21/08 Weekly Report: Institutions Are Buying on the Dip
Market Overview
Amidst rising concerns over higher government bond yields and inflation, coupled with worries over China’s unexpectedly slowing economy and looming debt crisis, global major stock indices experienced three consecutive weeks of declines. Both the S&P and NASDAQ have seen their steepest drops since the banking crisis in March and the end of last year. After an extremely optimistic sentiment in July, the market seems to have adjusted to a neutral range. Recent data indicates that some institutions have been buying on the dip over the past two weeks.
Stock Market
The S&P 500 index has dropped over 5% since the end of July, the NASDAQ 100 index and the Russell 2000 index both fell nearly 7%, the CSI 300 index fell 5.7%, the Hang Seng index declined almost 11%, the Nikkei 225 dropped 5.5%, and the Dow Jones Industrial Average showed a relatively mild drop. Despite this, the stock market has surged about 20% since the beginning of the year, so the current pullback is still considered healthy, without causing a significant deterioration in market sentiment.
The differences in declines reflect a shift in investment style, changes in interest rate and inflation environments, and a combination of earnings outlooks.
The Dow Jones Industrial Average is mainly composed of large, stable companies with a long history. In an environment of rising inflation and interest rates, investors might prefer these more defensive enterprises. Meanwhile, the NASDAQ index primarily consists of tech and growth stocks, and the Russell 2000 is predominantly small-cap stocks. High-valuation growth stocks, such as many in the NASDAQ, may face more pressure as rising capital costs could eat into future earnings prospects. By contrast, many Dow companies might fare better in an inflationary environment since they can more easily pass on increased costs to consumers.
Sector-wise, the biopharmaceutical, communication services, and energy sectors performed well last week, while non-essential consumer goods like automotive, durable goods, and travel sectors lagged.
Correlations between stocks (0.15–0.18) and sectors (0.33–0.35) have slightly rebounded due to the overall decline.
Interest Rate Market
Supported by supply-side pressures and strong economic data, the U.S. 10-year Treasury yield reached its highest level since October at 4.33% last Thursday. In contrast, the 1–12 month bond yields remained virtually unchanged. In the UK, due to strong inflation indicators and wage growth surpassing expectations, the 10-year bond yield surged to 4.75%, the highest since October 2008.
Concerns about China’s deteriorating real estate crisis and its impact on China’s sluggish economy also exacerbated negative sentiments.
Chinese real estate giant Evergrande Group filed for bankruptcy in New York on Thursday evening. The real estate dilemma is a significant drag on the beleaguered Chinese economy. Before the Evergrande news broke, another Chinese real estate behemoth, Country Garden, recently warned of losses amounting to billions of dollars for the first six months of the year. Moody’s downgraded the company’s rating due to “increased liquidity and refinancing risks.”
Overall, the stock market pullback reflects more of a repricing of interest rate and inflation expectations than a signal of a complete loss of economic momentum. The market had been overly optimistic in previous months, assessing the economic prospects in a rising interest rate environment. The momentum in the macro economy remains:
Regarding the interest rate market, the rise in the 10-year bond yield is not an indication that the Federal Reserve will significantly hike rates further. The prior rise in long-term rates didn’t match the rise in short-term rates. An adjustment was expected since either short-term yields would fall or long-term yields would rise. The bond market structure shouldn’t maintain long-term distortions. The Federal Reserve’s rate hike expectations have peaked, and marginal changes have limited impact on the interest rate market. Additionally, since August, the yield curve inversion has substantially narrowed, which can be seen as a sign of a rebound in long-term economic growth expectations.
Forex Market
The dollar strengthened alongside rising yields, with the DXY reaching a two-month high last week. USD/JPY briefly surged to 146.2, the lowest yen exchange rate since last November, surpassing the zones that triggered intervention by Japanese authorities in September and October last year. However, Japan’s Finance Minister Suzuki Junichi stated last week that the authorities did not intervene based on absolute currency levels.
The yuan briefly fell below 7.3 last week, hitting its lowest since last October. But the People’s Bank of China’s stance in defense of the yuan exchange rate, along with significant adjustments to the central parity rate, resulted in a significant rebound, with USDCNY finally settling around 7.28.
