Market Overview
Major global stock markets have fallen in the past two weeks, with only the Nasdaq recording a two-week gain:
The US dollar continued to remain strong, the Japanese yen was slightly weak, and the offshore RMB was flat:
Cryptocurrencies strengthened, while energy and metals weakened. It is particularly noteworthy that Saudi Arabia expressed its willingness to increase oil production to the United States to promote the "US-Saudi Mutual Defense Agreement". The news caused crude oil prices to plummet by 7%, but the Israeli-Palestinian conflict this week may provide impetus for oil prices to regain their upward momentum:
Cycle and defense strength and weakness bases remain unchanged:
Large-cap stocks continue to outperform small-cap stocks:
The most important event of the past week was the September employment report released by the US government last Friday. The number of employed people increased significantly more than everyone expected, so the first reaction of the market was panic. The price of 10-year Treasury bonds plummeted by nearly 2%, and the stock market seemed to have a trend of further decline. The CME federal funds rate forecast tool showed that the probability of a rate hike in November increased by 10 percentage points. But the final decline did not change, still at 27%.
But the situation quickly reversed, with the S&P 500 hitting bottom half an hour after the opening and closing up 1.2%. The 10-year Treasury bond hit bottom around 10:50 a.m., recovering about a third of its losses. The probability of a rate hike also retreated from the edge earlier in the day.
The 10-year Treasury yield climbed to 4.88% on Friday, its highest level since 2007. It closed at about 4.8% on Friday, up from 3.3% six months ago. The 30-year Treasury yield briefly topped 5.00% Friday morning before falling below that threshold to settle at 4.97%.
As long-term interest rates have risen faster recently, the yield curve inversion has improved significantly. The current 10-02Y inversion is only 30bp, but there is still a long way to go before the normal curve is restored. If 02Y maintains the current level of 5.08%, 10Y may have to rise to more than 6% to be considered normal.
This is mainly because after a brief panic, the market is more concerned about the smallest increase in wage growth since June 2021, close to the level that meets the Fed's 2% inflation target, which is an important sign of labor market loosening. At least it means that the labor market does not need the Fed to further raise interest rates.
Summary of the September non-farm report: employment in key sectors of the economy continued to recover, but wage growth slowed down. We believe this provides the Fed with room to continue tightening policy without seriously damaging economic growth (there is more room, but it may not be done). In terms of the impact on the market, the report is generally neutral, with the increase in employment offset by the decline in wage growth.
Nonfarm payrolls surged by 336,000 in September, beating all expectations and the biggest monthly gain this year. Data for the previous two months were also revised upward, totaling 119,000. This suggests the labor market remains strong.
Job growth continues to be concentrated in service industries that require a high degree of personal contact, such as education, health care, leisure and hospitality. These industries added 170,000 jobs in September and account for 55% of total nonfarm employment growth in 2023.
At the same time, wage growth was relatively weak, with average hourly earnings slowing to 4.2% year-on-year, lower than expected. Average hourly earnings grew by only 3.4% in the past three months. Various surveys show that companies are also less willing to raise wages, which indicates that the balance between demand and supply has improved, which is good for the Fed and inflation.
The combination of a tight job market but slowing wage growth provided the basis for the Federal Reserve to raise interest rates in November. The report overall showed that the labor market remained strong but inflationary pressures eased.
After the report, which both bulls and bears could find reasons for, the market reaction was also divided. U.S. Treasury yields collectively rose to new highs, but U.S. stocks closed higher. Generally speaking, they tend to show a negative trend. Such a report is unlikely to support the stock market's rebound. Friday's rebound is more like a technical one. The bear market is not over. Before waiting for the economic recession and credit events to lead to a policy shift, the stock market may fluctuate in a range, and the rebound is difficult to sustain.
In an ultra-low interest rate environment, investors value corporate valuations more than profit growth. But now that interest rates are rising, investors will have higher requirements for profit growth. Rising interest rates will increase borrowing costs for companies, potentially constraining growth. How the positive and negative impacts of interest rates and inflation on profits are offset in the future will determine whether the stock price can continue to rebound. The ideal situation is that the impact of falling inflation on profit margins has been weakened, and profits will not be caused by the rapid rise in raw material and labor costs as before. Space is significantly squeezed. While moderating input cost pressures and continued economic momentum could help boost margins, significant margin gains appear unlikely given the resilience of wage growth and higher interest rates and taxes.
Other economic events to watch
Most Federal Reserve officials generally believe that the high interest rate environment will need to be maintained for a long time, and "hawkish" representatives Bowman and Mester do not rule out the possibility of further interest rate hikes in November.
The U.S. PCE price index rebounded to 3.5% year-on-year in August, while the core PCE slowed down to 3.9% as expected.
The final value of the US Markit manufacturing PMI in September was revised up to 49.8; the final value of the services PMI was revised down.
The final value of the month-on-month growth rate of durable goods orders in the United States in August was revised down to 0.1%.
