LD Macro Weekly Report China’s Expectations Hit Bottom, Who are the Long-Term Beneficiaries of AI

LD Macro Weekly Report China's Expectations Hit Bottom, Long-Term Beneficiaries of AI

The risk asset market stabilized in the past week, but the degree of indecision has increased. Contradictory trends have emerged across asset markets. This is evident in the AI theme frenzy, better-than-expected earnings in the US stock market, and speculations that the Fed will turn to rate cuts once the economy cools down, which have driven a significant rise in the stock market. However, investors now lack further reasons to be optimistic. Investor sentiment has recently shown a noticeable decline, but this is a benign signal. In addition, the pessimism about the Chinese economy seems to have bottomed out in July, with increasing odds. NVDA’s financial report greatly exceeded expectations, but funds chose to exit. As the short-term beneficiaries of AI have already risen, which stocks of long-term beneficiaries should be bought? Goldman Sachs has conducted a quantitative analysis.

US Market

Last week, the upward trend in long-term interest rates in the bond market paused, while short-term interest rates caught up, especially after Powell’s hawkish speech on Friday, the 2-year Treasury yield hit the highest level since March.

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The major US stock indices rose last week, with volatile swings during Powell’s speech and ultimately closing higher:

The yield spread between stocks and bonds has reached extreme levels not seen in decades. Funds may be becoming more cautious, as reflected in:

The current dividend yield of the S&P 500 is approximately 1.58%, while the 10-year bond yield is approximately 4.25%. The difference between the two is 2.66%, the largest since 2007.

The gap between the current earnings yield of the S&P 500 and the 10-year bond yield is only 40 basis points, the smallest since 2004.

During Powell’s speech, the US dollar index hit an intraday low of 103.75. As soon as his speech ended, the US dollar index rebounded to a new high since June 1 at 104.45. However, the renminbi stabilized last week and closed at 7.288 on Friday, unable to break through the important support level of 7.3.

Crude oil fell slightly, while gold, silver, and copper all rose, and cryptocurrencies fell slightly. Gold achieved its best weekly performance since mid-July. Before Powell’s speech at Jackson Hole, US long-term bond yields fell, providing support for gold prices.

Federal Reserve Chairman Powell’s speech at the 2023 Jackson Hole Conference had three key points, but there was no new information: Firstly, the Fed remains committed to achieving the 2% inflation target and refuted speculation about tolerance or raising the target. Secondly, officials are prepared to raise interest rates further when necessary and will maintain high borrowing costs until inflation convincingly approaches the target. This means that interest rates may remain at higher levels for a longer period of time. Finally, after experiencing substantial rate hikes since 2022, the Fed is currently in a cautious phase regarding the risk of overtightening and will approach future rate hikes cautiously, not necessarily influenced by sustained economic resilience. In addition, there was no clear guidance on the focus of recent market concerns, the “neutral interest rate,” so this speech had little effect on resolving the current market uncertainties.

Investors in the interest rate futures market are divided on whether the Fed will raise interest rates once or keep them unchanged this year. On Thursday, the probability of another rate hike for the year was about 46%, which slightly increased to 53% after Powell’s speech on Friday. Although there was little change this week, it was significantly higher than the 32% of the previous week. By June next year, traders expect a 62% possibility of the Fed cutting rates from the current level, lower than their prediction of 83% a week ago.

Combined with the contradictory performance of rising stock market, sharp drop in short-term bonds, flat long-term bonds, and even a slight increase in junk bonds, as well as the market performance of gold and cryptocurrencies stabilizing after fluctuations, it can be seen that investors currently have divergent views and the market is in a state of stalemate between bulls and bears.

In terms of market comments, “Bond King” Bill Gross mentioned in relation to Powell’s speech on Friday that he believes the 10-year US Treasury bond yield may rise to 4.5% in the future, while short-term rates will remain relatively stable. He believes that Powell’s implication is “higher longer”. Former US Treasury Secretary Summers believes that Powell’s speech suggests that the Fed may need to raise interest rates at least once, or even more. Summers believes that Powell’s remarks indicate that the Fed has an open attitude towards the possibility that the neutral interest rate may be higher than before.

The US Economic Surprise Index fell slightly last week but remained at a high level since April last year:

In July, US durable goods orders fell by 5.2% compared to the previous month, marking the largest decline since the outbreak of the pandemic. This was mainly due to a sharp drop of nearly 44% in non-defense aircraft orders after a surge in the previous month.

In August, the preliminary manufacturing PMI for the US was 47, reaching a new low since February this year; the preliminary services PMI was 51, reaching a new low in two months; the preliminary composite PMI was 50.4, reaching a new low since February this year. Analysts believe that weak consumer demand and stagnant business activity in August have raised doubts about the strength of US economic growth in the third quarter.

