Source: Zhongjin Dim Sum
Author: Liu Gang, Li Yujie

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Since 2020, the US has experienced the impact of the epidemic, the Federal Reserve cut interest rates to zero, and drastic easing of unlimited QE. It has also experienced a cycle of high inflation and rapid interest rate hikes that have not occurred in 30 years, as well as the ebb and flow of small and medium banking crises. However, during this period, with the exception of a correction in the 2022 environment of high inflation and strong interest rate hikes, the US stock market has basically maintained strong performance. Recently, driven by expectations of interest rate cuts, it has reached a new high. In fact, “interest rate hikes have also risen, and interest rate cuts have also risen.” On the surface, US stocks seem to be strong. Especially in such a high interest rate environment, they can “go unscathed”, leaving many investors confused.

In fact, it seems that US stocks are “rising all the time” is not as simple as it might seem on the surface; it is the result of a series of factors relaying. We've summarized it into three macro pillars, namely leveraging, technology trends, and global capital rebalancing. Without any link, the bull market in US stocks may be “bleak” or even end early, and its subsequent trend will also be the key to determining the future trend of US stocks. In this article, we'll analyze these three pillars and their future evolution.

I. The three macroeconomic pillars of the US stock bull market: increased leverage, technological trends, and global capital rebalancing

Increased leverage: The government increases leverage to protect the balance sheets of residents' companies and stimulate consumption and investment. This is also the first and first pillar of the US stock bull market. In the face of the pandemic, dealing with shocks through fiscal stimulus and government leverage is a common practice, and it is no different. However, the “special” aspect of America's current round of stimulus is its large scale. This is related to the US dollar's status as an international reserve currency, and the cost of increasing leverage is far less than in other markets, especially emerging markets. Even with its already high government debt burden, the US introduced a fiscal stimulus of 6 trillion US dollars, which is among the most powerful in the world. Second, direct subsidies are given to residents. In the US $600 million fiscal stimulus due to the US pandemic, direct cash subsidies to residents reached 870 billion US dollars, and loans to the corporate sector totaled nearly 700 billion US dollars, directly subsidizing residents in the form of “payment”. This not only protected residents' and corporate balance sheets, but also increased corporate profits, forming positive feedback (”Comparing China and the US 4: Where did the money go?”). Of course, this is not without a “cost”. The cost is high inflation that has not been seen in decades. High inflation has also led to a series of chain effects, such as forcing the Federal Reserve not to raise interest rates at an unconventional rate and maintain high interest rates and inversion until now, which in turn has led to frequent pressure on small and medium-sized banks. Overall, however, the balance sheet of residential enterprises, which has remained healthy until now, is the undertone for the resilience of the US economy and the foundation for the first round of the post-pandemic bull market in US stocks. However, the momentum of this pillar also gradually declined after 2022. Apart from service consumption still being resilient, commodity consumption, real estate, and corporate investment have all slowed down. Without the industry trends led by ChatGPT and AI at the end of 2022, the current bull market in US stocks may have to be heavily discounted or even ended early.

Chart: The US ranked among the highest in the world in terms of fiscal stimulus after the pandemic

Chart: Fiscal incentives directly subsidize the residential sector and provide PPP loan support to the corporate sector

Chart: The US protects residents' and corporate balance sheets through fiscal leverage. Consumer consumption and real estate investment have also raised the level of corporate profits, which in turn has increased corporate capital expenses

Technology trends: Breakthrough advances in generative AI have freed US stocks from the original economic cycle and have become the main driver to take over the strengthening of US stocks after 2023. The Federal Reserve began raising interest rates in 2022. At the same time, US stocks turned down. In particular, the profit margin of the interest-rate sensitive NASDAQ index adjusted first. The profit forecast for 2023 was lowered by a total of 24% from high to low. Although profits in the post-cycle sector represented by the Dow Jones lag behind the NASDAQ correction, they also began to gradually decline in the second half of 2022. Therefore, if generative AI represented by ChatGPT at the end of 2022 had not achieved breakthrough progress to drive sentiment and NASDAQ profit margins to improve first, US stocks would probably be weak in the future. The increase in US stocks in 2023 is almost entirely due to leading stocks, for example$S&P 500 Index (.SPX.US)$The top ten leading individual stocks contributed more than 17% to the 24% increase for the whole year. The results also provided support for this round of the technology bull market. The profit growth rate of the S&P 500 semiconductor industry increased sharply by 47% in 4Q23 (vs. 9% in 3Q23).$NVIDIA (NVDA.US)$It contributed to almost all of the growth, and profit increased 4.9 times in the fourth quarter. Furthermore, strong stock market performance also had a wealth effect, providing some positive feedback to the economy.

