LD Capital Will the market remain bearish until the end of the year? What is the core of market speculation?

LD Capital Will the market stay bearish till year-end? What's the core of market speculation?

The foreign exchange market, the US dollar index fell first and then rose, rising for the ninth consecutive week, reaching the highest level since March.

Last week, both hawks and doves could find reasons in the inflation report that it is unlikely to significantly change the Fed’s policy stance. The moderate rise in bond yields confirmed this. The S&P 500 index and the Nasdaq Composite index fell for the second consecutive week, dropping 0.2% and 0.4% respectively. The main decline occurred on Friday (the largest single-day decline in three weeks), before which the stock market sentiment was more positive.

The strike by the UAW auto union on Friday was the direct trigger. This is the first time in the 88-year history of the union that it has simultaneously challenged the three major automakers.

In addition, the Philadelphia Semiconductor Index fell sharply by 3% on Friday. There are reports that TSMC will delay delivery of equipment to its factory in Arizona due to cautious outlook on demand prospects; Adobe’s earnings report exceeded expectations but unexpectedly fell sharply on Friday, which also led investors to have a more cautious attitude towards technology stocks on Friday. After Arm, a popular chip design company, soared 25% in its IPO on Thursday, its stock price fell 4.5% on Friday.

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The rise in oil prices has intensified pessimism, with oil prices surpassing $90 per barrel, hitting a new high for the year. WTI rose 3.5% for the week, and Brent rose 3.8%.

At the same time, the continued rise in US Treasury yields continued to put pressure on the stock market, with the yield on 10-year Treasury bonds climbing to 4.32%.

In terms of industry sectors, utilities +3.5%, non-essential consumer goods +2%, and finance +1.7% performed the strongest, while industry -1.1% and information technology -2% performed the weakest:

The foreign exchange market, the US dollar index fell first and then rose, rising for the ninth consecutive week, reaching the highest level since March; the yen briefly touched 148, hitting the highest level since November last year; however, the renminbi has been strong in the past week, with USDCNY falling to 7.25, hitting a new low since early August:

As for other stock markets, Hong Kong, Japan (JPN225 hit a new high since July, as Japanese investors flocked to technology stocks after Arm, a subsidiary of SoftBank Group, went public), and the UK (UK100 hit a new high since June) performed strongly. The Stoxx50 in Europe also recorded a 0.6% increase, while the mainland Chinese stock index, the CSI 300, fell for the third consecutive week:

So far in 2023, we have not seen a correction of 10% or more, which usually happens once a year. Therefore, if there is a deeper pullback in September and October, which are historically weaker months, we will not be surprised (the stock market may also trade sideways for a period of time instead of falling directly). However, in the short term, we have not seen any major economic or financial risks, so if there is a major decline, it can be seen as a good buying opportunity for long-term investments.

Cryptocurrencies rebounded on Monday after a sharp decline. The decline was mainly due to the ongoing news of the $3.4 billion liquidation of cryptocurrency assets by FTX. However, after the confirmation on Thursday, the market did not experience a significant drop. We have already analyzed this in our Muse morning meeting on Thursday:

Important Financial Events

[European Central Bank Raises Interest Rates by 25 Basis Points, But Implies Rates May Have Peaked]

The European Central Bank (ECB) raised its benchmark interest rate by 0.25 percentage points to 4% on Thursday. This is the 10th consecutive interest rate hike since the ECB started rapidly raising rates from below zero last year. ECB President Lagarde hinted that Thursday’s rate hike may be the last in this round of rate hikes, which led to a sharp drop in the euro and the US dollar index breaking through 105.3 to reach its highest level since the March crisis. However, Lagarde also mentioned that it is currently impossible to determine whether the interest rates have reached their peak and did not mention whether there will be a rate hike in November. She emphasized that the ECB has not discussed interest rate cuts and only stated that decisions will be data-driven. Market participants believe that the ECB is unlikely to raise rates further due to weak data.

[Slowing Demand, TSMC Reportedly Asks Suppliers to Delay Equipment Delivery]

Media reports on Friday stated that due to weak economic conditions and sluggish demand in the end markets, Taiwan Semiconductor Manufacturing Company (TSMC) has asked its major suppliers to delay delivery of high-end chip manufacturing equipment. The affected companies include ASML, which manufactures lithography equipment. On Friday, chip stocks in Europe and the United States all declined. TSMC’s Dutch suppliers ASML, BE Semiconductor Industries, and ASMI fell by 3.5%, 4.8%, and 6.6% respectively. The Philadelphia Semiconductor Index fell by about 3%, underperforming the broader market. Nvidia fell by about 3.7%, and TSMC’s US stocks fell by 2.4%, reaching a four-month low.

