Last week was the first week of full resumption of work for the U.S. stock market after the holidays. The market turned optimistic, with the S&P rising 1.7% and hitting a record high on Friday, while Nasdaq rose 2.9%. Most equity markets in the Asia-Pacific region fell except for Japan and India. Japanese stocks rose 6% after a strong earthquake and lackluster wage growth data forced market participants to reassess when the Bank of Japan will normalize its monetary policy. Europe's Stoxx 600 rose about 0.8%, which if sustained would be its biggest gain since mid-December. On the macro theme, the concept of interest rate cuts is outdated, and QT reduction has become a new hot spot. Because we observed that institutions were generally bearish the previous week, although the correction did not occur, citing the weekend view of the Goldman Sachs trading desk: We believe that orderly short-term risk aversion strategies are still effective.
US CPI exceeded expectations, PPI fell short of expectations, US Treasury bond market prices rose overall, short-duration yields fell more than long-term yields, short-term interest rates are still expected to fall, and interest rate futures predict a 77% probability of an interest rate cut in March, an increase of about 77% from the previous week. 10 percentage points, implying 6.5 interest rate cuts. Only five times in the past 90 years has the Fed cut rates when core CPI (currently at 3.9%) was above the unemployment rate (3.7%). Of those five, the trigger was once a war (October ’42) and four times a recession (October ’69, August ’74, May ’80, July ’81). So if the unemployment rate rebounds in the next two months (or the war escalates), there will be a good reason for the Fed to cut interest rates as a precautionary measure.
The U.S. dollar traded sideways last week. China's inflation fell again, imports and exports fell but the trade surplus expanded, loan data was disappointing, and the yuan remained stable. The market expects the People's Bank of China to lower its one-year benchmark interest rate this week. U.S. and British strikes against Yemen's Houthi rebels helped boost oil and gold prices, but the overall boost was limited.
[U.S. inflation exceeds expectations and does not change consensus on interest rate cut in March]
CPI +3.4% in December VS +3.1% in November. Most of the increase was driven by service costs, especially housing costs; core CPI continued to slow down, falling from 4% to 3.9%. The market consensus is that inflation is on a downward trend, although the actual situation appears to be more complicated, with shipping and energy no longer being a drag on the deflationary narrative. This slight rebound in CPI reminds people that it may take patience to complete the "last mile", but in terms of market conditions, it is still regarded as a dovish factor by the market.
Most signals suggest inflation will continue to fall:
After surging in 2022, rent increases for new leases have slowed and largely normalized. However, this is not yet fully reflected in the Consumer Price Index for Housing, which tends to lag more timely market indicators by several quarters.
Depending on the wholesale auction market, used car prices will fall further.
Falling job vacancies and resignations suggest the labor market is cooling, which will lead to slower wage growth and therefore slower inflation in some services sectors.
Consumer inflation expectations, which influence actual inflation, are moving lower. The latest survey from the New York Fed released last week showed one-year inflation expectations were the lowest in three years.
The leading indicator PPI was also lower than expected, unexpectedly falling 0.1% from the previous month. Downward pressure on wholesale prices should help reduce consumer price inflation.
[China has experienced deflation for three consecutive months]
China's consumer price index (CPI), which reflects inflation, contracted 0.3% year-on-year in December, marking the third consecutive month of deflation. On a full-year basis, China's CPI rose by 0.2%, far lower than the 3% expected by the State Council and the lowest inflation rate in China since 2009. At the same time, the producer price index (PPI), which reflects production costs, fell by 3%. However, the negative contribution of CPI is mainly related to food, and core inflation excluding energy and food remains stable. Analysts generally believe that the People's Bank of China may soon introduce more easing measures, including interest rate cuts and reserve requirement ratio cuts. So far, passive policy easing has failed to offset the strong tightening effect brought about by the deleveraging of housing and local government financing platforms, constituting a de facto fiscal tightening and becoming a downward pressure on the Chinese economy.
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[Customs data: China’s exports will fall for the first time in seven years in 2023, but it is not pessimistic]
Chinese customs data released on Friday (January 12) showed that China's full-year exports fell for the first time since 2016 as global demand for Chinese-made goods (except cars) slowed.
Last year, China sold $3.38 trillion worth of goods to the rest of the world, down 4.6% from the previous year's record. The last time China experienced a decline in export volume was in 2016, when it fell by 7.7%.