Last week, for three days, the People’s Bank of China set the onshore yuan’s central parity rate against the US dollar around 7.2, about 1000 basis points higher than the market rate. This is the largest scale of defense for the yuan via the central parity rate ever recorded. The yuan’s central parity rate serves as a reference point for trading, limited within a range of +2% and -2%. In theory, the People’s Bank of China would intervene indefinitely within this price range. Besides raising the central parity rate, there were reports that state-owned banks sold dollars directly in the foreign exchange market last week to purchase yuan.
The People’s Bank of China just cut interest rates at the beginning of last week, with more monetary and fiscal stimulus measures anticipated. The expanding interest rate differential may continue to put devaluation pressure on the yuan. However, mainstream institutions currently do not expect the yuan to depreciate significantly from its current position.
For years, China has been highly sensitive to any drastic fluctuations in the yuan, as speculative attacks accompanying yuan devaluation eight years ago (the 811 exchange rate reform) still loom large. With the rising pessimistic sentiment in the current market, China faces the risk of capital outflows, which could further trigger a more severe devaluation cycle, highlighting the need for appropriate intervention.
Trending Events
Federal Reserve Survey: US consumer short-term inflation expectations hit a new low since 2021
The survey published by the Federal Reserve Bank of New York on Monday shows that US consumer inflation expectations for the one-year period in July fell from 3.8% to 3.5%, the lowest since April 2021, marking the fourth consecutive month of decline. Expectations for inflation over three and five years also dropped, both from 3% to 2.9%.
Bank of Japan: July service e sector inflation reaches 2% for the first time in 30 years
CPI YoY increased by 3.3%, in line with expectations. However, the “core core CPI”, excluding energy and food, rose 4.3% YoY, the fastest since 1981.
Federal Reserve meeting minutes are hawkish: warns of significant upside inflation risks and is vigilant about stock market rises
The minutes indicate that most decision-makers still see significant upside risks to inflation and may need to hike rates further; many believe that even when cutting rates, balance sheet reduction might not halt; almost all decision-makers thought it appropriate to raise rates by 25 basis points in July, while two favored keeping rates unchanged. Fed staff no longer expect the economy to slightly contract this year, forecasting PCE inflation to fall to 2.2% in 2025.
In the FOMC policy meeting in July, Federal Reserve staff noted the general rise in stock prices, a slight narrowing of corporate bond spreads, and “significant” pressure on asset valuations. Risk assessment in May was “moderate”; they also highlighted residential and commercial real estate prices as “relatively high in relation to fundamentals.” Policymakers also pointed out the risk of a “significant decline in commercial real estate valuations, which could adversely affect certain banks and insurance companies among other financial institutions.”
Following energy and food, signs of sticky inflation reappear in the US, used car prices rise for the first time in four months
Statistics show that US used car wholesale data for the first half of August has increased MoM for the first time in four months, raising concerns that this might be another sign of lingering inflation following rebounds in energy and food prices.
US July retail sales MoM growth of 0.7% exceeds expectations, largest increase since January
Reaching $696.4 billion, surpassing the previous 0.3% (revised to 0.2%) and also beating market expectations of 0.4%, marking the largest increase in six months. Retail sales account for about a third of all consumer spending and are often seen as a barometer of the US economy. Benefiting from the continued growth in real wages, US retail sales growth in July significantly outperformed expectations, indicating a robust US economic performance.
China’s US Treasury holdings drop to a 14-year low
On Tuesday, August 15, Eastern Time, the US Department of the Treasury released the International Capital Flow Report (TIC), showing that as of June this year, China’s US Treasury holdings have declined for the third consecutive month, decreasing by $113 billion MoM, with total holdings dropping to $835.4 billion, the lowest since June 2009.
Since April last year, China’s US Treasury holdings have been consistently below $1 trillion. As of February this year, China reduced its US Treasury holdings for seven consecutive months, setting a new low for over twelve years for seven consecutive months. After increasing holdings in March and April, it set a new low since May 2010 in May.
However, China’s foreign exchange reserves rose to $3.193 trillion at the end of June, showing an overall upward trend this year:
Google’s “most powerful model” Gemini gives a glimpse, may be released in the fall
Media leaks suggest that Google’s new “superweapon”, Gemini, combines the capabilities of GPT-4, Midjourney, and Stable Diffusion. It can also provide analytical charts, create graphics with text descriptions, and control software using text or voice commands.
