Under the haze of high interest rates, the artificial intelligence "engine" has stalled, and the bearish continues to go, where will the US stock market go?

21st Century Business Herald reporter Wu Bin reported from Shanghai

The rally in U.S. stocks appears to be dying off, reversing gains earlier this year.

At one point, the S&P 500 was up nearly 30% from its October low. But since then, sentiment has reversed 180 degrees, and as of the close of trading on August 25, the S&P 500 has fallen 3.99% in August, the NASDAQ is down 5.27%, and the Dow is down 3.41%.

As August draws to a close, Wall Street is increasingly skeptical that the rally in U.S. stocks earlier this year can continue. On the one hand, after the release of NVIDIA's earnings report that exceeded expectations, NVIDIA's stock price closed down on Friday, and artificial intelligence, the key engine of the rise of US stocks, seems to be gradually stalled.

On the other hand, the US economy as a whole has shown resilience, and inflationary pressures have lingered, leading the market to expect the Fed to maintain high interest rates for a long time. After Powell said on the 25th that he may further raise interest rates to fight inflation, the sell-off of U.S. Treasury bonds intensified, U.S. bond yields rose, and the real yield of 5-year U.S. bonds once rose above 2.26%, touching the highest level since 2008, and the rise in real interest rates will also impact the valuation of U.S. stocks.

As the artificial intelligence boom cools down and the haze of high interest rates becomes stronger, where will the US stock market go next?

High real interest rates hit the market

Real yields on U.S. bonds have been rising recently, with yields on 10-year inflation-protected bonds (TIPS) breaking 2% this month, the highest since 2009.

At the same time, the current valuation of US stocks is not low. According to FactSet, the S&P 500's price-to-earnings ratio based on expected profits over the next 12 months is now at 18.6 times, up from 16.6 times at the start of the year and up from the past 20-year average of 15.8 times. Donabedian, CIBC Private Wealth's U.S. chief investment officer, said: "In a world with 2% real yields, can you justify a 19x P/E ratio? It looks a bit expensive. ”

After Powell said at the Jackson Hole Central Bank annual meeting that he may raise interest rates further to fight inflation, US Treasury bonds suffered a new round of sell-off. Under Powell's outline of "higher and longer" interest rates, borrowing costs may remain high, which in turn will put pressure on the stock market.

Lu Haomin, a researcher at the Bank of China Research Institute, told the 21st Century Economic Herald reporter that at present, the Fed's tightening monetary policy trend in the short term may affect the real interest rate trend. The US core personal consumption expenditures (PCE) price index has fallen significantly recently, but the Fed is uncertain about the sustainability of the lower inflation data and at what level underlying inflation will stabilize in the coming quarters. After a sharp and rapid interest rate hike in the early stage, US inflation has fallen from its peak, but it is still too high. Powell said that under the right circumstances, the Fed will raise interest rates further and keep policy at restrictive levels until it is confident that inflation is continuing to decline towards its target.

What is the impact of rising real interest rates on the US stock market? Lu said that rising real interest rates will raise the necessary return on stocks and reduce the price investors are willing to pay for stocks, and the U.S. stock market will come under pressure. On the one hand, higher real interest rates make riskier assets such as cash and bonds more attractive. During this period, attractive yields on bonds, certificates of deposit and other instruments weighed on stock markets. On the other hand, rising real interest rates have increased the debt burden of listed companies, higher debt costs have squeezed corporate profits, and stocks have fallen due to deteriorating operating conditions. In particular, growth stocks that rely heavily on credit, high interest rates have a greater impact on their valuations, and downward pressure on stocks persists.

The artificial intelligence engine is gradually stalling

In addition to the impact of high interest rates, the gradual shutdown of the artificial intelligence engine has also made the recent rally of U.S. stocks weak.

Nvidia, the "super leader" of the artificial intelligence boom, released a larger-than-expected earnings report last week, with record quarterly sales and performance guidance that exceeded expectations, but Nvidia's stock price did not rise but fell after the earnings report, and failed to promote the rebound of the U.S. stock market, and the very optimistic earnings outlook seems to have been reflected in the stock price.