However, the figure of 3.38 trillion is still about US$1 trillion more than before the outbreak. In addition, the export performance of the "three new" products such as electric vehicles, lithium batteries and solar cells has been outstanding.
At the same time, China-Russia trade volume reached US$240.1 billion, hitting a new record high in 2023, an increase of 26.3% over 2022.
China's imports also fell 5.5% last year to $2.56 trillion. This makes China's trade surplus of US$823 billion in 2023 basically consistent with the historical high of the previous year.
Considering the background of weak global demand, the result of China's weak exports in 2023 is understandable. Although there are political voices for de-Sinicization, structural de-Sinicization cannot be realized in the short term.
Quarterly China trade balance, in fact, both trade volume and surplus have increased since the Trump era:
China's automobile and auto parts trade balance:
Caixin PMI in December was actually at the fastest expansion rate in six months. Judging from media reports, more and more overseas institutions are or have admitted that Chinese assets are in a very cheap period (although it is unclear when they will rebound). China's pessimism may be bottoming out, but many bargain hunters appear to be waiting for the announcement of a massive economic stimulus package on a scale similar to that launched during the 2008 global financial crisis. The most recent large-scale stimulus was the central bank's pledge-based stimulus package in December. Supplementary Loans (PSL) issued RMB 350 billion in loans to policy banks to support real estate:
Valuation comparison: CSI300 index PE fell 40% from the peak in 2021, less than 12 times, Hang Seng is only 8.5 times, compared with 23 times for the US SP500, 17 times for Japan, 18 times for South Korea, and 14 times for Europe. CSI300 PB is 1.38x, less than one-third of the S&P 500.
[The Fed’s “QE” is expected to make a comeback]
Figure: QT has become a popular discussion topic among major institutions
The continued decline of ONRRP has triggered more and more discussions in the market about stopping QT, which may lead to insufficient liquidity in the financial system, triggering violent market turmoil similar to that at the end of 2018, when the Fed was pushing QT and raising interest rates, and the overnight repurchase rate surged sharply. To about 20%, the stock market also fell sharply. Therefore, the market is beginning to bet that the Fed is ending the reduction of its balance sheet ahead of schedule, which also means that the Fed's policy will turn dovish. What will follow is a tug-of-war between asset supply and liquidity, which may be a direct benefit to the bond market and the stock market. The impact is uncertain, but cryptocurrencies may find themselves the subject of a new round of hype following a pullback.
The Fed has been letting as much as $60 billion in Treasuries and $35 billion in agency bonds mature each month without reinvesting the proceeds for 18 months.
According to the current downward trend (-90 billion per week) ONRRP may return to zero as soon as March. It is worth noting that although the Fed reduced its balance sheet by US$1.3 trillion in 2023, bank reserve balances actually increased by US$350 billion to about US$3.5 trillion. This is because the reduction in the balance of the ON RRP instrument is hedged. Increased U.S. Treasury issuance and reduced uncertainty about the path of interest rates have prompted money market funds to invest more in Treasuries, resulting in rapid ON RRP erosion.
In addition, the increasing SOFR and benchmark interest rate spread at the end of the month is also considered to be a sign of tight liquidity:
Bank of America expects the Fed to begin reducing its monthly Treasury bond redemption quota from March to June this year: The Fed is expected to announce at its March meeting that it will reduce its Treasury bond redemption quota by US$15 billion per month starting in April and completely end the reduction of its Treasury bond balance by July. .
Deutsche Bank expects to cut interest rates for the first time in March this year, and then start to reduce QT in June, but if the economy has a soft landing, it will not completely stop until the first quarter of 2025.
Goldman Sachs expects to start reducing the pace of tapering in May and stop it completely by the first quarter of 2025. The bank believes that the pace of balance sheet reduction in this tightening cycle is much faster than in the past, and the distribution of liquidity among various market participants is also quite uneven. Therefore, the FOMC is worried that functional failures will occur in the money market during this process. Reducing the speed of balance sheet reduction is expected to prevent related risks, including ensuring that banks' reserve requirements are met in an orderly manner and avoiding liquidity collapse, which may lead to early termination of QT. risks of.
Barclays Joseph Abate predicts that the Fed has already had its previous fears and will terminate QT this time before any financial indicators show signs of stress. QT is expected to end in June or July.