Chart: In 2022, under the influence of the Federal Reserve's interest rate hike and the downturn in the real estate cycle, US stocks entered a technical bear market, and NASDAQ took the lead in pulling back

Chart: US stocks led the way in 2023 with leading technology stocks; the rest of the stocks actually did not increase much

Global capital rebalancing: The United States directly or indirectly provides financing support to the US by promoting re-industrialization and restructuring of the industrial chain, as well as global capital rebalancing under comparative advantages. First, financial support in support of the US policy of re-industrialization and industrial chain restructuring encourages capital to flow into trading partners such as the US and Mexico. Global FDI inflows to the US hit a new high since 2016, with an average annual inflow of US$333.6 billion from 2022 to 2023, up 50% from 2018 to 2019 before the pandemic. The targets related to the US reindustrialization theme also outperformed the S&P 500 index and the Russell 3000 index, which is another example of a bull market in US stocks since 2023. With$First Trust Rba American Industrial Renaissance Etf (AIRR.US)$In the case of funds, the basket of constituent stocks has risen by more than 50% since 2022 (vs. S&P 500 10.2%). Second, capital inflows and asset performance have formed positive feedback. The strong performance of the US stock market attracted foreign capital inflows, and US stocks formed a positive cycle of rising and capital inflows. Just imagine, without this large amount of capital forming a positive cycle, America's financing would not be so smooth. For example, if there is poor financing in the US bond market, the level of financial support itself may be constrained. However, judging from the results, even under high leverage pressure, overseas investors switched from selling US bonds to investing again in US bonds, and their holdings increased 10.1% since the end of 2021.

Chart: FDI inflows into the US hit a new high since 2016

Chart: The targets related to the subject of US reindustrialization also outperformed the S&P 500 Index and the Russell 3000 Index

Chart: Even under high leverage pressure, overseas investors are shifting from selling US bonds to investing again in US bonds

Based on the above analysis, what appears to be “rising interest rates and rising interest rate cuts” in US stocks is actually the result of relay support from these three macroeconomic pillars since the pandemic. Otherwise, the US stock bull market could be overshadowed or even come to an early end. Of course, the subsequent trend of the US stock market also depends on whether these three macroeconomic supports can continue. Just imagine, if any logic is destroyed or even reversed, the macro basis of the US stock bull market may also be shaken.

2. Possible future evolution: Increased leverage is more certain; more weekly expectations for fulfillment of technological trends; China's growth recovery determines the degree of capital rebalancing

Increased leverage: Whether it is government leveraging under a new round of stimulus after the general election, or residents leveraging real estate after interest rate cuts, it is likely that it will take some time to start, and the intensity remains to be seen; this path is similar to the small cycle of restarting the real estate cycle after three preventive interest rate cuts in 2019. Currently, the market is marked by re-inflation transactions marked by rising commodities. One is that the government re-leveraged after the general election, and the other is that residents increased leverage after interest rate cuts, but time is rushing, and intensity remains to be observed (“”Equities and bonds are rising at the same time; who is “at fault”?”). 1) In terms of time, re-inflation transactions will still have to wait. Even if the general election situation changes fiscal policy propositions, after the new president takes office in 2025, the new fiscal year will not start until October, let alone face the debt ceiling again in early 2025. For residents and the business sector, financing costs have now exceeded the return on investment, and starting a new cycle requires a reduction in interest rates. 2) To the extent, it remains to be seen whether it is financial or the extent of real estate restoration. The CBO recently lowered its forecast for this year's fiscal deficit from 5.8% to 5.3%, down 1 percentage point from 6.3% last year. Currently, the market is looking forward to more Trump's tax reduction proposals, and space is limited. Looking at the current level of interest rate cuts, we estimate that the 2024 real estate cycle is relatively moderate: if interest rates on US bonds fall back to 3.5% to 3.8%, corresponding housing sales will only increase by a low single digit (“Trading Strategy Before Interest Rate Cut Begins Monthly Report on Overseas Asset Allocation (2024-2)”). The current re-inflation deal isn't wrong; it's just a bit of a rush. If the trend of fiscal and consumer leverage is realized in the second half of 2024, the 2019 small-cycle recovery can take over the performance of US stocks, copper, oil, and$Dow Jones Industrial Average (.DJI.US)$Cyclical stocks are still benefiting.

Chart: CBO recently lowered this year's fiscal deficit forecast from 5.8% to 5.3%, down 1 percentage point from 6.3% last year

Chart: If interest rates on US bonds fall back to 3.5% to 3.8%, corresponding housing sales will only increase by a low single digit

Technology trends: Focus on the earnings season for the first quarter of April in the short term. If long-term industry trends can be started, they will be similar to the path after the interest rate cut in 1995. Investors' attention to the AI technology market has gradually shifted to the implementation of performance, the “Seven Sisters” of technology$Apple (AAPL.US)$und$Tesla (TSLA.US)$It was “left behind” just because the performance fell short of expectations and investors felt that it was not highly relevant to AI. In April, US stocks began the earnings season. Whether performance can continue to support short-term trends in the technology market at that time will affect the short-term trend of the technology market. If the path of technological progress succeeds, it is even more important for the long-term trend of US stocks. In the 90s of the last century, the boom in technology stocks continued from the early 90s until 2000 (”Nirvana in ruins, NASDAQ's 20-year growth path”). What's more, if natural interest rates are raised, the current apparently high valuation of US stocks may not be that high either. Under this trend, technological growth represented by the NASDAQ index directly benefited.

