LD Macro Weekly (2023/07/04): Risk assets collectively rise, ignoring interest rates to continue to climb

Summary

Global markets continued to rise this week, and the correlation between digital currencies and stock markets also returned to a positive range. This despite concerns about further monetary tightening. This week we have seen more overheated economic data, end-of-quarter position adjustments by funds, position levels gradually entering the Stretch state, and the breakdown of the historical correlation between interest rates and stocks.

Chart: Price movements of major stock indices and commodities last week

Source: Tradingview, TrendResearch

As June ended, the S&P 500 defied recession fears and a US banking crisis, gaining 15.9 percent in the first half, while the Nasdaq Composite gained 31.7 percent, its biggest first-half gain in 40 years.

Macro data out of the US last week continued to paint a picture of economic resilience - with housing, consumer confidence and durable goods all coming in above expectations, and coupled with hawkish comments from the Federal Reserve, a rise in interest rates seemed increasingly likely. The market is now pricing in an 84% chance of a rate hike in July, 29% in September, and expects rates to remain above 4% throughout 2024. That expectation has sparked a massive shift from growth stocks to value stocks, which, combined with banks' health certificates in the latest stress tests, big financial institutions raising dividends and restarting buybacks, has led to a sharp rebound in financial stocks.

Figure: Fed funds rate futures priced up overall last week

Source: Bloomberg, Trend Research

Chart: KBE Banking Index, IVE Value Stock Index, IVW Growth Stock Index Last Week Performance

Source: Tradingview, TrendResearch

Chart: Cyclical Stocks Vs Defensive Stocks

Source: GS, TrendResearch

Despite the supposed risks of rising long-term interest rates, the stock market is still doing well, and we can see that there are three common understandings in the market:

1. Optimistic about a soft landing

2. It is believed that the improvement of production efficiency brought about by technological innovation led by AI can hedge against rising interest rates (earnings growth expectations ↑)

3. Many funds still don’t believe that the Fed’s policy will be so strict (interest rate expectations ↓)

Chart: S&P 500 12-month forward PE is decoupled from real interest rate trends

Source: GS, TrendResearch

Historically, long-term bond yields have moved inversely to stocks most of the time, and when long-term yields peak, stocks tend to bottom out. However, in the current environment, where equities have continued to rally on the aforementioned optimism, it now looks like only a very serious hawkish shock or an external growth shock (similar to COVID-19) could cause significant damage to risk assets , let the market dip again.

U.S. economic surprises near one-year highs, Europe parting ways

On the data front, US Q2 GDP beat expectations again (+2% vs. +1.4% expected), pushing the US Economic Surprise Index to near a one-year high. However, there are also data that point to a looser outlook, with a slowdown in the US consumer market (e.g., PCE rose only 0.1 percentage point mom in May, a marked slowdown from 0.4% previously), and several warning signs in the industrial sector (factory price falls , output deceleration).

The divergence between Europe and the US is worth noting. Funds’ short-covering in the U.S. market has triggered this round of rebound. At present, when they are still continuing to increase their positions, various position indicators are gradually “crowded” but not excessive, and the market often reverses when it is excessive. But net hedge fund exposure to Europe is near a five-year high, while net exposure to U.S. stocks is at a five-year low. This scenario could put downward pressure on European stocks.

Figure: The trend of the European (purple) US (green) economic data surprise index over the past month has formed a sharp contrast

Sources: Citi, MacroMicro, TrendResearch

Market breadth is extremely low, historical experience...

The breadth of the stock market has improved slightly in the past two weeks, but it is also necessary to note that the current market breadth is still low. On the one hand, some people in the market interpret it as a bullish signal and believe that the market for supplementary growth is expected; There is a vulnerability. When the giant's financial report numbers are weaker than expected, the market rally will stop.

Figure: The market breadth of the S&P 500 constituent stocks according to Goldman Sachs is currently 1 standard deviation lower than the history

Source: GS, TrendResearch

The narrow width means that the rally is concentrated, which is in line with the logic of the current environment. In the case of slow economic growth and widespread fear of recession, investors seek the highest quality and steady growth. Generally speaking, security is directly proportional to the market size and market value of a company. Large, high-quality growth businesses rarely exist. So, despite narrowing the breadth, the market has moved higher.

Historically, the sharp decline in market width has often occurred when there is either a top or a bottom. Some obvious low points can be seen in the above picture, including 1984, 1990, 2016, and 2020, when the market bottomed out, and the wide decline in 2000 and 2007 was the top of the market. Therefore, both optimists and pessimists can find their own logic and historical evidence, but in the longer term, it is still the classic saying: pessimists are right, and optimists make money.

The second quarter earnings season kicks off

In the short term, whether the U.S. stock market can continue to gain momentum, the next biggest challenge is the second quarter financial report (which will be released successively from this week to August). The previous artificial intelligence boom triggered a new bull market in technology stocks, but Wall Street now expects that the overall earnings of the S&P 500 index companies are expected to decline by 5.7% from the same period last year. Times, has entered the top 10% valuation range, obviously not cheap.