Outside the United States

The pan-European Stoxx 600 index closed flat. Most Chinese stock indexes fell, but the real estate sector rose due to policy support measures such as “buying a house without requiring loans” for first-time homebuyers and tax refunds for improved housing sales. Additionally, over the past weekend, the stock market received a combination of policy support, including halving stamp duty, optimizing IPO and refinancing regulations, further regulating share reduction behavior, and reducing the financing margin ratio. Many analysts expect a significant rebound in A-shares this week. In addition, there are rumors that stamp duty may be canceled in the Hong Kong stock market.

The pessimism of China’s economic expectations seems to have bottomed out in July, except for the extraordinary period of nearly three years since the Covid epidemic in 2020. The surprise index of China’s economy is so low that it dates back to 2015, coinciding with the extreme positions of the United States cyclically:

In terms of the Chinese market, investors were actively positioning themselves in July. The scale of public funds reached a new high with a monthly increase of over 1 trillion yuan. Among them, the net value of equity funds increased by 127.77 billion yuan compared to the end of June, reaching 2.83 trillion yuan. The net value of hybrid funds decreased slightly by 41.43 billion yuan to 4.59 trillion yuan. The net value of bond funds increased by 178.69 billion yuan to reach 4.94 trillion yuan compared to the end of June. In addition, influenced by the money-making effect in overseas markets, the net value of QDII funds increased significantly by 42.498 billion yuan in July, with the scale reaching 401.302 billion yuan.

Fund Flow and Positions

Last week, the market was in a stalemate, and there was no obvious differentiation between defensive and cyclical stocks:

Last week, US mutual funds had a net outflow of $4.3 billion, the first time in 12 weeks:

However, technology sector funds had the largest net inflow in 10 weeks last week:

The net leverage of US hedge funds reached a high of 70% in the second quarter, but it has dropped to 65% last week, below the 50th percentile of historical data in the past five years, indicating that the position of hedge funds is not high and there is room for further increase:

US bond funds have seen 28 consecutive weeks of net inflows (+$5.2 billion), setting the longest record of continuous inflows since 2010:

Sentiment Indicators

Goldman Sachs’ sentiment indicator for US stocks fell from 0.8 the previous week to 0.6 last week, still in the neutral range:

The bullish sentiment in the AAII investor survey has fallen sharply, and the bearish proportion has risen significantly. This is the first time since early June that the bearish sentiment has exceeded the bullish sentiment. Such an adjustment is healthy, as the optimism was too high before:

CNN’s Fear & Greed Index remained largely unchanged last week after a sharp decline the previous week:

CryptocurrencyIRS Discloses Stricter Tax Requirements

The U.S. Department of the Treasury and the Internal Revenue Service (IRS) have proposed new regulations that plan to require cryptocurrency trading platforms (such as Coinbase and Kraken) to report detailed information about customer transactions starting from 2026, including customers’ capital gains and losses – similar to existing requirements for stock and bond brokers. This measure aims to combat tax evasion related to cryptocurrencies and increase transparency.

This news is obviously a major negative for the cryptocurrency industry in the medium term, as it will further reduce potential investment returns. However, since the implementation will not take place until January of the following year, the market may not be sensitive to this yet. But in the long run, it is beneficial for the industry as it will help bring more compliant use cases.

Stablecoin Liquidity

According to Glassnode’s statistics, the balance of stablecoins in centralized exchanges has hardly changed, with a slight outflow of $4.4 million:

The total balance of stablecoins on the chain has increased significantly by $1.22 billion, the largest growth in ten months, but almost all of it is contributed by DAI, which has limited impact on market liquidity:

In the past month, the MakerDao system’s liquidity pool has locked up 1.26 billion DAI, accounting for 24% of the total DAI locked up, so the growth of DAI is almost entirely due to the liquidity pool:

Focus on AI leader NVDA

Nvidia’s data center revenue exceeded expectations last Wednesday:

• Nvidia’s second-quarter revenue was $13.5 billion, surpassing the company’s guidance of $11 billion.

• Of particular note is the company’s data center revenue, which grew significantly by 171% year-on-year, with cloud service providers accounting for 50% of the revenue, higher than the previous quarter’s 40%.

• The growth was strongest in the United States, while China contributed 20-25% of the total revenue.

• The surge in demand has allowed Nvidia to charge higher prices for its chips. The company’s gross margin for the second quarter was 70.1%, higher than the 43.5% of the same period last year.

• For the third quarter, Nvidia provided revenue guidance of $16 billion, dispelling some concerns in the market about possible supply chain bottlenecks. Nvidia guarantees that even in the face of potential export restrictions by the United States, the company’s supply will increase every quarter over the next year.

In addition, a $25 billion stock buyback also briefly excited the market, making it the fifth-largest buyback announcement among U.S. companies this year. Despite the staggering amount, the buyback represents only 2.1% of its nearly $1.2 trillion market value, even lower than the historical buyback yield of 2.58% for the entire S&P 500 index.

Meanwhile, several other large technology and growth companies have announced their buyback plans for this year: Apple plans to repurchase $90 billion, Alphabet plans to repurchase $70 billion, and Meta plans to repurchase $40 billion.