Barclays reminded us of an important question, which is whether QT appears before or after the liquidity crisis. If so, the market may be happy to see this. Due to the expected addition of Fed buying, bonds will once again become an asset with high certainty of rising prices. , yields are expected to fall further, and risk assets may rise further or be able to maintain high valuations. But if unfortunately a liquidity crisis occurs, the market may develop a V-shaped trend.
Some analysts believe that the scarcity of bank reserves will not itself cause liquidity problems and force the Fed to stop QT. It is likely that the depletion of ON RRP and a reversal in hedge fund basis trading caused problems in 2024. Because hedge funds do not have the backing of the Federal Reserve, and the high leverage used in trading could cause liquidity problems to spread more quickly through the financial system. Basis trading is conducted by hedge funds through financing in the private repo market, in which hedge funds borrow money to buy Treasury bonds and sell Treasury bond futures to obtain arbitrage returns through leverage. While such transactions increase demand for Treasury bonds, they also increase the market's reliance on cash liquidity.
The Fed is aware of this problem. Two key events: First, the minutes of the December FOMC meeting released on January 3 showed that the Federal Reserve has begun to consider the timing and communication method of reducing QT. Then on January 8th, Dallas Fed Logan’s speech at the beginning of this year clearly suggested that once the ON RRP is exhausted, QT should be reduced, because stopping QT will have a smaller impact on inflation than cutting interest rates in advance.
[BTFP expires in March]
The use of BTFP, which is used for bank emergency rescue, has surged in the past two months, but analysts generally believe that this is due to arbitrage, not bank liquidity constraints. If the Fed also acknowledges this fact, it should not renew this policy after it expires in March. However, it also provides a new support for reducing QT when the time comes. The Fed has no reason to take the risk of a recurrence of the regional banking crisis.
[The situation in the Red Sea escalates]
The Houthi armed forces launched the largest attack last week and the first attack on the British and American fleets. It is said that all missiles and drones were successfully intercepted without causing damage to the warships. Britain and the United States launched joint air strikes against the Houthis on Friday. Media reported that an oil tanker named ST.Nikolas was controlled by Houthi armed forces. The Houthis said all ships owned or operated by Israeli companies and flying the Israeli flag would be "legitimate targets" for the group. So far, cargo ships flying the five-star red flag or indicating that there are Chinese employees on the crew can pass safely. Last week, media reported that most oil shipping companies did not plan to detour around the Cape of Good Hope. This week, after the situation escalated, the statement began to change. However, judging from the price performance, concerns about oversupply still linger.
Traffic through the Red Sea/Suez Canal has dropped by 35–45% in the past 4 weeks:
[Another milestone for BTC, but please control your excitement]
Bitcoin hit a 21-month high of $49,051 on Thursday, just 30 minutes after the launch of the first U.S. spot ETF. But over the next two days, it fell 12%, triggering a loosening of sentiment. One of the reasons is that the Grayscale GBTC ETF, which was converted from a closed-end fund, experienced an outflow of $579 million, causing net inflows to fall to $800 million two days after the ETFs were issued, which was far lower than the $2 billion previously expected by market participants. , or the US$4 billion expected by Bloomberg on the first day, which makes the US$100 billion inflow predicted by Standard Chartered seem particularly outrageous (I personally think that even this result is already very good).
Referring to the situation when BITO was listed, because it was the first Bitcoin exchange-traded fund in the United States, long-term pent-up demand pushed the assets held in the investment vehicle to more than $1 billion in just two days, even higher than this time Net inflow of new ETF 800 million. However, it was not until October 2023 that its market capitalization exceeded $1.4 billion. Due to the highly self-fulfilling nature of BTC, it is difficult to expect large-scale inflows of new funds once the price continues to fall.
With the exception of GBTC, there are only $1.4 billion in these 10 truly new ETFs, a drop in the bucket compared to Bitcoin’s $840 billion market cap. If GBTC is added, the total scale reaches 25 billion U.S. dollars. Considering that GLD is only more than 50 billion, BTC's goal of catching up with gold has been halfway completed.
In addition, FTX's bankruptcy estate is selling on highs, which also contributed to the decline. Since the ETF has stimulated a 50% increase in Bitcoin prices through expectations, short-term adjustments are not difficult to understand.
