Source: Zhitong Finance Author: Rousseau
Bullish forces have covered almost all of Wall Street, yet “extremely excited” warnings are playing out.
After experiencing a debt boom for more than a decade, the era of monetary austerity and uncertain anti-inflationary trajectory begun by the Federal Reserve's aggressive interest rate hike may bring a major stock market liquidation to Wall Street and other financial centers.
Of course, some of the pain seemed to come as expected. After all, no one can ignore the new liquidity difficulties faced by banks and commercial real estate in the US region in recent weeks, or even forget the double-digit collapse in segments such as bonds, stocks, and speculative technology in 2022.
However, despite these pressures driven by interest rate expectations, the US financial market has generally withstood the test of this currency storm — some key risky investment measures are even reminiscent of the happy days of the easy money era.
Although two higher-than-expected inflation figures prompted traders to re-evaluate the timing and extent of the Federal Reserve's first rate cut, the S&P 500 index is still close to the recent historical record, falling only 0.4% this week.
After the overall CPI increase in January exceeded expectations, the overall PPI and core PPI growth rate of the US also exceeded economists' general expectations in January. Core CPI increased 0.4% month-on-month in January, the biggest increase since May last year. This is a 3.9% increase compared to a year ago. The producer price index (PPI), which represents an indicator of producers' terminal demand, rose 0.3% from December last year, exceeding economists' general expectations of 0.1%. At the same time, the index rose 0.9% from the same period last year, which also exceeded economists' expectations of 0.6% year-on-year growth.
According to some analysts, the S&P 500 index has recently reached new highs and remains high, thanks to the continued artificial intelligence investment frenzy triggered by extremely strong demand for AI chips, and at a time when the UK, parts of Europe, and Japan are falling into recession, the US economy is still booming and is expected to achieve a soft landing.
Although the inflation data hit the market's overly aggressive interest rate cut expectations (after PPI data was released, interest rate futures traders drastically lowered their expectations for interest rate cuts in May, believing that the possibility of interest rate cuts in May is only one-quarter. Interest rate cuts are expected to rise sharply in June, and interest rate cuts of less than 100 basis points are expected in 2024), but many economic data and indicators seem to strongly support the bullish power of US stocks. A comprehensive global financial stress index compiled by Bank of America (Bank of America), which measures market risk, risk hedging needs, and investor liquidity, was at its lowest level since April 2021 this month.
Furthermore, also driven by bullish forces in the US stock market and expectations of interest rate cuts, stock traders are buying bullish options one after another, while the price of high-yield US dollar bonds in the Asian region has been rising for 17 consecutive weeks. This period of time has reached a record high. Even Bitcoin, which has a very high risk factor, surpassed $50,000 for the first time since 2021.
“The stock market looks really optimistic, and corporate profits are very flexible. As a result, a soft landing for the US economy is still under discussion. For the bulls, this information couldn't be better.” Que Nguyen, Research Affiliates' Chief Investment Officer of Equity Strategy, said. “It is true that these two inflation figures are more sticky than we would like, but the Fed officials seemed very optimistic about all of this and said that the next step is to cut interest rates, but the pace may be slower than market expectations.”
In the face of heightened risk appetite, the financial environment has eased to a level not seen since the Federal Reserve began active action against inflation. According to well-known analyst Ed Yardeni, when deciding on the next rate change, Federal Reserve Chairman Jerome Powell (Jerome Powell) may refer to former Federal Reserve Chairman Alan Greenspan (Alan Greenspan)'s famous 1996 speech on irrational prosperity.
“If Powell and his peers came to the conclusion that the US stock market bubble like in the 90s was expanding, would they choose not to lower the federal funds rate?” The founder of Yardeni Research said. “We're not sure, but we doubt this outcome could happen this year.”
Be alert! The “buying expectation, selling fact” effect may be evident
Wall Street traders have indeed been hit amidst this week's mixed economic data. On Tuesday, the stock market was sold off due to hot CPI data. The following two trading days saw a slight rebound in the stock market due to weak retail sales, but after the release of strong PPI data, the stock market came under pressure again. Despite a fall on Friday, the S&P 500 remained above 5,000 points. During this period, traders drastically lowered their expectations for the Federal Reserve to cut interest rates.
However, as the Q4 earnings season comes to an end, US companies can be described as collectively handing over a steady quarterly record. According to data compiled by Bloomberg Intelligence, the overall profit per share of the S&P 500 companies increased 7% in Q4, continuing the recovery from the contraction in the first half of 2023.