Bridgewater’s flagship fund took a bearish stance on US stocks and bonds in late July
Bridgewater reported to investors that in late July, its flagship fund, Pure Alpha, was “moderately” bearish on US stocks and bonds. Among the 28 assets analyzed by the fund, 15 held a bearish stance, including the US dollar, metals, and global stocks. The most bullish positions were in the Singapore dollar and the euro. The latest 13F report shows that Bridgewater increased its holdings in Pinduoduo and Chinese ETFs in Q2, heavily invested in US stocks and emerging market ETFs, and completely sold off its positions in Netflix and gold ETFs.
Market Sentiment
Earlier this year, there was a lot of pessimism in the market. The shift from pessimism to optimism powered the stock market rebound. We saw it quickly change from excessive pessimism to excessive optimism, and now we are beginning to see this situation reverse.
The CNN Fear and Greed Index has significantly dropped back to levels seen at the end of March, with a current reading of 45, which falls within the neutral range:
In the AAII Investor Survey, the bullish percentage has dropped significantly from 44.7% to 35.9%, and the bearish percentage has rebounded for two consecutive weeks, currently standing at 30.1%:
The Goldman Sachs Institutional Position Sentiment Indicator rose from the previous week (0.7 to 0.8):
Financial tensions surged to the highest level since March:
Bank of America survey: Investor pessimism is the lowest since February last year. Investors still expect the global economy to weaken in the next 12 months but believe that central banks can achieve a soft landing during this period.
Currently, investors’ asset allocation is at the lowest level in 16 months for underweighting stocks, with the highest overweighting of tech stocks in over two and a half years:
The cash allocation ratio has dropped from 5.3% the previous month to 4.8%, the lowest level since November 2021.
Capital and Positioning
Overall Positioning
Deutsche Bank’s aggregate U.S. stock positioning level has fallen for the fourth consecutive week to its lowest point in two months (52nd percentile historically). The decline is largely driven by discretionary strategies, with positioning levels now slightly below neutral (41st percentile). Systematic strategy funds have seen little change in the past week, overall maintaining their highest levels since the end of 2021 (70th percentile historically).
Sector Positioning
Tech (73rd percentile), staples (78th percentile), discretionary (83rd percentile), and communication services (84th percentile) are still over-allocated, though they decreased this week.
Industrials (72nd percentile) positioning has also decreased, still moderately over-allocated, and energy (70th percentile) is the same.
Real estate (40th percentile) is moderately under-allocated and remains stable, financials (33rd percentile) is also under-allocated and decreased this week.
Healthcare (37th percentile) and materials (33rd percentile) are under-allocated and remain stable, while utilities (17th percentile) are under-allocated and decreasing.
Fund Flows
Global equity funds saw net outflows of $2.1 billion, mainly driven by a net outflow of $5.2 billion from the U.S. European markets saw a net outflow for the 23rd consecutive week (-$1.3 billion), while emerging markets saw a net inflow for the 6th consecutive week ($3.7 billion), mainly flowing into Chinese funds but at a slower pace than the previous week. Money market funds saw an accelerated inflow, reaching $21.8 billion, marking the fifth consecutive week of inflows. Bond funds experienced a significant slowdown in net inflows, hitting a five-month low (+$0.03 billion).
Futures Data: Despite the spot market pullback, as of last Tuesday, U.S. stock futures net long positions rose for the third consecutive week, mainly due to increased net longs in the S&P 500 and Nasdaq 100, while Russell 2000 net longs decreased, very close to neutral.
Notably, the increase in net longs last week was mainly due to more sensitive leveraged funds.
In other futures markets, net bond shorts fell for the second consecutive week, mainly due to decreased net shorts in 5-year and 30-year bonds and increased net shorts in 2-year and 10-year bonds. In the forex market, the U.S. dollar net short positions increased, mainly due to increased net long positions in the euro and British pound, and decreased net shorts in the Swiss franc and yen. Canadian dollar net shorts increased, as did Australian dollar net shorts. In commodities, crude oil net longs decreased slightly. Silver and gold net shorts increased, with gold net longs cut for the fourth consecutive week, and copper net shorts also increased.
Goldman Sachs PrimeBook Data
As markets fell, hedge funds shorted U.S. ETFs at the fastest pace since September 2022, adding more than 7% of market value in a single week. However, this might not necessarily be a bearish signal, as they observed increased U.S. stock trading activity in recent trading days. Portfolio managers increased individual stock exposure and also increased Beta hedging, while ETFs typically represent large caps or sectors but beta.
