Real interest rates have soared, borrowing costs have been high, and assets have become less attractive. If the Fed continues to raise rates, it will greatly increase the risk of a hard landing. For the US stock market, Wall Street giants are issuing risk warnings one after another. Goldman Sachs advised investors to prepare for the possibility of a more than 20% decline in U.S. stocks in the coming months due to a potential recession.
01 US real interest rates soared
On Friday, the blowing non-farm payrolls data did not quench investors' panic about rate hikes, and the larger-than-expected wage increase left many investors pricing in the Fed's July rate hike. U.S. bonds quickly moved lower after the data, with 10- and 30-year yields rising to their highest levels this year. At the same time, yields on inflation-protected bonds, which represent real interest rates, are soaring. The nominal yield on the inflation-adjusted benchmark 10-year Treasury note rose to 1.82 percent on Friday, its highest level since 2009.
The real interest rate usually represents the real investment income of the real economy and the real financing cost of enterprises, which has an important impact on the behavior of micro-subjects, the allocation of financial resources and asset pricing, and has been widely concerned by policy makers and market participants.
Higher real yields on ultra-low-risk Treasuries will make other assets less attractive, while higher borrowing costs will have a negative impact on the corporate sector.
Fidelity International data shows that new loans issued by U.S. banks so far this year are equivalent to an annualized rate of $279 billion, down from the average of $481 billion between 2015 and 2019.
For the stock market, five years ago, a 5% to 7% stock return should have been good, but not now, and in order to keep the same gap, the return from beating Tips is much higher, and the stock return should be 10% or 15%. Therefore, the share price should fall.
This logic is one of the reasons why a sharp rise in real yields after Wednesday's Fed meeting triggered a sell-off in stocks. Still, the stock market has risen sharply this year, largely as excitement about the possibilities of AI has prompted investors to flock to a handful of big tech companies. But both booming stocks and pessimistic bond investors are not right, and keeping real yields high will eventually hurt stocks.
Against the backdrop of soaring real interest rates, if the Fed continues to raise rates, it will also greatly increase the risk of a hard landing. At present, the market has fully priced in the July rate hike. According to the CME Group Fed Watch tool, the fund market currently sees a 93% probability of a July rate hike.
However, many analysts point out that current valuations are still quite high, based on investors pricing in a sharp pullback in real interest rates next year.
02 The latest voice from the Federal Reserve
The unexpected "explosion" of the job market has sharply raised hawkish expectations from the Federal Reserve.
On July 6, local time, Lorie Logan, the 2023 FOMC voting committee and president of the Dallas Fed, said that he was skeptical of the significant impact of the lagging effect of interest rate hikes; Stricter policies are needed to achieve the objectives of the FOMC; There are very concerns about whether inflation can cool quickly, and further rate hikes may be necessary.
The minutes of the Fed meeting, released just the day before, showed that almost all officials expect more rate hikes in 2023 to continue the fight against stubborn inflation. Proponents of a rate hike point to a tight labor market, a stronger economy than expected, and no evidence that inflation will gradually return to its 2 percent target.
The just released labor market data also confirms the Fed's concerns, which will strengthen the Fed's determination to raise interest rates further. At present, the market is worried about whether the Fed will raise interest rates more often and more than expected this year.
In addition, the minutes also showed that Fed officials were worried that persistently high inflation could push up inflation expectations and weak commercial real estate, and stressed the need to monitor whether tightening credit conditions related to the banking sector would drag down the economy; A few officials believe that the issuance of bonds by the Ministry of Finance may put upward pressure on money market interest rates in the short term; Fed staff still expect the banking impact to lead to a mild recession this year, but believe that avoiding a recession is almost as likely as it is to be a recession.
Goldman Sachs warns
For the US stock market, Wall Street giants are issuing risk warnings one after another. Goldman Sachs advised investors to prepare for the possibility of a more than 20% decline in U.S. stocks in the coming months due to a potential recession.
David Kostin, chief U.S. equity strategist at Goldman Sachs, said in the latest report that some portfolio managers expect a U.S. recession to begin next year, which is in line with the view of most economic forecasters. In this case, the S&P 500 could fall 23% to 3400.
Goldman Sachs believes now is a good time for investors to hedge their portfolios against future losses. Kostin gives 5 reasons in the report:
1. In the case that a large number of investors have already gone long, it may be more difficult for the market to rebound further from now on;
2. A small market rally indicates an increase in downside risk, and historically, sharp declines in market breadth have typically been associated with large declines in the following months, as measured by this metric, which has recently seen its biggest narrowing since the tech bubble;
3. Valuations are high in both absolute and relative terms, with the S&P 500 index having an NTM price-to-earnings ratio of 19 times, the 88th percentile since 1976;
4. The stock market already reflects an optimistic outlook, Goldman Sachs economists expect the average growth rate of US GDP in the second half of 2023 to be 1%, however, measured by the performance of cyclical stocks relative to defensive stocks, the stock market implies that the pace of economic growth is about 2%;
5. Position adjustments are no longer tailwinds for the stock market, and the latest data shows that the U.S. stock sentiment indicator hit a 114-week high, suggesting that capital flows are unlikely to be a driver of the stock market this year.
