On the evening of Wednesday, May 12, local time, the US Department of Labor released the US April CPI data. The data shows that both the overall CPI and the core CPI in the United States have set an astonishing record growth rate in April. Among them, the overall CPI in the United States in April increased by 4.2% year-on-year, significantly exceeding the previous market expectation of 3.6%, and the growth rate hit a new high in 13 years since September 2008; the core CPI of the United States in April recorded a seasonal adjustment rate of 3%, the largest growth since January 1996.
Rising inflationary pressures have sparked fears that the Fed's rate hike will come early, with the 10-year Treasury yield once again surging 1.7 percent. On May 12, local time in the United States, the three major U.S. stock indexes were hit hard, with the Dow falling nearly 700 points, a drop of nearly 2%, and the Nasdaq and S&P 500 indexes both fell by more than 2%. Large U.S. technology stocks fell across the board, with Google falling more than 3 percent and Apple, Microsoft, Amazon, and Netflix all falling more than 2 percent. Chip stocks fell hard, with the semiconductor sector ETF falling more than 4%, Miracle Optoelectronics falling more than 10%, and Applied Materials falling more than 7%.
The stock market is often touted as a barometer of the economy, but the astonishing performance of the U.S. stock market is completely out of touch with the macro economy, and the speculative characteristics are becoming more and more obvious. Various economic indicators show that the U.S. economy is still in recession, the stock market index has reached new highs, the bond market bubble is getting bigger and bigger, and the market speculation frenzy has caused the cryptocurrency and commodity markets to soar.
This phenomenon partly reflects changes in the structure of investors and the disruptive impact of fintech on financial markets. Since the 2007-2009 U.S. financial crisis, the Fed has suppressed long-term interest rates through asset purchase programs for a long period of time, resulting in bond rates being too low. Although this reduces the financing costs of enterprises and stimulates economic growth, it also hurts the financial investment returns of domestic savers, pension funds and foreign investors, forcing them to seek weakly liquid and risky financial assets, creating a bubble in the price of other financial assets.
Since the outbreak of the new crown epidemic in the United States, the Fed has played the role of a "firefighter". The Fed's bailout measures focus on easing liquidity pressures in financial markets, first by financial institutions, especially issuers in the bill market (short-term liquidity markets for U.S. financial institutions and large corporations), tier 1 brokers (systemically important financial institutions, liquidity providers, and redistributive market makers), and financial institutions engaged in money market business. Later, the scope of the bailout was expanded to include corporate bond issuers (primary market), trading market entities (secondary market), commercial real estate mortgage brokers, leveraged lenders, loan mortgage brokers and small and medium-sized enterprises. Innovative highlights of the Fed's policy are the establishment of the General Corporate Credit Scheme (MABLP) with the Small Business Administration to address the funding needs of smes most affected by the pandemic, as well as the ease of local government financing pressures by expanding the list of acceptable pledged assets. The Fed's total assets rose sharply from $4.24 trillion on March 4, 2020, to $7.86 trillion on May 5, 2021, surpassing JPMorgan Chase & Co.'s assets ($3.69 trillion, March 31, 2021).
The Fed does whatever it takes to keep financial markets up and running, but the huge bond market is constantly in trouble. The U.S. repo market is an important part of the money market, with the responsibility of redistributing liquidity within financial institutions (banks, insurance companies, asset managers, money market funds, and other investment institutions) to ensure the smooth operation of financial markets. Once the trillion-dollar market is disrupted, the resulting butterfly effect will instantly affect the entire financial system. In mid-September 2019, there were problems in the repo market, with the pledge overnight lending rate rising sharply from the usual 10 basis points to 20 basis points at most to 700 basis points, and the daily volatility of the federal funds rate market was also abnormally high. On March 3, 2021, the situation was again out, and the 10-year Treasury bond mortgage borrowing ratio fell to -3% intraday, and once as low as -4.25% on the 4th, and the atmosphere of the market selling the 10-year Treasury bond was very strong. Fed Chairman Powell believes that the market conditions are normal, and the Fed's inaction naturally causes various speculations in the market.
The Fed's monetary policy orientation created the largest bubble in the history of the U.S. bond market. Fed Chairman Jerome Powell has repeatedly said that the Fed is more focused on economic growth, tolerates inflation to exceed the policy target by 2% in the short term, and maintains a low interest rate policy for an extended period of time.
As vaccination rates rise and the recovery scenario becomes clearer, the Biden administration's new stimulus plan will increase inflationary pressures and raise interest rates more and more likely. Since March 2021, the interest rate of us 10-year Treasury bonds has repeatedly broken 1.7%, and the interest rate of 30-year mortgages has exceeded 3%. U.S. Treasury yields are ultra-low and are no longer a good investment option, and rising yields lead to increased risk in bond prices, which spread further to other types of bonds. As Shown in Table 1, foreign investors have sold off U.S. Treasuries in large quantities in March and April 2020, followed by increased holdings of high-yield institutional bonds (Fannie Mae, Freddie Mac and Geely Mae) and U.S. corporate stocks. The share of U.S. Treasury bonds held by foreign investors fell from 35.06% at the end of 2019 (42.99% at the end of 2010) to 29.85% at the end of September 2020, so domestic investors in the United States must buy more newly issued Treasuries.