[Massive US Auto Industry Strike Affects 9% of North American Auto Production Capacity, Musk Benefits]

The United Auto Workers union (UAW) launched a strike against the Detroit “Big Three” on Friday, September 15th. This is the first time in UAW history that strikes have occurred simultaneously against the three major US auto companies. It is also one of the strongest strikes in the United States in recent years. However, the most successful new players in the electric vehicle field, such as Tesla and Rivian, have not formed unions. Regardless of the outcome of the strike, Tesla CEO Musk has already won. The “Big Three” will definitely spend more money, and any pay raises will further enhance Tesla’s huge cost advantage in the electric vehicle field. Tesla’s stock price rose by 10% last week.

[Surpassing Nvidia, Tesla’s Supercomputer?]

Tesla’s stock price increase is also related to the fact that major Wall Street banks have raised their target prices. On Monday, Morgan Stanley raised Tesla’s stock target price from $250 to $400, emphasizing the potential of Tesla’s Dojo supercomputer project. Dojo is a supercomputer network that can integrate millions of Tesla vehicles and is designed to train artificial intelligence systems to perform complex tasks, such as assisting Tesla’s driver-assistance system Autopilot and driving the ability for “fully autonomous driving.” As of July this year, Tesla has sold nearly 4.53 million vehicles, each of which sends data back to Tesla to develop autonomous driving capabilities.

By using this backend supercomputer specifically designed for learning real data, Tesla is able to combine a vast network of mobile sensors and cameras with powerful edge computing capabilities, creating an unprecedented model that goes beyond the scope of traditional car manufacturers.

Morgan Stanley believes that in theory, Dojo could bring the company long-term value of up to $500 billion. Morgan Stanley predicts that by 2030, Tesla will be able to earn a recurring income of $2,160 per month from vehicle owners, which comes from the services provided by Dojo, as well as subscription software for autonomous driving systems, vehicle charging services, maintenance, software upgrades, and future developments.

[China’s August RMB Loan and Social Financing Increment Both Show Significant Rebound]

In August, RMB loans increased by 1.36 trillion yuan, and the increment of social financing scale was 3.12 trillion yuan. By the end of the month, the stock of social financing scale increased by 9% year-on-year, while the broad money supply (M2) increased by 10.6% year-on-year. Compared with the previous month and the same period last year, the increment of new loans and social financing in August showed significant growth. This was primarily due to the intensive introduction of economic, stock market, and real estate stabilization measures by regulators in that month, which boosted market confidence. Financial support for the real economy continued to strengthen, and real demand also rebounded synchronously.

[Weight-loss Drugs are the New AI]

The weight-loss drug market is booming. As the market value of the two major weight-loss drug manufacturers, Novo Nordisk and Eli Lilly, continues to soar, the financial blog ZeroHedge directly claims that “weight-loss drugs are the new AI.” According to JPMorgan’s latest forecast, by 2030, with the duopoly of Novo Nordisk and Eli Lilly, the annual sales of GLP-1 drugs will exceed $100 billion.

[Stubborn US Inflation: August CPI Rises to 3.7% YoY, Core CPI Accelerates Monthly for the First Time in Six Months]

Oil prices surged, and US inflation accelerated again in August, potentially requiring the Federal Reserve to maintain high interest rates for a longer period of time. The overall CPI’s year-on-year growth rate rebounded for the second consecutive month, surpassing expectations at 3.6%, with the previous month at 3.2%. The month-on-month growth rate of CPI increased from 0.2% in July to 0.6% in August, in line with expectations, marking the largest month-on-month increase in 14 months. The core CPI, which excludes energy and food, decreased from 4.7% to 4.3% year-on-year, in line with expectations, representing the smallest increase in nearly two years. However, the month-on-month growth rate of core CPI slightly increased from 0.2% in July to 0.3%, exceeding the expected 0.2%.

[US PPI in August Rebounds Higher Than Expected: YoY Increase of 1.6%, Highest MoM Growth Rate in Over a Year]

Due to the rise in energy prices, US PPI continued to rise higher than expected in August, with a year-on-year increase of 1.6%, exceeding the expected 1.3%. This marks the second consecutive month of higher-than-expected growth. PPI increased by 0.7% month-on-month, the highest growth rate since June of last year, with July’s growth rate revised up to 0.4%. The core PPI in August increased by 2.2% year-on-year and 0.2% month-on-month, both showing a slowdown in growth compared to July, in line with expectations.

