4 of the biggest risks to stocks that investors should be watching
The stock market has been on a months-long rally but the road ahead isn’t necessarily clear.
On Monday, researchers at HSBC’s global investment team said they identified a handful of downside risks that could potentially “derail” the rally in stocks since President Donald Trump’s tariffs first rocked financial markets in early April.
The bank said it remained “aggressively risk-on” overall and would continue to be overweight on US stocks, but the recent run-up to all-time highs looks vulnerable on a few fronts, strategists and analysts said.
Here are some of the largest risks the bank identified that could hit the market:
1. The Fed gets hawish again
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The biggest risk facing stocks is that the Fed ends up being way more hawkish than investors anticipated, HSBC said.
The bank pointed to the potential for the US economy to re-accelerate — a situation that could prompt the central bank to even raise interest rates down the line.
“Fed pricing remains far too dovish, in our view,” HSBC said. “The mix of growth re-acceleration, Fed rate cuts and positive effects from the OBBB opens the risk of markets flipping to the risk of rate hikes towards the end of 2026/H1 2027. Such a hawkish flip would be the key risk to our broad-based risk-on view,” strategists said.
Investors aren’t expecting the Fed to raise interest rates anytime soon. Markets are pricing in an 89% chance of a rate cut next month and a 68% chance of a cut in November.
2. The AI trade flounders
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There’s a chance the AI trade could lose momentum after a blistering rally for high-growth names in the space sice April lows.
The overall market remains highly concentrated in tech stocks, chiefly the biggest winners of the burgeoning AI trade. The top 10 companies in the S&P 500 now make up a whopping 54% of the broader index, according to a July analysis from Apollo Global Management.
“We cannot deny the downside risk of the AI trade fizzling out and putting pressure on risk assets overall,” the bank said, speculating that even if a sell-off were to be largely concentrated in the Magnificent Seven stocks, it could spill over into “broad-based” weakness across risk assets.
Researchers said they didn’t see this scenario as the base case, largely due to factors like tech investment still rising, the bar for corporate earnings being lowered across the S&P 500, and corporate guidance getting more optimistic since tariffs were announced in April.
3. Supreme Court slaps down tariffs
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The threat of tariffs rocked markets earlier this year. Now, the threat of a legal reversal of Trump’s sweeping import duties is also a risk, the bank said.
The Supreme Court isn’t set to make a ruling on whether President Donald Trump’s Liberation Day tariffs are legal until early November.
Financial markets aren’t expected to be “overly concerned” about the ruling until then, HSBC said, but, should the tariffs be struck down, there could be a “near-term cross-correlated sell-off,” the bank said.
“On the one hand, one could argue that equities should cheer such a ruling — after all, companies would have to be reimbursed and that’d be an unexpected earnings windfall,” researchers said. “We’re more concerned about such a ruling putting the fiscal deficit outlook even more in jeopardy.”
That scenario could result in long-end US Treasury bonds selling off, which could cause yields to rise toward the “Danger Zone.”
In previous notes, strategists have defined the “Danger Zone” as when the 10-year US Treasury climbs above 4.7%. Should yields breach that level, that could cause a broad-based, but short-lived sell-off in risk assets, in the bank’s view.
4. Investors get ahead of themselves
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There’s a chance that investors become too optimistic about the direction of stocks, something that could trigger a contrarian sell signal, HSBC said.
“The combination of improving fundamentals alongside rate cuts coming through creates an especially bullish backdrop for risk assets. So, while our aggregate sell indicator is no longer flashing a warning sign that sentiment is too stretched, this could still reverse,” the bank said.
Should that happen, any pullback would also likely be short-lived, the researchers said.
4. The job market continues to slow
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The US labor market is a notable pocket of weakness in an economy that otherwise appears to be holding up well.
Should payroll data keep falling below expectations, that could cause “at least a short-term setback over the coming months,” the researchers wrote.
“A marked softening of the labour market could spark expectations for more aggressive rate cuts from the Fed over concerns to its mandate of maximum employment. From a market perspective, a classic risk-off backdrop would dominate. Risk assets would be dragged down while DM sovereigns and other typical safe havens would outperform,” they said.
But, even if the job market were to weaken substantially, that would also likely be a short-term risk to stocks, strategists said, noting that the Fed was already expecting the economy to post weak jobs growth in the coming months.