Fintech is redefining U.S. financial markets, social media and commission-free trading software such as Robin Hood are concentrating the power of retail investors against Wall Street tycoons, and financial markets are emerging with new faces. Just as social divisions in the United States have intensified, tensions between institutional and retail investors have deepened, the financial crisis of 2007-2009 has left the new generation fresh in its memory, hatred of Wall Street and traditional media has continued unabated, and the "Occupy Wall Street" protests in September 2011 are continuing in new forms. The soaring and plummeting share price of game stations has pushed big fund companies like Melvin into the abyss, while at the same time attacking CNBC (National Broadcasting Corporation Commercial), which speaks for sponsors. U.S. options trading soared from an average daily trading volume of 19.45 million in 2019 to 29.74 million in 2020, refreshing the investment community's understanding of trading products. The financial market changes rapidly, and it took only 126 trading days for the stock index to go from the new high to the trough in 2019, and the speed of the market's ups and downs can be described as unprecedented.
The spread between the S&P 500 yield and the yield on the 10-year Treasury note has fallen to its lowest level in a decade and is now only 1% higher than the risk-free benchmark rate, which is a good indication that the returns of the index's constituents are in urgent need of improvement. The difference in returns between the two assets began to rebound in late 2017 and reached a range peak before the epidemic, but with the retaliatory rebound of the stock index, the spread continued to fall and is now falling back to 1%.
There are only two solutions to the inflated valuation of stocks: the molecular method and the denominator method. The former refers to the improvement of operating performance of LISTed companies in the United States, while the latter refers to the Expansion of Asset Acquisitions by the Federal Reserve and the suppression of rising long-term interest rates. If inflation continues to rise, the Fed will consider raising interest rates early, which means that the ultra-low interest rate policy is over, and the stock market bubble will definitely be punctured. If the Fed expands its asset purchase program to curb rising interest rates, the stock market bubble could continue to amplify. To be sure, the U.S. government will continue to issue more Treasuries, inflationary pressures will increase, and the stock market will have to carefully evaluate the Fed's determination to curb interest rates, as well as its market operation strategy in the coming months.
In 2020, the dow jones index's earnings profile best illustrates the bubble in the U.S. publicly traded stock market. The 30 constituents of the Dow Jones Industrial Stock Index are all high-performing stocks in various industries, but the operating conditions of individual stocks have varied greatly during the epidemic. In 2020, there were only 13 constituent companies with net earnings per share that exceeded 2019: 3M, Apple, Dow Chemical, Goldman Sachs, Home Depot, Intel, Microsoft, Procter & Gamble, crm (salesforce.com), Travelers Group, United Healthcare and Walmart. At the closing price on March 5, 2021, there are only 9 constituents with a dividend-to-share ratio of more than 3%: 3m, Chevron, Cisco, Coca-Cola, Dow Chemical, IBM, Merck, vz Communications and WBA Pharmaceuticals. The performance of blue chips in the United States is still so, and other listed companies can imagine that improving the operating performance of listed companies is an important supporting factor for the continuous rise in stock prices. If the yield on the 10-year Treasury note continues to climb, the corporate value of listed companies will become more and more inflated, and it is not surprising that a large number of funds have withdrawn and shifted to other markets ( such as emerging markets ) .
The US 10-year Treasury note has once again become a bellwether for the market. The bond market bubble has widened, foreign investors have reduced their holdings of U.S. Treasuries on a large scale, and even some domestic investors in financial institutions have made it clear that they are reluctant to buy low-yield Treasuries. According to a variety of indicators, the yields of listed companies in the United States are at a historic low level, and the stock market bubble has reached a dangerous point. Even for high-performing companies like blue chips, yields based on current stock prices are no longer attractive. Although financial markets always look beyond the present and incorporate the positives of future expectations into the pricing equation, U.S. listed companies must hand over an answer sheet that satisfies investors as soon as possible, and the continuous improvement of each quarter's performance is a big test for listed companies.
The employment situation in the United States has attracted much attention from the market. The U.S. job market has improved a lot, but the data obscures the real situation of the market, so it is not a happy thing. In April 2021, 9.8 million people were unemployed in the United States, 4.18 million were long-term unemployed (more than 27 weeks), the employment participation rate was only 61.7% (at a historically low level), and the unemployment rate was 6.1%. Clearly, the recovery of the U.S. job market has entered a tough phase, which is a major economic problem that the Biden administration is anxious about.
Shortly after taking office, the Biden administration launched a massive stimulus package and is negotiating a $4.3 trillion plan to boost economic recovery (including infrastructure, education, job skills development, and climate change) in the hope of addressing the problems that hinder the U.S. economy and promoting high-quality economic development. Fed Chairman Jerome Powell expires next year, and whether he will be nominated for re-election depends on President Biden's face. The Fed should cooperate with the Biden administration to restore the economy and dare not rush to raise interest rates. However, whether the market will follow up is a big question. In the first seven months of fiscal year 2021, the U.S. federal government's fiscal deficit reached $1.9 trillion. The us federal government deficit is expanding, and the pressure on the treasury bond market has been greater, affecting the trend of medium- and long-term interest rates.
(The author is a teacher at the Faculty of Finance, City University of Macau)
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