Overview of US stock market from early 2024 to present: Expectations of interest rate cuts pushed back, technology giants driving US stocks up
1.1. Resilience of economic data drives a rebound in US bond yields
A series of economic data released in January 2024 showed that the US economy still has resilience. In December 2023, the number of non-agricultural employment rebounded from the previous value of 199000 to 216000, returning to above the median level from 2015 to 2019, and the unemployment rate remained unchanged at 3.7% compared to the previous value; Retail sales in December 2023 increased by 0.6% month on month, exceeding previous expectations and rebounding to 4.78% year-on-year, in the upper part of the growth range from 2015 to 2019. In Q4 2023, the quarter on quarter discount rate of GDP was 3.3%, although it decreased from the previous value of 4.9%, it is still at a relatively high level, especially with a consumption quarter on quarter discount rate of 1.9%.
Under the unexpected economic data, the expectation of interest rate cuts at the Federal Reserve's March meeting has decreased, driving the 10-year US Treasury yield, which has been declining too quickly since the fourth quarter of 2023, to rebound from a low of 3.78% to over 4.1%. According to Bloomberg's calculation of the implied policy rate for federal fund futures, the earliest expectation of rate cuts has been postponed from March to May, and the number of rate cuts for the entire year of 2024 has decreased from the expected 6 at the end of 2023 to the expected 5 on January 19, 2024.
1.2. AI leads the rise of the S&P 500, with large cap stocks outperforming small cap stocks
Although expectations for interest rate cuts have decreased and risk-free rates have risen, AI giants have led the rise in US stocks. From the beginning of 2024 to January 26, six companies, Nvidia, Microsoft, Meta, Alphabet, Amazon, and AMD, contributed 82% of the S&P 500 index's growth.
The upward trend of risk-free interest rates affects market style. From mid November to the end of December 2023, small cap stocks represented by the Russell 2000 Index underperformed large cap stocks represented by the Russell 1000 Index. From early 2024 to January 19th, large cap stocks outperformed small cap stocks. From November to December 2023, interest rate sensitive real estate led the rise, while from early January to January 19, 2024, real estate fell, and technology and communication services were boosted by fundamental expectations, leading the increase.
2、 Outlook for US Stocks: Goldilocks Stage with Enhanced Expectations of a Soft Landing, Profit Growth Expectations Continuing to Drive the Stock Index
2.1. The US stock market is still in the Goldilocks stage, where strong expectations for an economic "soft landing" and rising profit expectations are driving up valuations. The valuation of the "Big Seven" in the US stock market does not seem particularly dangerous
The expectation of a soft landing for the US economy is strong. The economic data released in January shows that the US economy still has resilience. Inflation is likely to continue to decline in 2024. On the one hand, housing service inflation in 2024 will lag behind the decline in new lease prices. On the other hand, the current improvement in the supply and demand of the labor market and the slowdown in the year-on-year growth rate of service industry wages will help reduce the pressure of inflation in super core services.
In the macro environment of a "soft landing", the recent rise of the US stock market appears to be driven by an increase in profit expectations driving valuation. Taking the "Big Seven" of the US stock market as an example, if optimistic profit expectations are ultimately realized, then valuations do not appear to be very dangerous. Nvidia's PE calculated based on the expected EPS for the next 12 months is only 29 times, at the percentile of 34% in the past decade. Meta's PE22 times and PEG1 times in the next 12 months are in the percentile of 39% in the past decade. However, companies like Tesla with poor short-term profitability have continued to decline since 2024, with PS5.67 times, at a percentile of 61% in the past decade (the above valuation data is as of January 24, 2024).
2.2. Based on historical experience, during the transitional phase of the Federal Reserve's monetary policy, the trend of US bond yields has declined, US stocks have risen, and growth stocks often outperform
Looking back at the six interest rate hike cycles since the 1980s, the yield of 10-year US Treasury bonds has shown a downward trend from the last rate hike to the first rate cut in the next round.