Art Hogan (Art Hogan), chief market strategist at B. Riley Wealth, said: “I think the biggest change is that we have changed the narrative logic from 'hey, the Fed will cut interest rate' to 'hey, the Fed will cut interest rate'.” “As a result, the outstanding performance of US companies in the fourth quarter of last year can be said to have replaced expectations of interest rate cuts by the Reserve Bank and became the most critical catalyst to support the market.”
However, according to some analysts who are more cautious about the future market of US stocks, even if the company's Q4 performance generally exceeds expectations and the growth rate is strong, it is not ruled out that US stocks will experience a “buying expectations, selling fact” effect. After all, global stock investors tend to use speculative expectations to raise share prices rather than potentially substantial facts.
Therefore, according to these cautious analysts, the strongest supporting force of “AI faith” and the upcoming quarterly results of Nvidia (NVDA.US), the S&P 500 superweight stock, is more likely to be a negative catalyst to end the rise in US stocks. The main logic is the “buy expectations, sell facts” effect. Unless, Nvidia's actual results and globally focused performance guidance far exceeded market expectations.
In the field of fixed income, it is also difficult to find fears; it is enough to see that bulls have penetrated into every corner of the financial market. Data compiled by the agency shows that globally, the additional yield required for investment-grade and junk grade corporate bonds held by investors has fallen to the lowest level in two years, reflecting a sharp rise in market risk appetite.
As optimism prevails, is it time for investors to consider hedging or slashing positions?
The market's interest in hedging downside risks also appears to be waning. Credit default swap (CDS) prices fell, and the Markit CDX North American High Yield Index and a similar investment-grade CDS tracking indicator all hit a two-year low.
The US stock market is also full of feelings that seem “too optimistic”. Stock traders generally do not hedge against the risk of falling, but instead hoard bullish options, which seem to be preparing for further increases. A differential value known as call option bias reached its highest level since 2021. It was in 2021 that all kinds of speculative frenzy broke out, from MEME stocks to NFT assets.
Brian Garrett (Brian Garrett), managing director from Goldman Sachs Group, wrote in a report: “Many measures of sentiment are consistent with irrational levels during the 'extreme excitement' period in 2021.” “I personally saw more than one 'SPX 5000 point' hat circulating on the floor.”
Investors' reluctance to add downside protection measures for potential losses is understandable to some extent. After all, options hedging has largely failed in the past two years. According to a model indicator from Morgan Stanley (Morgan Stanley), the implied probability that the S&P 500 index will fall 10% in the next six months this week is only close to 9%, the lowest level since at least 2010, and half of the historical average.
But for reverse investors, now is the time to consider hedging downside risks and reducing positions. In particular, this year, everything from stock selection hedge funds to rules-based traders and individual investors has increased their exposure to stocks. According to a data compiled by Bank of America, global equity funds have attracted 59.5 billion US dollars in the past four weeks. This is the largest inflow since February 2022. Often, after this data reaches a phased peak, there may be a sharp outflow scale, mainly due to profit settlement sentiment.
“The overheating of CPI has made the market realize that the risk is two-sided. However, the investment mentality may be difficult to change because most people are stuck in recent history,” the Morgan Stanley analytics team, which includes Christopher Merley, wrote in a report. “Stock holdings are becoming more crowded, so many investors are more in need of hedging measures.”
“Wall Street's Most Promising Strategist” Sounded the Alarm: US Tech Stocks Are in a Bubble, Waiting to Burst
Bank of America strategist Michael Hartnett (Michael Hartnett), who has the title of “Wall Street's Most Promising Strategist,” recently said that there are many similarities between current US technology stocks and the previous bubble burst period. This indicates that technology stocks are close to but have not reached a level that could cause their bubble to completely burst; that is, they are in a bubble and are waiting to burst.
The research team led by Hartnett wrote that inflation-adjusted bond yields are seen as an indicator of tight financial conditions and a common way to judge the bursting of a stock market bubble. According to their estimates, given all the debt overflowing in the global financial system, the real yield (10-year US Treasury yield minus inflation) must reach 2.5% or 3% to end investors' fanaticism about artificial intelligence and big tech stocks. Currently, Bank of America estimates an actual yield of around 2%.
Valuation is another reason. The research team led by Hartnett said that the current price-earnings ratio of the seven major US tech giants (Magnificent Seven), which has high weight in the NASDAQ and S&P 500 indices, is about 45x, which is very expensive no matter what.
“This valuation level is very expensive, although it is far from the 67x price-earnings ratio of the Japanese stock market in 1989 and the 65x price-earnings ratio before the Nasdaq Composite Index plummeted in 2000. However, it is undeniable that the burst of the bubble did occur after a phased high point in valuation, not necessarily the highest point in history, and the timing of the bubble bursting was the same every time in history.” Hartnett and other analysts said.