Figure: Stock Market Valuation by Region under the MSCI Index Framework

Source: GS, TrendResearch

The U.S. government slams the accelerator on debt issuance, but financial conditions continue to be loose

After the debt ceiling was lifted at the end of May, the U.S. government immediately accelerated its borrowing speed to replenish its fiscal account. In June, the total debt increased by US$850 billion to US$32.32 trillion, and there was no surprise that it continued to set new record highs:

Chart: US Government Total Debt

Source: fiscaldata.treasury.gov, TrendResearch

The balance of the treasury account quickly replenished from $23 billion, which was about to bottom out, to $465 billion (the blue line in the figure below), but the balance of the Fed’s overnight reverse repurchase account also fell by $120 billion during the same period. The short-term Fed wealth management account was transferred to the bond market, thereby offsetting the water-absorbing effect of some bond issuance on the market, but the degree of hedging is limited in terms of volume comparison:

Chart: U.S. Treasury Balance vs. Federal Reserve Overnight Repurchase Balance

Source: Macro Micro, Trend Research

But the strange thing is that the financial market conditions index has become more loose (this index construction includes bond spreads, market volatility, bank lending conditions, etc.), showing that the market has not really been "absorbed":

Chart: Chicago Fed Financial Conditions Index

Source: chicagofed.org, TrendResearch

We suspect that this is mainly due to the increase in demand from international investors for U.S. bonds. The U.S. official data includes changes in foreign holdings of treasury bonds, but the data can only be obtained with a lag of two months. Therefore, this speculation is based on the latest EPFR It is speculated based on the trend of international capital flows - as of last week, US bond funds have been inflowing for the 26th consecutive week.

Considering that the balance of the Treasury Department is only expected to be replenished to 500-700 billion US dollars, the fastest bond issuance stage is about to pass, so the expected tightening of bond issuance will not occur, and financial conditions in the United States may remain loose.

Global capital flow data: European and American stock markets

According to EPFR data, flows into mutual funds were fairly limited for the week ended June 28, with both equity and bond funds seeing relatively weak net inflows of $1.5 billion (prv -4.97 billion) and $400 million respectively (prv + 5.04 billion).

Among them, global stocks saw an inflow of US$1.5 billion. Although the scale was small, it was a significant improvement compared to the previous net outflow of US$4.97 billion, mainly due to the support of funds flowing into emerging markets. Weekly -$0.32 billion, largely driven by China (+2.88 billion). However, Hong Kong stocks and A-shares only recorded slight gains last week.

Source: GS, TrendResearch

Developed market equities posted net outflows of $3.31 billion last week, with US net outflows of $1.59 billion for the second consecutive week and Western Europe outflows of $4.56 billion for the 16th consecutive week, bringing total withdrawals so far this year to $27 billion. However, related outflows failed to make European and American stock markets fall, and the gains in European stock markets were weaker than those in the United States.

Japanese equity funds saw inflows of $1.4 billion last week and $7.86 billion over the past four weeks, the largest four-week inflow since April 2020.

From the perspective of the industry, the allocation ratio of technology stocks has risen sharply again after only a week of decline, and now accounts for nearly 24% of all stock allocations:

Source: GS, TrendResearch

Global bonds saw small net inflows for the 14th consecutive week, totaling $460 million. The divergence between developed and emerging markets is significant. Developed markets saw net inflows of $1.79 billion, while emerging markets experienced net outflows of $1.22 billion.

Source: GS, TrendResearch

Market Sentiment Indicator

The Bank of America Merrill Lynch Sentiment Indicator fell slightly to 3.2 from 3.4 the previous week and is now in neutral territory:

Goldman Sachs' position sentiment indicator is in the heavy long range for the third consecutive week, but it has not yet extended to the extent of extreme heavy positions:

AAII Investment According to the survey of investor sentiment, the proportion of bulls has declined for two consecutive weeks, but remains at a high level since November 2021:

The CNN Money Fear and Greed Index returned to the 80 extreme greed range last week:

digital currency

The digital currency market rose together with the traditional market last week, and the correlation finally returned to the positive range. This time, the negative correlation lasted only 40 days, which is in line with historical laws (there have been 15 negative correlations in 30 days since 2018, and the average lasted 35.5 days (median 39 days):

Stablecoin balances on centralized exchanges were basically flat last week and did not continue to rise with prices:

The total amount of stablecoins on the chain dropped slightly from 128.6 billion to 127.4 billion, basically giving up the growth in the second half of June:

Institutional Viewpoint

Goldman Sachs: 10% Rule

Year-to-date stock market performance is a good reminder that usually only a small group of stocks determines an index's returns. The seven largest tech stocks (AAPL, MSFT, GOOGL, AMZN, META, TSLA, NVDA) have returned 58% year-to-date, while the remaining 493 S&P 500 stocks have returned only 5%.

So the reality is that identifying companies that can consistently deliver revenue growth above 10% can be rewarding for investors. We refreshed our "10% rule" screen to identify stocks that achieved and expected annual sales growth of more than 10% over the five-year period 2021-2025. Stocks expected to grow the fastest from 2022 to 2025 include ENPH, TSLA, SEDG, PANW, NOW. We also provide a similar filter based on net revenue growth. There are 8 stocks that appear in both screens: NOW, PAYC, FTNT, PODD, CMG, INTU, CDNS, APTV.

Low macro uncertainty will drive stocks higher

Macro Risk Advisors analyst John Kolovos: Low implied volatility fuels bullish rhetoric. “Our macroeconomic concerns have dissipated,” he said. “When macro uncertainty is very low, that’s a huge boost for stocks.”

Follow this week

US markets are closed this week on Tuesday (Independence Day). Important data include June non-farm payrolls, June ISM manufacturing and non-manufacturing PMIs, weekly jobless claims, and the minutes of the June FOMC meeting.