In the six rounds of monetary policy cycles of the Federal Reserve since the 1980s, the US stock market tends to rise during the period from the last interest rate increase to the first interest rate reduction. Except before the Internet foam burst in 2000, the S&P 500 index rose during the transition period of monetary policy.
During the period from the last interest rate hike to the first interest rate cut, growth stocks often outperform value stocks. In the transition period of monetary policy from the end of three rounds of interest rate hikes by the Federal Reserve since 1999 to the first interest rate cut, the S&P 500 growth index outperformed the S&P 500 value index from December 2018 to July 2019, and from June 2006 to September 2007. Only during the period from May 2000 to January 2001 when the Internet foam burst, growth stocks outperformed value stocks.
2.3 Important future events to focus on: Federal Reserve meetings, Treasury bond issuance plans, financial reports
The Federal Reserve meeting on January 31st may signal a slowdown in balance sheet contraction, which will be beneficial for the downward trend of US bond yields. Firstly, the balance of reverse repo is rapidly declining, and at the rate since May 2023, it is expected that the balance of reverse repo will decline to pre pandemic levels from April to May 2024. At that time, the Federal Reserve's continued balance sheet reduction will begin to affect bank reserves. When the bank reserve level reaches what the Federal Reserve considers to be an "adequate reserve level," the Federal Reserve will stop its balance sheet reduction. Referring to 2019, the proportion of bank reserves to GDP at 8% may be a warning line, and by the end of September 2023, this proportion would be around 11%. We estimate that with a monthly contraction of $95 billion, the Federal Reserve is expected to see an opportunity for easing by mid-2024. Secondly, the BTFP tool launched in 2023 due to the crisis of small and medium-sized banks is about to expire on March 11, with a current balance of $167.8 billion. If the BTFP is not renewed upon maturity, it will cause a contraction in the Federal Reserve's balance sheet.
We need to pay attention to the impact of the new bond issuance plan announced by the Ministry of Finance at the end of the month on US bond interest rates. If the issuance plan for the first quarter of the 2024 fiscal year is raised or the scale guidance for the second quarter exceeds expectations, it may affect US bond supply and demand, thereby driving up the 10-year US bond interest rate. The size of the US federal government deficit reached $509.9 billion in the first quarter of fiscal year 2024 (October December 2023), an increase of $88.5 billion compared to the first quarter of fiscal year 2023 (October December 2022), a year-on-year increase of 21%. Among them, an increase of $71.2 billion in interest expenses was an important factor driving the increase in the deficit.
The next half month is the peak period for financial report release. As of January 26, 2024, there were 124 companies on the S&P 500 that released financial reports, of which 97 had higher than expected profits, 5 remained unchanged, and only 22 were lower than expected. Based on the consistent expectations provided by Factset, the profit forecast for Q4 2023 was not given too high. The S&P 500 index's profit forecast for Q4 2023 decreased by 1.66% year-on-year, lower than the growth rate of 5.25% in Q3 2023. Given the strong resilience of economic data in the fourth quarter of 2023, the probability of overall profits falling below expectations is not high. Therefore, we can actively explore companies whose profits can exceed expectations.
3、 Suggestion for US stock ETF allocation: Increase holdings of long-term US bonds, continue to allocate US stocks, and prioritize growth over value
US bonds have entered a cost-effective allocation range. In view of the downward trend of the yield of the 10-year treasury bond bonds in 2024, it is recommended to increase the holdings of long-term US bonds at the right time. In the Goldilocks stage where the expectation of a "soft landing" is expected to strengthen, profit growth expectations continue to drive the stock index. It is recommended to continue allocating to US stocks, where style growth is better than value. It is recommended to continue allocating NASDAQ related ETFs. Pay attention to industries with stronger profit growth, such as communication services and information technology. By taking advantage of the rising US bond interest rates, we can gradually increase the allocation of index ETFs with strong interest rate sensitivity, such as Russell 2000 and Biotechnology.