US equity indices: Is this the beginning of a stock market correction?

US equity indices suffered their biggest one-day fall since October this week as market attention fixated on geopolitical risks and a big in Japanese bond yields.

Investors pulled in their horns as US President Donald Trump doubled down on threats to take Greenland and threatened tariffs on 8 European countries, including the UK, France and Germany.

Trump said “there can be no going back” on Greenland, and is due to hold a meeting in Davos on Wednesday with “various parties” to discuss Greenland. Earlier he had threatened to impose a 10% tariff on the eight European countrieson 1 February, rising to 25% in June if no agreement is struck to allow the US to acquire Greenland.

On Tuesday, with traders on Wall Street returning from the Martin Luther King holiday, the Dow Jones Industrial Average dropped 870.74 points (-1.76%) to finish at 48,488.59. The S&P 500 fell 2.06% to 6,796.86. The Nasdaq 100 declined 2.12% to 24,987.57.

NDX gapped lower to trade below its 50-day moving average at 25,308 and never recovered this level through the session. SPX also closed below its 50-day SMA, which is at 6,830. Since its post-Liberation rally it’s done closed below its 50-day line three times before continuing higher. The broad market is less than 3% below its all-time high.

The VIX pushed up above 20. Short-dated stress signals remain elevated, with very near-term volatility rising faster than longer-dated measures, suggesting continued sensitivity to headlines and policy comments in the days ahead.

Geopolitical developments seem to be driving headline action and equity indices will be sensitive to developments on Greenland and any escalation of the simmering trade war between the EU and US. 

What could spark a deeper correction?

• Escalation of the trade war with Europe – failure to ‘do a deal’ this week leads to EU and US becoming more entrenched and hardening their line on trade; pushing Trump to go ahead with his tariffs; Europe proceeds with €93bn in tariffs already lined up.

• Still no deal is done by June, resulting in tariffs being raised by the US to 25%; Europe responds by deploying the Anti-Coercion Instrument (ACI) ‘bazooka’ and targets US tech giants, European investors start to offload Treasuries in greater numbers - whilst the numbers are small, the headline impact on sentiment is large.

• Talk of military intervention by the US is misplaced as though Trump is probably serious, Republicans will not countenance the idea, allowing the EU to stand firm hoping that the pressure of key midterm elections this year will see the president back off.

• Nevertheless, the escalation of a trade conflict with Trump backed into a corner would cause a serious market reaction with bond yields surging higher and stocks correcting lower by at least 10%.

• This makes talks in Davos key. Note this is just a potential scenario.

Deeper dive: Near-term risks remain elevated beyond the Greenland topic

Stocks are also very sensitive to moves in rates, which have been significant this week. We saw US treasuries sell off sharply Tuesday, likely in part on contagion from the instability in Japanese government bonds. After Friday saws the key 10-year benchmark US treasury yield rising above the range of the prior few months, it rose another seven basis points to close near 4.29% after testing above 4.30% at one point.

Japan risk

My colleague Ole Hansen makes a strong case for spillovers from Japan raising risks to the bull market:

“If markets have not been watching Japan, now is the moment. The relentless surge in long-dated JGB yields signals that one of the world’s most reliable liquidity backstops is fading, with consequences that extend well beyond Tokyo. For decades, ultra-low Japanese yields have acted as a global liquidity anchor, encouraging capital to flow abroad in search of return and underpinning risk appetite across global bonds, equities, and credit. That anchor is now shifting, with Japan’s bond market seeing a sharp repricing, with 30-year JGB yields at 3.86% after jumping 25 basis points today and the 10-year rising 8 basis points to 2.34%. Both are modern records which are now accelerating. The global implication matters more than the domestic politics. Higher JGB yields raise the opportunity cost of funding carry trades and overseas investments that for decades have relied on Japan as the world’s cheapest source of capital. As yields rise, capital is pulled back toward home, draining liquidity from global markets almost by definition. Policy options are limited: direct yield control would likely shift pressure straight to the currency, while more restrictive measures risk market distortion and loss of confidence. Whichever route the Bank of Japan takes, the outcome is the same — tighter global liquidity.”