Chart: Apple and Tesla were “left behind” because their performance fell short of expectations and investors thought they were not relevant enough to AI

Chart: In the 90s of the last century, the boom in technology stocks continued from the early 90s until 2000

Chart: What's more, if natural interest rates are raised, the current apparently high valuation may not be that high

China's recovery in growth determines the extent to which global capital is being rebalanced. Leaving aside issues that cannot be changed in the short term, such as the geographical situation, policies, and industrial chain restructuring, the marginal changes that can currently affect the rebalancing of global capital are the extent to which China's economic growth has been repaired. If the fundamentals of the Chinese economy are clearly repaired, the trend of large capital inflows into the US market may slow down. At that time, undervaluation of Chinese assets can provide appeal, but this still requires strong policy support, especially fiscal strength, to reverse the current credit contraction in various sectors (”Comparing China and the US 4: Where did the money go?”). The recent back-up of bears and the return of some short-term game-type foreign capital have had a certain effect on driving the recovery of the Chinese market, but a greater inflow of foreign capital requires further policy support.

Chart: If a greater inflow of foreign capital is needed, China's economic fundamentals will need to be clearly repaired. This requires further policy support

3. Historical experience: Compared with 2019 and 1995, the former is a small-cycle real estate repair cycle, and the latter is a trend in a large-scale science and technology cycle

There have also been situations in history that are very similar to the current economic and financial environment. We have pointed out many times in our past reports that there is also a resilient economic undertone, a soft landing after a cycle of interest rate hikes, and a slight preventive interest rate cut by the Federal Reserve. There are many similarities between economic data and asset performance in 2019 and 1995. However, the former was not supported by technology; it was more reflected in a short economic recovery cycle where real estate was restarted after interest rate cuts; the latter, supported by technological trends, showed even stronger performance in US stocks.

The macro background of the two experiences is quite similar, and it also has strong reference significance with the present. Both of these experiences involved cutting interest rates by 75bp a total of 3 times without a recession. The US unemployment rate remained stable during the interest rate cut phase, and PMI clearly stopped the downward trend after interest rate cuts. Before the end of the interest rate hike cycle and the beginning of the rate cut cycle, the decline in US bond interest rates drove a clear rebound in real estate sales. However, after the actual interest rate cut, interest rates on US bonds began to rise, and the recovery slope of real estate sales slowed marginally. The US CPI basically determined an upward trend during the interest rate cut cycle. If we take this comparison, we may see economic recovery, real estate repair, and a rebound in inflation before and after interest rate cuts are expected to begin in the second half of this year. However, due to the limited number of interest rate cuts, the extent of the recovery and rebound is likely to be moderate.

Chart: The macro background of the two experiences is quite similar. Economic recovery, real estate restoration, and inflation rebound after interest rate cuts

The difference between the two experiences is whether there is a technology trend. The former is a small real estate cycle (copper, Dow), and the latter is a major technology cycle (NASDAQ). 2019 was basically just asset performance driven by the macroeconomic cycle. The rise in US stocks during interest rate cuts was not smooth. Under repeated trade frictions and downward pressure on growth, US stocks continued to repeat at the beginning of the Fed's interest rate cut cycle, and only strengthened with certainty until the last interest rate cut. The restoration of economic fundamentals after interest rate cuts supported commodity prices such as copper, and the Dow rose. In 1995, there was a strengthening trend in the technology industry. US stocks began trending upward even before the interest rate hike ended. NASDAQ showed leading performance and was more sustainable, but industrial metals such as copper performed worse than the technology market, and fell before and after the interest rate cut cycle.

Chart: The difference between the two experiences is whether there is a technology trend. The former is a small cycle, and the latter is a large cycle

In summary, combined with the evolution of the three macroeconomic pillars and the historical review, we believe that in the future, interest rate cut transactions will still be the main short-term line, while inflation deals will rush too much. Therefore, we suggest that bonds are currently more cost-effective; US stocks are better after facing certain twists and turns; prime time is still available but space is limited; a pullback can be stepped in but less cost-effective. Furthermore, inflation-driven copper and oil are also rushing, and demand will improve until interest rates are cut. (《Equities and bonds are rising at the same time; who is “at fault”?》)

Editor/jayden