Gasoline prices strongly support US retail sales, with a month-on-month increase of 0.6% in August, far exceeding expectations

In August, US retail sales increased by 0.6% month-on-month, surpassing the revised value of 0.5% and far exceeding market expectations of 0.1%, achieving the fifth consecutive month of growth. Overall, retail sales in August still have elasticity, mainly supported by the rise in gasoline prices, with the pressure of price increases beginning to show in other areas.

Hot Topic: Inverted Yield Curve

Many investors believe that the rise in real yields this time is different from the past, as yields continue to rise despite the end of the central bank’s tightening cycle. The market increasingly expects higher new equilibrium real interest rates compared to the ten years before the pandemic, which is driven by higher fiscal deficits and productivity growth. Due to higher fiscal deficits than in the past, there is also more government bond supply, and recent technological innovations have brought higher productivity, which is in stark contrast to the long stagnation during the 2008 financial crisis.

Today, US real yields and real GDP growth appear similar to those before 2008. In mid-2006, 10-year Treasury bonds priced real yields at around 2.5%. The previous year, the real growth rate of the US economy was 3.0%, while the Federal Reserve raised its policy rate target to 5.25%.

Today, 10-year Treasury bonds offer real yields close to 2.0%, while the real economy has recently grown by 2.5%. Even today’s target federal funds rate range of 5.25%-5.50% is similar to that of 2006. This market pricing is hardly any different from the situation before the global financial crisis of 2008.

The most obvious and most concerning difference compared to 2006 is that today’s yield curve is much flatter, both in nominal and real terms. In mid-2006, the 2-year Treasury bond yield was the same as the 10-year Treasury bond yield. Today, the 2-year yield is 70-100 basis points higher than the 10-year yield. Many people believe that the severity of the 2022 yield curve inversion indicates a recession in 2023.

In addition to the market structure distortions caused by the previously mentioned expectations gap, the scale of central bank balance sheets may also be one of the reasons. The larger the proportion of long-term government bonds held by the central bank compared to the total issuance, the flatter the yield curve theoretically should be. Today, the size of the Federal Reserve’s balance sheet is one order of magnitude larger than in 2006, so for the same short-term policy rate, the yield curve should be flatter.

If we consider the impact of the scale of the balance sheet, today’s real yields may actually be much higher than in 2006, which is an important difference. In 2006, the size of the Federal Reserve’s balance sheet was about 800 billion US dollars. Today, the size of the Federal Reserve’s balance sheet is about 8 trillion US dollars. That is to say, it has expanded by about 10 times compared to 2006.

In the background of the Fed’s continued tapering (although slow) and the government’s constant increase in issuance, it is difficult to expect a significant decline in the yield curve of the bond market in the short to medium term, unless there is a significant economic slowdown and a corresponding interest rate cut by the Federal Reserve, which is a scenario that many people expect for a crisis or recession.

Here is an analysis from the pessimistic side, Via CICC, on September 17:

The Federal Reserve began monetary tightening in March 2022, but the large-scale and continuous fiscal expansion has significantly delayed the credit tightening, and the renewed fiscal expansion after the SVB incident in March is a typical example. However, delay does not mean absence, and the initiation of credit tightening will become a “gravity” that restricts growth. Since March, the exposure of risks in small and medium-sized banks has promoted government credit expansion and accelerated private credit tightening, especially in indirect financing that is more relevant to small and medium-sized banks: 1) Bank credit standards have significantly tightened, especially for commercial real estate, large and medium-sized enterprise, and small enterprise loans. The proportion of banks tightening loan standards has rapidly increased, approaching the highest point since the beginning of the pandemic; credit card and housing loan standards have also tightened. 2) The absolute scale of industrial and commercial loans has significantly declined, with a year-on-year growth rate close to zero growth, and the growth rate of consumer loans and housing loans has fallen from a high level.

Looking ahead, the major key nodes of the U.S. economic cycle are: the Federal Reserve nearing the end of interest rate hikes at the end of this year, while credit tightening continues; excess savings will gradually be exhausted in early next year, which will gradually restrain consumption, and inventory liquidation will continue until around the second quarter of next year. Therefore, the U.S. economy may continue to decline by the end of this year and next year, but not deeply (the balance sheet of household assets and liabilities remains healthy). Therefore, the market expects that the Federal Reserve may start an interest rate cut cycle after the second half of next year, when the credit cycle restarts and stabilizes, which will promote the reopening of the restocking cycle and achieve a recovery after the economic bottoming out.