Morgan Stanley strategist Michael Wilson said that although NVIDIA's earnings report exceeded expectations, the subsequent decline in the U.S. stock market showed that the market's upward momentum this year has been "exhausted" and will fall in the future. The market's unexpected reaction to chipmaker Nvidia's blowout outlook is a perfect indicator of a market peak.

As the impact of a long period of high interest rates and tighter liquidity becomes more apparent, AI's boost to equities could fade in the second half of 2023. Bank of America strategist Michael Hartnett said AI may not be able to help tech stocks out of trouble. The positive side around the AI boom will be overshadowed by the negative impact of prolonged high interest rates. The Nasdaq Composite has performed strongly in the current rate hike cycle, but the Fed's balance sheet has continued to decline over the same period, which is highly incongruous.

However, not everyone is pessimistic. After Nvidia's second-quarter results well exceeded expectations and provided optimistic guidance, Rosenblatt analyst Hans Mosemann even raised his target on Nvidia's share price from $800 to $1,100, describing Nvidia's AI growth story as "the source of the cycle" and confident about future prospects.

Bearish continues, where will U.S. stocks go?

Against the backdrop of high interest rates and the stalling of artificial intelligence engines, what will happen to U.S. stocks next?

In the view of pessimists, US stocks will continue to come under pressure next. Dubravko Lakos, chief global equity strategist at JPMorgan Chase, said that the rally in U.S. stocks this year is over, and by the end of 2023, a series of factors will put pressure on the market: the U.S. stock market earnings ratio is still quite high, and the S&P 500 index is currently trading at about 20 times earnings; Investor positions are too bullish; Fed monetary policy is likely to remain tight; Fiscal policy will be tightened.

In Lakos' view, while optimists believe the U.S. may avoid a recession this year, the economy's resilience is now largely due to strong fiscal spending and consumer spending, both of which are expected to decline by 2024. Consumer savings are also rapidly declining, which will leave the economy unbuffered in a financially stressful environment and a U.S. recession inevitable.

Many analysts believe that the rally of U.S. stocks this year has basically come to an end. Chad Morganlander, senior portfolio manager at Washington Crossing Advisors, said the case for the bull market isn't that obvious at the moment. Valuations have become less convincing, with the S&P 500 around 4400 and many tailwinds priced in.

In the eyes of some optimists, the current correction in U.S. stocks is not a cause for concern. Huang Senwei, senior market strategist of AllianceBernstein, told the 21st Century Business Herald reporter that the S&P 500 index has entered a technical bull market earlier this year, and historical experience shows that since the 1950s, when U.S. stocks entered a technical bull market, the probability of rising in the next year was as high as 92%, with an average increase of 19.03% and a median increase of 17.84%.

Regarding the correction of U.S. stocks in August, Huang Senwei believes that although U.S. stocks have a short-term shock retracement, the probability of continuing to rise in the long term is high, mainly because this round of U.S. stock rises have not provoked large-scale speculative activities like before the bursting of the Internet bubble in 2000. The financing balances of U.S. stocks show that individual investors have not yet invested heavily in the stock market, and the global institutional investors' allocation to stocks is relatively conservative, and these data prove that it is still far from the "shoe shine theory" scenario where everyone talks about stocks.

In fact, the future trend of US stocks will largely depend on the Fed's monetary policy, and the Fed itself, which is currently in a "data-dependent mode", seems to be full of confusion about the future, and the huge divergence in the market is not difficult to understand, and it will take time to give an answer in the end.

Todd Sohn, ETF and technology strategist at Strategas Securities LLC, said: "U.S. stocks were very hot in late July, but they are now in the phase of cooling down and discussing what to do next. The clarity of interest rates will certainly help the future market. Is the Fed's rate hike over? This could be the next catalyst that determines the market. ”

In the long run, the real interest rate of U.S. bonds may be difficult to maintain high for a long time, and the pressure on U.S. stocks may be reduced in the future. Lu Haomin told reporters that the real interest rate is supported by the long-term real return on investment. Under the background of weak global economic growth, the economic prosperity of Asia and Europe is in a downward channel, the real return on investment of enterprises will be at a relatively low level for a long time, and it is expected that the real interest rate will be difficult to maintain at a high level for a long time.

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