Perhaps few people could have imagined at the beginning of last month that after experiencing the "Black Friday" and "Black Monday" triggered by poor non farm payroll data, the US market could still fully recover in August, which has once again boosted the confidence of many cross asset investors in the local market
The US market has not encountered the following scene in 17 years: ETFs tracking government bonds, corporate credit, and stocks have risen synchronously for four consecutive months, which is the longest continuous rise period since at least 2007.
Meanwhile, historical statistics compiled by Ned Davis Research over the past seventy years show that the S&P 500 index has risen by 25% in the past 12 months. Before the first rate cut of the Federal Reserve's easing cycle, the US stock market had never seen such a significant increase in the past!
Obviously, despite lingering doubts about the economy and inflation, as well as how central bank officials will respond, traders are not currently "nervous" about it. Before the Federal Reserve took action, the bond market had already digested a series of interest rate cuts, default risk indicators were declining, and the stock market surge reflected a confident bet on the prospect of a soft landing.
Magical counterattack
Let's review the performance of various markets in the past month: the S&P 500 index rose 2.3% in August, ETF funds tracking long-term treasury bond bonds rose 1.8%, and investment grade bonds rose 1.5%. The four major asset ETFs (SPY, TLT, LQD, HYG) all rose at least 1% this month, and the US stock market alone increased its market value by over $1 trillion.
SPY, TLT, LQD and HYG are the codes of US S&P 500 index ETF, US treasury bond bond ETF, corporate bond ETF and high-yield bond ETF respectively.
These are all manifestations of cross asset bulls showing their skills, who firmly believe that Federal Reserve Chairman Powell can cut interest rates in the event of achieving an economic soft landing. Of course, everything will largely depend on the performance of economic data before the Federal Reserve's interest rate meeting on September 18th.
Everything must go smoothly, "said Lindsay Rosner, head of multi industry investments at Goldman Sachs Asset Management." We need to continue to maintain trend or above trend economic growth. We need a lukewarm labor market so that consumers can continue to consume. All of this must be perfectly balanced
Of course, although the market has returned to normal, the consecutive "black trading days" experienced in early August do indicate the fragility of some crowded trading at present. At that time, the July non farm payroll data in the United States triggered market turbulence, causing Wall Street's fear index VIX to soar above 65, and US stocks, especially technology stocks, fell sharply for several consecutive days.
Some industry insiders have said that if the short-term market crash experienced in early August has taught us any lesson, it is that the bets that people are unanimously pursuing, such as long AI themed and yen financed arbitrage trades, may suddenly turn around.
New Tide and New Wind Direction
Since the beginning of this year, the rise of the US stock market has still been mainly driven by technology giants, but the range of rising stocks in recent months has actually expanded. Many investors have turned to previously neglected areas in the market, such as smaller companies and industries that are more sensitive to the economy.
The Russell 2000 Index, composed of small cap stocks, and the equally weighted S&P 500 Index, which gives equal weight to all constituent companies, have performed better than the benchmark S&P 500 Index since the end of June.
Traders now seem to be interested in various assets, from small cap stocks to speculative debt. They firmly believe that despite the weak performance of labor market data last month, the United States will still be able to avoid a recession. According to EPFR Global data compiled by Bank of America, funds focused on US stocks had a net inflow of $5.8 billion again last week, and have now shown a net inflow for nine consecutive weeks. Funds focused on high-yield bonds attracted $1.7 billion.
However, stocks still appear to be relatively expensive at present. According to FactSet data, the forward P/E ratio of companies in the S&P 500 index for the next 12 months is about 21 times, which is about 18 times higher than the average level of the past 10 years.
Credit spread - the extent to which investors require a higher yield when holding corporate bonds than when holding US treasury bond bonds, usually reflecting investors' concern about the economy. The stronger the worry, the larger the interest rate spread, in order to compensate for the higher default risk faced by corporate bonds.
But currently, investors do not seem to be worried: by historical standards, corporate bond spreads are still relatively small. In 2022 and 2023, the related interest rate spread was even larger, as investors were more concerned that the Federal Reserve would trigger an economic recession while suppressing inflation. Recently, although the market briefly widened interest rate differentials due to poor employment data in July, there has been a basic reversal since then. This indicates that investors feel that they need to see more bad data before truly pressing the sell button.
In the US treasury bond bond market, the yield of two-year and 10-year US bonds is now expected to end the longest consecutive record of upside down in the history of more than two years - this usually happens when the economy enters or is on the verge of recession, or when the Federal Reserve is close to cutting interest rates. It is currently unclear how the situation will unfold this time.
Federal Reserve officials have stated that even if there are no further signs of labor market weakness, they plan to gradually cut interest rates as a precautionary measure. This may lead to the normalization of the yield curve without an economic recession. However, another scenario in the market is that disappointing data could lead to more aggressive interest rate cuts and a faster decline in short-term yields, which could be a sign of a possible repeat of history (the end of the yield curve inversion predicting recession).
At present, some market participants are still cautious. For Jack McIntyre, a global bond portfolio manager at Brandywine Global Investment Management, predicting the post pandemic world is almost futile. If he had to make bold guesses, it would be that the economic resilience would weaken in the coming year, and in this environment, bond yields would outperform stocks.
He said, "For me, a soft landing is just a postponement of a hard landing. I don't think we will go back from a soft landing to not landing
This Friday, the US Department of Labor will release the latest non farm payroll data for August, which undoubtedly deserves close attention from investors. At a time when economic growth becomes the sole focus of the market, the performance of heavy macroeconomic data may significantly affect market sentiment. Federal Reserve Chairman Powell stated at the Jackson Hole Global Central Bank Annual Meeting last month that the "direction of future policy is clear," but "the timing and pace of interest rate cuts will depend on new data, changing prospects, and the balance of risks.