An analysis from the optimistic side comes from Deutsche Bank:

In its report on September 14, the bank believes that the U.S. economy is currently in a resilient growth phase and there are no obvious signs of a recession. This is mainly based on the following positive factors:

(1) Both businesses and households have good financial conditions and healthy balance sheets. The leverage ratio of businesses is low, and households have sufficient savings. This is different from previous economic recession cycles.

(2) The job market is still relatively tight, with the unemployment rate close to historical lows. Businesses are less willing to lay off employees. The number of employed people is also still below the pre-pandemic trend level. (Until now, the total number of employed people is still slightly below the assumed level of continuous growth at a rate of 1.6% from 2015 to 2019.)

(3) During the pandemic, households accumulated a large amount of additional savings. Even with relatively optimistic assumptions, these savings are sufficient to support consumption until at least the second half of 2023.

(4) Real estate is the most sensitive part of the economy to interest rates, but its GDP share is not high, only 2.8%. In addition, there are signs of stabilization in real estate sales in the recent period.

(5) The internal cash flow of enterprises can cover dividends and capital expenditures. Enterprises have little demand for new debt financing.

Although various leading indicators indicate that the economy should enter a recession, the actual growth rate has only shown a slight slowdown. The report believes that the economy may continue to grow at a low speed rather than enter a recession. The Federal Reserve’s interest rate hike cycle is also about to end, and it is unlikely to tighten significantly. However, the report also predicts that the Federal Reserve is unlikely to significantly cut interest rates to stimulate the economy in the future.

The combination of liquidity, stock buybacks, issuances, and changes in positions has historically explained most of the fluctuations in stock market returns. In a lighter short-term recession, it is expected that positions will experience modest declines, and small outflows of funds will be offset by stock buybacks. The balance of supply and demand is enough to keep the S&P 500 index at around 4500 points by the end of the year.

Funds and Positions

Summary: The overall stock position rose slightly last week, with subjective investors adding positions; stock funds saw the largest net inflows in 18 months, bond funds saw a slight increase in inflows, and money market funds continued to see strong inflows.

Looking at the market, we are currently in a typical correction phase. The overall stock position rose slightly this week, slightly higher than the neutral level (historical percentile 61%), mainly driven by the increase in subjective investor positions:

Among them, the position of subjective investors rose from the historical 49th percentile to the 53rd percentile, and the position of systematic strategy investors rose from the 71st percentile to the 72nd percentile:

Overall, the rebound driven by extremely bearish positions has basically been completed by August and is no longer the main driving force supporting the stock market. In the current stage, it is necessary to be driven by fundamentals, such as better-than-expected economic data and improved corporate profits, to drive the stock market to establish more long positions.

Deutsche Bank’s view is that the expectation of positive economic data is still low. A series of better-than-expected growth data has continued to strengthen the surprise index of the economy, but the expectation of future economic slowdown is still mainstream, so this may support the next round of better-than-expected data. In addition, the change in the position of subjective investors is highly correlated with the surprise index of the economy:

In addition, the position of subjective investors has always been highly negatively correlated with interest rate volatility (the correlation coefficient has been -89% since 2021), because they continue to focus on the lagging impact of monetary policy tightening, and the current interest rate volatility has dropped to an 18-month low:

Last week, stock funds (ETFs and mutual funds) recorded the largest weekly net inflow in 18 months ($25.3 billion), mainly from the United States ($26.4 billion). Emerging market funds (-$1.2 billion) recorded two weeks of net outflows, while European funds (-$1.4 billion) continued their 27-week net outflow:

Bond funds ($4.8 billion) saw slightly higher inflows compared to last week. Investment-grade corporate bonds ($2 billion) accelerated inflows, but high-yield bonds (-$1 billion) and emerging market bonds (-$1.1 billion) continued to see net outflows. Inflows into government bonds ($3 billion) continued.

Money market funds saw inflows of $28.9 billion, slightly slower than last week, but still strong, mainly from the United States ($23.2 billion).

In terms of sectors, the technology sector ($1.3 billion) saw inflows after a net outflow last week. The energy sector ($200 million) also saw moderate inflows. The healthcare (-$800 million), non-essential consumer goods (-$600 million), telecommunications (-$400 million), commodities (-$300 million), and financial (-$200 million) sectors saw net outflows, while flows in other sectors were smaller.