Longer term, earnings growth is set to remain strong. Financial conditions are close to the loosest they’ve been in four years, the Fed has just cut 75bps, deregulation is a massive tailwind and President Trump’s One Big Beautiful will inject ~1% of GDP worth of fiscal impulse into the economy. Furthermore, weak oil prices, a depreciating US dollar, the potential for more rate cuts and AI investmentsuggest markets may be under-pricing US growth in 2025.

Note that BofA’s global fund manager survey shows global growth expectations among  investors at 5-year highs and fading inflation concerns pointing to a ‘goldilocks’ scenario and record bullishness on equities...this could be a sign they are not terribly well positioned for a correction. Or does it reflect the longer-term bull thesis that surging investment in technology, massive fiscal expansion in the G3, loose financial conditions and other tailwinds will drive the S&P 500 to fresh highs? It can be both.

So near-terms geopolitical headline risk is not necessarily a reason to sell, if earnings and economic growth is going to be supercharged. But there is a bigger story with the geopolitical aspect and the so-called ‘Sell America’ trade.

On Tuesday a Danish pension fund said it would offload £100mn in Treasury holdings, citing "poor government finances", but clearly Greenland made this decision somewhat easier. It’s small fry but could be a canary in the coal mine to some extent in terms of global investors reassessing exposure to US assets. Weaponisation of Europe's $8tn holdings of US stocks and bonds has been dropped into conversation but it's less clear how you would actually coordinate this as a 'response' to the crisis. Nevertheless, markets are clearly moving ahead of an expected rotation out of US assets by investors. But we've been here before and seen US assets rally after the initial shock.

My hunch is that if investors are seriously dialling back US exposure, it’s more likely to show up first through the fixed income and FX channel, with moves in rates getting out of hand and pressuring stocks.

Mag7

The stock market is the economy to some extent.  AI has been the key performance driver over the last couple of years. Most of the dominant top 10 stocks in the US by market cap that make up some 40% of the overall market overlap with developments in AI. Soin short, where AI and Mag7+ go, so goesthe US economy, at least in the near term.

Correction on the cards? Mag7 valuations topped out in December at a level consistent with the past two S&P 500 corrections. Mag7 have underperformed the other 493 since November as the bull market broadened out but the move in Mag7 is a concern as it could lead the rest of the market lower.

Note that the upward revision to 2026 earnings for the S&P 500 since Liberation Day comes solely from the Mag7. Earnings expectations for the S&P 493 have not moved. This is the K-shaped economy in a nutshell, but it won’t necessarily matter as long as the AI truck keep rolling. Note for instance the US economy expanded on the back of a productivity boom - non-farm business productivity increased at a 4.9% annualised pace in the third quarter. This ‘productivity miracle’ seems consistent with declining labour force and increased use of AI.

Earnings season is upon us to provide a further catalyst. Consensus estimates point to an 8.3% year-over-year increase in S&P 500 earnings per share.

Microsoft CEO Satya Nadella made the point in Davos - the next leg of the AI trade depends on the adoption and integration of AI into the broader economy. This is the AI dispersion trade. Whilst this can drive earnings and share price growth this year, there are risks of a near-term disappointment in terms of the AI space overall. Now is arguably a moment where investors may question whether investors have too much exposure to AI and a 3-year-old startup with questionable financial expectations.

Anyway, his comments fit the idea of a shift from AI enablers to adopters, winners and losers...greater dispersion among stocks and narrative shift from chipmakers to other sectors – financials, healthcare and industrials.

US500– support seen at the Dec 17th lows around 6,700 then the big round number at 6,500 which held throughout the big Oct and Nov drawdowns, and sits just above the 23.6% retracement of the post-Liberation Day rally. Ongoing divergence in the RSI and MACD momentum indicators signals risk for bulls, whilst also noting a bearish MACD crossover signal –though these have been less than reliable of late.