Cryptocurrency Stablecoin Flows
On-chain stablecoins saw net outflows for the ninth consecutive week, with a significant outflow of $1.13 billion last week, marking the largest weekly outflow since April 2 of this year.
However, exchange-held stablecoin balances increased after two weeks, with a net increase of $240 million.
Focus of the Week
The main market catalysts this week are Jerome Powell’s speech on Friday at the Jackson Hole Economic Symposium and NVIDIA’s (NVDA) Q2 report on Wednesday.
Preview of the Jackson Hole Symposium
The symposium will be held from August 24th to 26th. This year’s theme is “Structural Changes in the Global Economy”, with a particular focus on the strengths of the global economy and potential inflation risks. The Jackson Hole Symposium could be a decisive moment; the market will be keenly watching for any signals from the Federal Reserve regarding expectations for higher neutral interest rates, which could be interpreted by the market as a hawkish stance, implying higher rates to cool the economy.
Key Points of the Fed Chairman’s Speech:
Jerome Powell is expected to rely heavily on recent data, including the latest CPI and Core Personal Consumption Expenditure (PCE) inflation reports.
He is anticipated to highlight some progress made in combating inflation, but will remain cautious. He might be relatively optimistic about the economic situation and will emphasize price stability, including growth below trend.
UBS believes Powell may maintain a sufficiently hawkish stance, paving the way for more rate hikes, but is confident he will not consider raising rates in September.
Bank of America states that Powell might reiterate the Federal Reserve’s commitment to its 2% inflation target and counter the market’s pricing for next year’s rate hikes. They believe that there is significant uncertainty in estimates of the neutral interest rate, but do not expect any significant shift in the neutral interest rate at this meeting.
Preview of Nvidia’s Earnings Report
Nvidia (NVDA) will release its second-quarter report after the market closes on Wednesday. This will be the biggest test for the AI hype cycle to date. It will showcase whether the AI craze that has swept the market in the past 8 months has genuinely brought economic value. Google and Microsoft saw positive profit growth last quarter, but they did not attribute this growth to AI. Instead, they credited their existing business gains. Microsoft’s AI-driven New Bing division saw a 4% decline in revenue last quarter.
Key Metrics to Watch for NVDA:
Revenue: Analysts predict a revenue of $11 billion, up from $6.7 billion the same period last year, indicating a 65% YoY increase.
Gross Margin: Declined last year, started to rise in Q1 to 66.8%.
Data Center Revenue: Continuously growing. Ongoing growth would quantify Nvidia’s momentum in the AI sector.
Gaming Revenue: Declined significantly in Q2 last year, and the downtrend persisted till the end of the fiscal year 2023.
Earnings Per Share: Q2 EPS is projected at $2.07, a 305% increase from $0.51 the same period last year.
Nvidia’s current P/E ratio is 146 times its trailing twelve months, 222 times its GAAP, with a price-to-sales ratio of 43 and a price-to-book ratio of 45. This is a steep valuation. Nevertheless, Nvidia’s expected growth is also very high. If the company meets expectations, with a growth rate of several hundred percent CAGR, it can indeed quickly catch up to such extreme valuations.
Market Commentary
Wall Street Warns: U.S. Bond Yields of 5% May Become the New Normal; Inflation Might Force the Fed to Raise Rates to 6%
Bank of America warns investors to be prepared for the return of U.S. bond yields to 5%, reminiscent of the pre-financial crisis U.S. bond market. Given that the average inflation rate for personal consumption expenditures reached 3.7% in the second quarter, the Federal Reserve might be compelled to tighten the policy benchmark to at least 6%. Meanwhile, an inverted yield curve indicates that there is still a risk of recession in the U.S. economy in the short term.
JPMorgan Warns: U.S. Economy Might Lose a Major Boost as Excess Consumer Savings Deplete
JPMorgan estimates that U.S. consumers had an accumulated excess savings of $2.1 trillion at its peak in August 2021, and it dropped to -$91 billion by June this year. The liquidity surplus in households, backed by cash and cash-like assets, currently stands at around $1.4 trillion and is expected to be exhausted by May next year. This liquidity might not be sufficient to support consumption levels that are currently above trend.
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