Source: Citic Securities Research Author: Jiang Ya, Yang Qingpu, Xu Yingbo, Liao Yuan, Dan Zhuling Dubbed 618 grand promotion in 2024 has come to an end, and Citic Securities expects that the e-commerce large cap GMV during this period is expected to achieve low double-digit growth (+12% or so), continuing the positive trend since the beginning of the year and May. Structurally, it is judged that the growth center of content e-commerce platforms has moved downward, and the growth rate of shelf e-commerce platforms has rebounded under active investment. Platform-wise, Citic Securities judges that the core platform GMV growth rate during 618 is ranked as follows: TikTok > PDD Holdings > Tmall > JD.com.

Since the end of June this year, we believe that the US stock market has gone through three stages: the Trump trade, the rate cut trade, and the recession trade. The rate cut trade and the recession trade stages are compounded by the reversal of the arbitrage trade, which has led to a significant pullback in the US stock market. Regarding the outlook, we determine that although investors have already fully anticipated the Fed rate cuts, if the balance sheet continues to shrink, the liquidity of the US stock market will continue to shrink. Secondly, the real economy data in the first half of the year has already weakened, but the monetary policy transmission cycle is longer. Even though there is ample room for this round of Fed rate cuts, it may not be able to reverse the trend of economic weakness in the short term. In addition, from October 2021 to the end of May 2024, the cumulative net purchase of US long-term securities by foreign capital has reached 2.48 trillion US dollars. Therefore, it is difficult to say that the reversal of the arbitrage trade has ended. In the second half of the year, with further tightening of US liquidity, there may be signs of systemic financial risk in the financial system.

Looking ahead, we judge that although investors have fully anticipated the Fed rate cuts, the liquidity of the US stock market will still be shrinking if the balance sheet continues to contract. Secondly, the real economy data in the first half of the year has already weakened, but the monetary policy transmission cycle is longer. Even though there is ample room for this round of Fed rate cuts, it may not be able to reverse the trend of economic weakness in the short term. In addition, from October 2021 to the end of May 2024, the cumulative net purchase of US long-term securities by foreign capital has reached 2.48 trillion US dollars. Therefore, it is difficult to say that the reversal of the arbitrage trade has ended. In the second half of the year, with further tightening of US liquidity, there may be signs of systemic financial risk in the financial system.

In the current earnings season, the performance expectations of the S&P 500 continue to decline, and the fundamental and valuation indicators do not support the allocation value of the Russell 2000. Based on the industry performance during each of the Fed's interest rate reduction cycles, we recommend that investors pay attention to: 1) The medical care industry, which will benefit from the decrease in borrowing costs during rate reduction cycles; 2) The utility sector, which has stronger defensive attributes in the later stages of the rate reduction process.

1) The medical care sector, which will benefit from the lower borrowing costs during the interest rate decrease period;

2) The utility sector, which has stronger defensive attributes in the later stages of the interest rate decrease period.

The US stock market has experienced the Trump trade, the rate cut trade, and the recession trade, and during this period, the reversal of the arbitrage trade has occurred.

After the June 28 to July 10 Trump trade, the US stock market experienced the rate cut trade from July 11 to 23 and the recession trade from July 24 to August 2. During this period, there was also a reversal of the arbitrage trade.

The problem with the rate cut trade: expectations have already been priced in, but liquidity continues to be tight. Currently, the market has already generally anticipated that the Fed will start a new round of rate cuts at the September FOMC meeting this year. If we compare this with the rate cut trade in November-December last year (VIX index and credit spreads both fell), we can see that the current market is still accompanied by panic selling. The main reason for this difference is that the liquidity in the US is still tightening, and there is also the impact of Japan's monetary policy tightening. Therefore, even if the Fed starts to cut rates in September, if the balance sheet continues to shrink, it will be difficult to reverse the trend of shrinking liquidity in the US financial system.

The problem with the recession trade: real economic data has already weakened, but the monetary policy transmission cycle is longer. Since the Fed's monetary policy has tightened, the cumulative employment in non-farm jobs has been cut by 0.465 million, and wage growth has also dropped significantly. At the same time, since the beginning of this year, the growth rate of personal disposable income in the US has slowed significantly, while the growth rate of personal consumption expenditure has continued to rise. In addition, the US credit card default rate rose to 3.2% in the first quarter of this year. Therefore, although there is ample room for this round of Fed rate cuts, there is a possibility that the expected rate cut in September may not be able to reverse the trend of economic weakness in the short term due to the continuing weak real economy data and longer-than-usual monetary policy transmission cycle.

The problem with the reversal of the arbitrage trade: the scale of the unquantifiable arbitrage trade. Since the beginning of 2008, the trend of the balance of US national debt held by Japanese investors and the reserve funds of the US banking system has shown a high correlation. Based on this, we speculate that arbitrage trading behavior may have been widespread before the global financial crisis broke out. Although we cannot accurately calculate the overall scale of arbitrage trading involving US assets globally, overseas investors resumed large-scale net purchases of US long-term securities after September 2021, which happened to coincide with the starting point of rising US bond yields after the Fed signaled that it was about to start taper. From October 2021 to the end of May 2024, the cumulative net purchase of US long-term securities by foreign capital has reached 2.48 trillion US dollars.