Goldman's view of market sentiment and investor positions was reinforced by Wall Street veteran Ed Yardeni, who stressed in a note that the U.S. stock market could be "too long" and that high bullish sentiment could be a warning sign.
03 Industrial Securities
Overseas "moths" are expected to gradually ease
Be aggressively long: direction is more important than rhythm.
First, the overseas "moths" are expected to gradually ease
This week the market has been hit again by external risks:
1) U.S. bond interest rates rose sharply and broke new highs for the year, dragging down global risk appetite. With the release of the minutes of the Fed's June meeting on July 5 and the fact that all officials agreed to continue raising interest rates this year, and the release of the June "small non-farm" data on July 6, which far exceeded expectations, the US Treasury rate rose rapidly, and the 10-year rate exceeded 4% and hit a new high for the year. The rapid rise in U.S. bond interest rates once again hit global risk appetite, and major markets experienced significant corrections, and Hong Kong stocks and Chinese concept stocks suffered heavy losses.
2) The exchange rate continued to come under pressure, and foreign capital flowed out again. The USD/RMB exchange rate continued to run at a high level this week, and foreign capital also showed a net outflow for four consecutive trading days, which further dragged down the market.
But looking ahead, we believe that the overseas "moths" are expected to gradually ease:
First of all, with the June non-farm payrolls lower than expected, the pressure from rising US bond rates, exchange rate depreciation, and foreign capital outflows is expected to ease. On July 7, local time, the US Bureau of Labor Statistics released the latest non-farm payrolls data, and the number of non-farm payrolls increased by 209,000 after the quarterly adjustment in June, the smallest increase since December 2020, lower than the expected 225,000, reversing the strong employment expectations brought by the "small non-farms" on July 6. After the release of the data, the 2-year US Treasury rate fell back and the US dollar index corrected significantly. As a result, the pressure from rising US bond interest rates, exchange rate depreciation, and foreign capital outflow is expected to ease.
Secondly, Yellen visited China and stressed that the United States does not seek "decoupling and breaking the chain", and if the emergence of phased geopolitics eases expectations, it is expected to push up the repair of market risk appetite.
Second, the excessive pessimistic expectations in China will be gradually revised
1. The worst moment of economic sentiment will gradually pass, and the market's pessimistic expectations for economic growth will be revised. Since the beginning of the year, the repetition of economic expectations has largely led to fluctuations in market sentiment. Especially in the second quarter, fluctuations in expectations and inventories amplified concerns about insufficient demand, and this pessimistic expectation also led to a continued contraction of market risk appetite. In terms of growth expectations reflected in equities and bonds, the implied pessimism was close to the level at the end of October 2022 in mid-June.
However, judging from the recent data, the domestic fundamentals have shown initial signs of bottoming. The June PMI data was generally better than expected, and the recovery in the production index and new orders index pointed to an improvement in both supply and demand. Moreover, from the perspective of high-frequency data, the momentum of domestic economic recovery is also expected to continue: on the investment side, manufacturing production continues to improve, and infrastructure investment margin strengthens. On the consumption side, under the influence of summer factors, cultural tourism consumption continues to maintain strong momentum. Looking forward, the market's pessimistic expectations for the economy will gradually be revised, which will lead to the overall market sentiment repair.
2. Various policy easing measures have been gradually implemented. Subsequently, at least until the important meeting at the end of the month, the market can always have policy expectations. On June 16, the National Assembly clearly pointed out that "in view of changes in the economic situation, we must take more powerful measures to enhance development momentum, optimize the economic structure, and promote the sustained recovery of the economy", and called for the study and introduction of a number of policies and measures to promote the sustained recovery of the economy. On June 30, the central bank's second-quarter monetary policy meeting also reiterated the need to "increase counter-cyclical adjustments" and called for "overcoming difficulties and riding on the momentum" and "effectively supporting the expansion of domestic demand".
3. The current market itself is already in a position where the implied risk premium is high and the congestion of most industries is low, and there is room for repair:
The equity risk premium is an effective indicator of our market price-performance ratio. The historically high three-year rolling average +2x standard deviation reached twice at the end of April and October last year helps us judge that the market was at the bottom. At present, after the adjustment since May, we see that the current equity risk premium of the Shanghai Composite Index has approached a relatively high level of +1 standard deviation on a three-year rolling average, indicating that equity assets have a high cost performance.
In terms of congestion, most industries are still at historically medium or low levels. Congestion is an important indicator that we have built exclusively to assist in short-term timing. At present, except for a few growth tracks, the congestion of most other sectors and subdivisions is still at a historically medium or even low level.
Therefore, although the market has encountered volatility again this week, with the gradual correction of pessimistic expectations of the economy, and the landing of policy easing, the impact of superimposed external factors has gradually eased, at this moment that has reflected too many pessimistic expectations, it is recommended to respond positively and optimistically, with a heavier direction than the rhythm.
In the future, the market is expected to enter a beta repair, with the spread of industry sectors and the improvement of the money-making effect. Therefore, in addition to the two main lines of "digital economy" and "special valuation", there are opportunities for low-level repair in phased stages such as military new energy, such as technology manufacturing and high-performance consumer stocks with excellent performance, as well as some pro-cyclical sectors.
This article is from Securities Star