August to October as Treasury yields surged. The nadir of this selloff coincided with the peak of the 10-year Treasury yield, exceeding 5%—a level not seen in 16 years, according to FactSet data.

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During the first quarter of this year, Treasury yields have once again begun to inch upwards. However, expectations of robust economic growth potentially bolstering corporate earnings have mitigated the impact on stocks, at least thus far.

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Since the beginning of the year, the yield on the 10-year Treasury note (BX:TMUBMUSD10Y) has climbed by 39 basis points to 4.252%, while the S&P 500 (SPX) has surged by 9.4% since the start of the quarter and by 26.7% since October 27, closing at 5,218.19 on Monday.

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Similarly, the Nasdaq Composite (COMP) has risen by 9.6% since the beginning of the first quarter, reaching 16,452.69 at Tuesday's close, while the Dow Jones Industrial Average (DJIA) has gained 1,670.79 points, or 4.5%, to 39,388.56.

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