Nvidia CEO Jensen Huang stated that it is estimated that approximately $1 trillion will be spent on AI data center upgrades worldwide over the next four years, including GPU upgrades. According to Huang, most of the costs will be covered by cloud service providers and other large technology companies, including Amazon, Microsoft, Google, and Meta. These companies are actively promoting generative artificial intelligence.

However, some analysts pointed out that Huang’s estimation is too optimistic, as the combined cash and cash equivalents of Amazon, Microsoft, Google, and Meta currently only amount to $334 billion. Even if future annual cash flow is taken into account, it is still far from Nvidia’s estimated $1 trillion over four years.

Nvidia’s stock price had been rising in the days leading up to the report release, with a more than 6% increase on Thursday, reaching a new all-time high during trading hours. However, the price fell back by the end of the day and experienced a 2.4% decline on the following trading day. Nevertheless, it still recorded a 3.4% increase for the week.

Wall Street analysts collectively raised their price targets for Nvidia after the report was released. According to FactSet, the current target price for the stock is $640.71. The stock closed at $460.18 on Friday.

Prominent investor Cathie Wood was not impressed by Nvidia’s impressive financial report. She sold nearly $3 million worth of Nvidia stock before and after the report was released, stating that the valuation has already been reflected and she insists on selling at high prices. She stated, “I believe that Nvidia, which can provide the basic tools needed for AI in the next five years, will be in a very favorable position. However, everyone knows this, and Nvidia’s value has already been adequately evaluated.”

Last week, we mentioned that the market had high hopes for Nvidia’s performance to boost sentiment. However, even though Nvidia reported historical performance and future guidance that far exceeded expectations, it ultimately failed to sustain market sentiment. Some analysts point out that this is a signal that the rebound momentum for this year has already been “exhausted,” indicating that there will be more declines in the future.

Morgan Stanley strategist Michael Wilson stated that although Nvidia’s financial report was impressive, the decline in U.S. stocks on Thursday indicates that the market’s upward momentum for this year has been exhausted and suggests that there will be further declines. The market reaction on Thursday is a perfect sign of a peak. Wilson explained, “The market tops on good news and bottoms on bad news. I can’t think of anything better than Nvidia’s news. The fact that Nvidia’s financial report failed to boost the market is a negative technical signal that the overall market’s upward trend has been exhausted. Now we need a new story to excite the market, but I don’t know what that is.”

Bank of America strategist Michael Hartnett agrees with Wilson’s view. He believes that as interest rates remain high for a longer period of time and the impact of reduced liquidity from the Federal Reserve becomes more apparent, the boost that artificial intelligence gives to U.S. stocks will fade in the second half of this year, and U.S. tech stocks are expected to face difficulties.

Hartnett expects that the second half of this year will be a troubled time, rather than a new era of artificial intelligence rules. The reason is the inconsistency between the liquidity of the Federal Reserve and the technology stocks. While the Nasdaq index is approaching its historical high, the Federal Reserve’s balance sheet is declining significantly.

Institutional Viewpoint

Short-term beneficiaries of AI have already risen, so which stocks of long-term beneficiaries should be bought?

Goldman Sachs economists calculated the share of companies’ wage bills facing AI automation among 1,000 companies. They used task content data from over 900 occupations in the ONET database in the United States to estimate the total workload of labor-saving automation faced by occupations, and assumed that AI can complete tasks in the ONET “level” scale with the highest difficulty level of 4.

Then, they took the weighted average of the importance and complexity of the basic work tasks of each occupation, estimated the proportion of AI’s potential to substitute for the total workload of each occupation, and calculated the proportion of labor costs to total revenue for each company based on the number of global employees and the median employee compensation reported in the annual statement. Combining these two indicators, they further calculated the potential improvement in returns under the assumptions of maintaining stable profit margins and stable revenue.

Figure: Valuation Logic

Finally, two “wealth passwords” tables are obtained as follows. Of course, we have always advocated light conclusions and heavy logic. Interested people can conduct more detailed analysis or improvements based on their logic:

The stocks selected by Goldman Sachs in this basket are expected to have a median EPS that is 72% higher than the market expectations after the widespread adoption of artificial intelligence. The performance of this basket of stocks this year is only 6 percentage points higher than the S&P 500, far lower than those short-term beneficiary stocks, indicating that most potential productivity improvements have not been priced in. The improvement in profit margins under this logic may not be permanent, but investors may speculate on this possibility.

This Week’s Focus

August non-farm employment report in the United States, July PCE, progress in the new fiscal year budget agreement of the U.S. Congress, U.S. Treasury Secretary’s visit to China, PMI of China, the United States, and Europe, and preliminary CPI of the eurozone in August, etc.

September, which is coming soon, has historically been a mediocre month for the U.S. stock market. Since 1945, the S&P 500 index has averaged a 0.7% decline in September, making it the worst performing month of the year.

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