In the futures market, US stock futures remained relatively stable, with net long positions in the S&P 500 futures increasing to the highest level since February last year, but net long positions in the Nasdaq 100 futures decreased:

The net short position in the US dollar has decreased for the fourth consecutive week and is now at its lowest level since October last year, mainly driven by a decrease in net short positions by large asset managers:

In terms of commodities, net long positions in crude oil have reached the highest level since October last year:

However, net long positions in gold have decreased:

Net positions in copper have flipped from net long to net short:

As for cryptocurrencies, centralized exchanges saw a small net inflow of stablecoins of $57 million in the past 7 days, bringing the total to $13.86 billion:

On-chain stablecoins saw a net outflow of $92 million, bringing the total to $124.3 billion. The outflow was mainly contributed by BUSD, USDT, and TUSD, while the inflow was mainly contributed by DAI and USDC:

Investor Sentiment

The proportion of neutral views in last week’s AAII survey rose to 36%, the proportion of bullish views decreased to 34%, and the proportion of bearish views remained unchanged:

The CNN Fear & Greed Index has hardly changed and remains near the neutral level of 51:

Goldman Sachs’ institutional positioning sentiment index jumped to 1.2, indicating a stretched range:

Focus of the Week

This week is a super week for central banks, with the central banks of the United States (unchanged), the United Kingdom (expected +25bp), Switzerland (expected +25bp), and Japan (unchanged) all making appearances. The main focus will be on Wednesday’s Federal Open Market Committee (FOMC) meeting. The market generally expects the Federal Reserve to maintain interest rates steady after raising them in July, but to emphasize in its forecasts and communications that further tightening is still possible this year. There is relatively little data this week, with the main focus on housing. It is unlikely to have a major impact on the information from the Federal Reserve meeting.

The meeting statement may show mixed progress in the conditions for pausing further rate hikes, including signs of moderate economic growth and improved inflation, but with a still tight labor market.

The summary of economic projections may show upward revisions to growth forecasts, particularly for 2023, but a slight downward revision to inflation forecasts, considering that the PCE figures have already reached the expected 3.2% for June. In terms of interest rates, the Fed’s June SEP showed a peak federal funds rate of 5.6% in 2023, expected to decrease to 4.6% in 2024, and further decrease to 3.4% in 2025, with a long-term rate of 2.5%. Given the progress in data over the past three months, the forecast of 5.6% for 2023 seems likely to remain unchanged or slightly downward, while the median rates for 2024 and 2025 may remain unchanged or slightly upward.

Although long-term rates have remained at 2.5% since the June meeting, the central tendency has shifted from the range of 2.4%-2.6% to the range of 2.5%-2.8%. This suggests that the Federal Reserve may believe that the neutral interest rate (the rate that neither stimulates nor restricts economic activity) may be higher than before, with a 2% inflation target implying a real interest rate of 0.5%.

In the bond market, the yield on 30-year Treasury bonds is about 4.2%, which, subtracted by the Fed’s 2% inflation target, results in a real interest rate of 2.2%, much higher than the Fed’s expectations. Therefore, the bond market is relatively aggressively priced, while the decline in earnings yield and the increase in P/E ratio in the stock market indicate that the stock market still does not believe that the Fed must maintain restrictive interest rates for a period of time.

Looking at the interest rate derivatives market, in the short term, it is almost completely consistent with the Federal Reserve. The highest policy rate is 5.45%, and by the end of 2024, the rate will drop to around 4.6%, as predicted by SEP in June:

However, the long-term path is quite different. Unlike people’s intuitive impression of an “L” shape, the interest rate path in the futures market is “U” shaped. The futures market expects the nominal interest rate to rebound quickly to around 4.7% after hitting bottom in 2026, and then gradually rise to around 4.1% by 2026. This indicates a huge difference of more than 100 basis points between the market’s expectation of 3.4% for Fed in 2025 and the traders’ funding vote. The difference in long-term expectations exceeds 200 basis points.

Who do you believe? Those who think Fed is wrong can take a short position in risk assets, while those who think the interest rate futures traders are wrong can take a long position.

As for the press conference, Powell is bound to emphasize the dependence of policy on data and be cautious about declaring victory over inflation, but he may take note of some initial progress in labor market balance. It is unlikely that he will explicitly state the timing of further rate hikes.

Why do officials remain cautious? The second round rebound of inflation has always been a concern for older officials. Young people who have not experienced the 1970s may not understand. This historical background will limit any potential magnitude of interest rate cuts:

Of course, it is already very difficult to try to predict the next month, not to mention the situation two or three years later. But the key point is that there are divergent expectations in the stock market and bond market regarding future interest rate trends. The stock market seems to be betting that the Fed will cut rates multiple times in the future, while the bond market has different expectations. As the Fed updates information next week, whether there will be any changes in the expected significant rate cuts in the coming years is the most important point to watch. Will it be the bond market being pulled back, or the stock market being pulled back, this is the core game of the market.

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