The latest initial jobless claims rose to 207,000.
As of October 7, the Atlanta Fed's GDPNow model predicted that the annualized rate of U.S. GDP in the third quarter would be 4.9%, the same as the forecast on September 29.
The minutes of the Bank of Japan's September interest rate meeting showed "hawkish" views. One "hawkish" official said that he believed that the inflation target was about to be achieved and the normalization of monetary policy might not be far away.
U.S. stock third quarter report is coming soon
The third quarter 2023 earnings season kicked off this week, with the first batch of reporting companies including PepsiCo, JPM, Citigroup, Wells Fargo, BlackRock, etc., with a strong preference for financial stocks. The earnings season will not be digested until November 3 at the earliest, when 80% of the companies in the S&P 500 will release their earnings reports.
The market expects that the overall profits of S&P 500 companies in the third quarter will grow by 0 year-on-year, which is the most optimistic expectation of analysts for the earnings season since the fourth quarter of 2022; excluding the energy industry, it is expected to grow by 5%, the best since the first quarter of 2022; the median expected EPS growth of individual stocks is 2%:
From the perspective of sectors, the consensus is most optimistic about the growth of EPS in the communications services industry (+28%), and the most pessimistic about the EPS in the energy industry (-38%). Although the price of Brent crude oil rose by 27% in the third quarter, the average price was still 12% lower than the same period last year. Excluding the energy industry, the EPS of the S&P 500 index is expected to grow by 5%.
According to GS estimates, information technology is the largest contributor to the S&P 500 EPS forecast in 2024 and 2025, contributing 2 percentage points of growth each year. After the slump in 2022, communication services and consumer discretionary profits have bottomed out and will contribute about 3 percentage points of growth in 2024 and 2025 due to META and Amazon's expense management and profitability focus. However, the need for companies to invest in AI may limit profit growth in these sectors.
The concentration of Big Tech’s share of S&P 500 sales and profits poses a risk that could weigh on the index as a whole if these companies fail to meet expectations. In 2022, the seven largest stocks (Apple, Amazon, Google, META, Microsoft, Nvidia, Tesla) account for 12% of S&P 500 sales and 17% of earnings. By 2025, the market expects Big Tech to contribute 15% of S&P 500 sales and 24% of earnings. Antitrust scrutiny from regulators is a potential headwind to future sales and profit growth for this group of stocks, with recently announced lawsuits targeting the market practices of Apple, Amazon, and Google. Our previous case studies show that historically, AT&T, Microsoft, and IBM all experienced slower sales growth following the resolution of their respective antitrust lawsuits.
Since earnings are expected to reach a new high this quarter, and historically, earnings season is good for the stock market as a whole, with the overheated bullish sentiment easing and strong earnings expected, the outlook for the next quarter is not overly pessimistic. The key is to see whether the volatility of US bonds can be alleviated, that is, whether the yield can turn from a unilateral rise to a range of fluctuations.
Normally, such a massive surge in real yields would push the S&P 500’s forward price-to-earnings ratio down to 12 times from its current 18, according to old bond king Bill Gross. But excitement about the potential for AI breakthroughs and massive government spending have blunted the impact. Even so, “can AI and a future $2 trillion fiscal deficit prove that ‘this time is different?’ ” he wrote. “I doubt it.”
Impact of the war
More than 600 Israelis have been killed so far in a weekend of surprise attacks by the Islamist militant group Hamas. Saturday was Israel's deadliest day in decades following months of a surge in violence between Palestinians and Israelis, as the long-running conflict now enters uncharted and dangerous new territory. Israel formally declared war on Hamas on Sunday and responded with airstrikes on densely populated Gaza, with Prime Minister Benjamin Netanyahu vowing to retaliate, warning that Israel would take "strong revenge" and be ready for "a long and difficult war." The Palestinian Health Ministry said at least 413 Palestinians had been killed in Gaza since Saturday.
In addition, Hamas has launched attacks in Israeli-occupied territories, killing several foreigners, including Americans and French. Major developed countries have expressed support for Israel, and the United States has moved the Ford aircraft carrier strike group closer to Israel.
The national financial markets were closed over the weekend, and the related war news did not have an impact. The digital currency market continued to fluctuate weakly. From the last large-scale war, when Russia invaded Ukraine, the time point was February 2022. The S&P 500, gold and digital currencies all closed higher that month, but then fell for three consecutive months. However, at that time, the Fed continued to raise interest rates.
Positions and Fund Flow
Several indicators of stock market investor positioning fell again, showing that investors' overall bearish sentiment has further strengthened.
The positions of systematic strategy portfolios dropped sharply to a neutral level, which is the 40th percentile in history (the dark blue line in the figure below). The positions of subjective investors (already in the underweight range) also dropped further to the level in May this year, which is the 29th percentile in history (the green line in the figure below).
Deutsche Bank analysis believes that the stock market's gain during the earnings season is negatively correlated with the stock market position at the beginning of the earnings season. The lighter the position, the greater the gain.