The problem of financial system stability: a harbinger of systemic risk? Currently, the high interest rate environment and the Fed's continued contraction of the balance sheet are expected to further increase the pressure on the stability of the US financial system in the future. Looking back at the two recessions experienced by the US real economy since the beginning of the century, both were caused by the Fed's excessively tight monetary policy, which triggered the outbreak of systemic financial crises, which then spread to the real economy and caused a recession. Therefore, even if the Fed can adjust its monetary policy in a timely manner, investors still need to remain highly alert to the issue of financial system stability. In addition, considering that: 1) the interest expense of the US Treasury is continuing to rise in the current high interest rate environment; 2) if the Trump trade returns, investors may worry about the reappearance of US long-term deficit pressure; and 3) the suspension of the US debt ceiling will expire on January 1st next year, and even if the Fed starts a new round of rate cuts, the liquidity of the US stock market will still be shrinking before it stops the contraction of the balance sheet. Therefore, it is expected that the liquidity of the US financial system will further tighten in the second half of the year.

The expected growth rate of net income for US stocks has been downgraded, and the AI driving force is no longer present.

Since July, the expected revenue growth rate of S&P 500 this year has remained at 4.5%, but in the past two weeks there has been a downward inflection, while the net profit growth rate forecast has been revised down by a total of 0.6 percentage points to 9.9% since early July. Among the 11 primary industries, only finance and real estate have shown a significant upward revision in profit growth rate expectations, while the negative growth rate expectations of energy and raw materials have further widened, and the expected growth rate of industrial and medical care has also been significantly downward revised. In addition, during this period, the expected net profit growth rate of the seven leading technology companies in the US stock has continued to rise, but the expected revenue growth rate has dropped significantly to 13.4%. During the period, the net profit growth rate expectations of the S&P 500 constituent stocks except for the seven technology giants have also been significantly revised down by 0.9 percentage points to 5.3% this year.

Overall, due to previously high expectations for the performance of the US stock market this year and the gradual weakening of the economy, the underlying fundamentals of the US stock market are under pressure, with upstream resource stocks being most affected. In addition, from the perspective of AI dynamics, although the capital expenditure of the major technology companies in the network is still maintaining or accelerating, the future outlook is mostly extension and expansion, but the continuous increase in AI investment enthusiasm seems to be difficult to be transmitted to the stock prices of enterprises themselves and the AI hardware supply leaders. In the context of the market sentiment turning down, the high valuation of AI is difficult to support.

Neither the fundamental nor valuation dimensions support the configuration value of the E-mini Russell 2000 index.

Russell 2000 has strong cyclical attributes, and its valuation price-performance ratio is relatively weak compared to the large-cap blue chips. According to historical data, the Russell 2000 index usually only continues to outperform with excess returns under the background of the widening US term interest rate spread (10Y-2Y), and since 2015, the Russell 2000 index has been highly positively related to international copper prices. Furthermore, as of the end of June this year, the total weight of the pro-cyclical sector and consumer industries in the Russell 2000 exceeded two-thirds. Therefore, in the recent period when data such as the US PMI showed signs of economic weakness, the underlying fundamentals do not support the Russell 2000 to continue to outperform the large-cap blue chips and NASDAQ.

Furthermore, as of the end of July this year, the dynamic PE of Russell 2000 was 26.5 times, ROE was only 5.3%, and the free cash flow yield and shareholder cash return rate were 1.8% and 2.5% respectively. Therefore, the overall view is that the price-performance ratio of Russell 2000 is not strong compared to S&P 500 or NASDAQ.

Since 1995, the US has experienced five complete interest rate reduction cycles, and the overall performance of US stock industries has been relatively weak during each cycle from the beginning of the reduction cycle to the end of the Fed's rate cut. In all five interest rate reduction cycles, primary industries have generally experienced a decline, with daily consumption and medical care industries having a relatively small decline and an average decline of less than 10%. If we distinguish these five interest rate reduction cycles into interest rate reduction processes without accompanying economic recession and interest rate reduction processes accompanied by economic recession, we can see that in the two interest rate reduction cycles in 1995 and 1998, primary industries covered by the S&P 500 realized positive returns, especially the medical care, finance, and communications services industries showed outstanding performance.

Combining the performance of the interest rate reduction cycle, it is recommended to focus on the utility and medical care sectors in the short term.

However, in the three interest rate reduction processes accompanied by economic recession after 2000, primary industries of the U.S. stock market generally declined, but despite this, the decline of daily consumption and medical care industries was still relatively small. Combined with the industry performance during the interest rate reduction cycle, we recommend paying attention to: 1) the medical care industry, which will benefit from the decline in borrowing costs during the interest rate reduction cycle; 2) the public utilities sector, which has relatively strong defensive properties in the later stages of the interest rate reduction process.

In addition, as of the end of July this year, the dynamic PE of Russell 2000 was 26.5 times, ROE was only 5.3%, and the free cash flow yield and shareholder cash return rate were 1.8% and 2.5% respectively. Therefore, the overall view is that the price-performance ratio of Russell 2000 is not strong compared to S&P 500 or NASDAQ.

Since 1995, the US has experienced five complete interest rate reduction cycles, and the overall performance of US stock industries has been relatively weak during each cycle from the beginning of the reduction cycle to the end of the Fed's rate cut.

Investment strategy:

1) The amplitude of the timing of the monetary easing of the Fed is lower than expected; 2) The unexpected tightening of monetary policy by the Bank of Japan causes a significant capital outflow; 3) Overseas systemic financial crisis erupts; and 4) The US economy falls into recession.

Editor/Emily