A friend's comment: There are two prerequisites for the large-scale expansion of the web3 industry: 1. Recognition of the value of crypto; 2. Wallet. The first item is currently being carried out. The passage of ETF is already a huge success, which means that it has successfully entered the system. Next, we will wait for the compliance market to cultivate more wallet users. When the number of wallet users increases, the industry will can get rid of traditional constraints.
Positions and Fund Flow
Inflows into U.S. open market funds slowed, with net outflows last week:
Judging from the trend of the most shorted stocks, the short squeeze market has been completed and is now entering an orderly short covering market:
Goldman Sachs: "Long positioning is extreme...Non-dealer positioning in U.S. stock index futures is at all-time highs. System strategy positioning (CTA + Volatility Control + Risk Parity) is near one-year highs."
Goldman Sachs clients’ long-only fund purchases of U.S. stocks last week were net purchases of US$1.2 billion, and hedge fund clients were net sellers of US$4 billion. Short-selling activities in real estate, travel and leisure, health care, and finance increased (these industries all performed at the end of last year) protrude):
Bank of America still believes that it is more likely that long CTA funds will stop the loss and leave the market:
Deutsche Bank's statistical caliber is in a moderate overweight state. The current position of subjective investors is at the 72nd percentile of history, and the position of systematic strategy investors is at the 67th percentile of history. The positions of subjective investors have fallen back recently:
CTA capital position is at the 72nd percentile historically:
Inflows into bond funds ($13.9 billion) further accelerated to a nine-month high, in large part as inflows into investment-grade bonds ($7.2 billion) jumped to their highest level since June 2020, while Treasury fund outflows. Money market funds (+$39.7 billion) received another week of strong inflows, and although slower than last week, inflows of $163 billion in the first two weeks of 2024 were the strongest to start the year on record:
Sector-wise, technology ($2.3 billion) inflows rebounded to a four-month high after being sluggish for the past three weeks. Real estate ($500 million) received inflows after four consecutive weeks of outflows, while utilities and healthcare each received $400 million in inflows this week. Materials ($100 million) received small inflows for the first time in eight weeks. Meanwhile, Consumer Staples (-$700 million) and Energy (-$500 million) continued to witness outflows for the 5th and 11th consecutive weeks. Industrials (-$400 million), Financials (-$300 million) and Telecommunications (-$200 million) also saw outflows this week:
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institutional perspective
[Goldman Sachs: Trading advice in a highly valued market]
Valuations for the S&P 500 on a total and equal-weighted basis are at historically high levels. Barring an unexpected further decline in yields, further valuation expansion is unlikely. Here are three trading strategies that have value in overvalued markets:
(1) Hold small-cap stocks: Low valuations and good economic prospects predict a 15% return for the Russell 2000 Index over the next 12 months, compared with just 8% for the S&P 500 Index.
(2) Hold stocks with weak relative to strong pricing power: Companies with weak pricing power generally outperform as EBIT margins improve.
(3) Among defensive industries, consumer staples are better than Utilities. In eight Fed easing cycles since 1984, the probability of consumer goods beating the S&P 500 within 12 months of the first rate cut was 75%.
The Russell 2000's price-to-book ratio of 2.0x remains below the 40-year average of 2.1x and the 10-year average of 2.2x. The P/E ratio is less useful for the Russell 2000 Index because about a third of its constituents lose money:
This chart shows the median relative returns of various industry sectors to the S&P 500 over the 12 months following the start of a Fed rate-cutting cycle since 1984, and how often they outperform the S&P 500:
[Deutsche Bank: Repurchases may increase significantly]
Entering the fourth quarter 2022 earnings season, the company is expected to once again report strong earnings growth and earnings surprises. But given the current market pull and positioning levels, the rebound may not be as strong as usual earnings season, which historically has an 80% probability of a rise, with a median gain of 2%.
Stock buybacks have been one of the largest buyers of U.S. stocks and have historically been highly correlated with earnings. However, since 2022, although the company's profits have reached new highs, the amount of repurchases has not rebounded significantly and is still far below the historical average.
The main reason for the lack of buyback rebound is that uncertainty about the economic outlook remains. However, with corporate cash flow abundant, buybacks are expected to accelerate again as corporate profits continue to improve.
If the repurchase ratio returns to historical averages, share repurchases in 2022 may grow from about US$800 billion to US$1 trillion. This helps U.S. stocks achieve annual price growth of 7 to 8%.