The overall stock position of CTAs (momentum strategy) has dropped significantly from last week and is currently at the 25th percentile historically, with a low position.
At the same time, CTAs are clearly bearish on bonds, extremely bullish on the US dollar, extremely bearish on gold, and extremely bullish on crude oil. This structure is quite clear and is getting closer and closer to a reversal.
The volume of U.S. stock call options minus the volume of put options continued to fall sharply, falling to the lowest level in 9 months and at a rare negative level in history (only 1 percentile)
Equity funds (ETFs and mutual funds) recorded net inflows ($3.3 billion) for the second week, but the scale slowed down from the previous week. Net inflows slowed down in the United States ($3.9 billion) and Asia ($1.2 billion), and emerging markets ($200 million) recorded slight net inflows. Net outflows in Europe ($1.8 billion) have continued for 30 weeks. Bond funds recorded net redemptions ($2.5 billion) for the second week, mainly due to outflows from corporate bonds and emerging market bonds, while government bonds continued to maintain a continuous inflow trend.
Money market funds ($70.8 billion) posted their strongest net inflows in three months, ending two weeks of net redemptions.
According to the latest data from the CFTC, the overall position of US stock futures has fallen again, the net long position of S&P 500 has decreased, and the net short position of Russell 2000 has increased. The net long position of Nasdaq 100 is flat, and the net short position of Dow Jones Asset Management + leveraged funds has exceeded 20% of the overall position value:
Driven by the rebound of the US dollar, the net short position of the US dollar has been reduced for three consecutive months and is almost zero:
Sentiment Indicators
The Goldman Sachs sentiment index is currently at 0.5, which is a neutral to positive range:
Bank of America's sentiment indicator fell sharply and is now in bearish territory
The bearish ratio of the AAII investor sentiment index rose to 41.58%, the highest level since early May, but the bullish ratio also rebounded slightly, and the sharp decline in neutral views showed that the long-short game would become obvious again:
The CNN Fear and Greed Index fell to 17.58 last week, the most panicky level since October last year, but rebounded in the following three days:
Share your views
[Bank of America’s view: Pay attention to structural trading opportunities]
Because as deleveraging caused by rising capital costs is continuing, there is a high probability that a recession will come, and that is when the market will bottom out and rebound. At present, we should focus on the relative value of different assets and sectors, rather than just looking at the absolute value.
Bank of America cited many obvious mismatch opportunities in its October 5 report, including:
Japan represents the concept of "no hard landing", while China represents the concept of "with a hard landing"
Bank stocks represent "hard landing", while brokerage stocks represent "no hard landing"
Transportation stocks represent "no hard landing", while retail stocks represent "yes hard landing", and the former have begun to catch up with the latter's decline
Small-cap stocks are sending signals of a US recession. Once a recession is confirmed, we should actively sell the "no hard landing" concept and buy the "hard landing" concept.
While waiting for a recession, it is more important to focus on these mismatch trading opportunities rather than just looking at the absolute value of individual stocks or sectors.
[Dalio said the United States will fall into a debt crisis]
“There’s going to be a debt crisis in this country,” the founder of hedge fund Bridgewater Associates said in a CNBC interview. The two spoke at a Managed Funds Association fireside chat. “The speed at which it happens, I think, is going to be a matter of supply and demand, so I’m watching very closely.”
Dalio is concerned that the economy faces headwinds beyond just high debt levels, saying growth could drop to zero, plus or minus 1% or 2%.
“I think the economy is going to slow down significantly,” Dalio said.
[Who is the main force in the bond market? ]
Due to the increase in supply and the change in demand structure, the yield of US Treasury bonds may remain at a high level. Against the background of rising government issuance (an additional $1 trillion was issued in the past three months), the Federal Reserve no longer purchases, the demand of commercial banks has declined, and institutional investors have reduced their risk appetite for bonds. These factors mean that Treasury bonds need to attract buyers with higher yields, so it is difficult for the 10-year Treasury yield to fall significantly.
Evidence for Optimism
Optimists believe that inflation is falling, which will eventually help curb the rise in interest rates in the secondary market. In the early 1980s, when inflation peaked and fell below the 10-year yield, the 10Y rate also peaked and fell, but with a lag of about 1 year.
【Consumer enthusiasm is high】
High-frequency consumption data in the United States rebounded sharply in the past two weeks to 1.8% YOY, and increased by 2.0% after excluding fuel consumption: It can be seen that when fuel consumption is excluded from total consumption, consumption growth is more obvious. This may mean that although energy prices are rising, this has not prevented consumers from increasing their consumption on other goods and services.
The Price of Carnival
The light blue line shows that banks have significantly relaxed their lending standards for enterprises since 2022. Historically, when standards were relaxed, clubs ushered in a wave of defaults. This time, it may be unusually difficult. The default rate of high-yield bonds in the dark blue has accelerated its rebound:
