Tech Slump, Small Caps Stir, Retail Investors Optimistic
Stocks
Last week, U.S. stocks rose slightly with the Nasdaq underperforming due to mixed earnings reports. Major banks largely posted excellent results, and some analysts believe this might indicate a strong economy overall, with regional banks showing clear differentiation. Tech stocks fell due to unstable earnings, causing some major stocks to drop, while large airlines reported better-than-expected earnings. Utilities, energy, and healthcare were the best-performing sectors this week, while communication services and industrials were the laggards. The market overall was more defensive last week:
Despite the strong performance of the tech-heavy Nasdaq index for most of this year, the index experienced its biggest single-day decline in over four months last Thursday. Disappointing earnings data from two major companies, Tesla and Netflix, led to a daily decline of more than 2% for the index, highlighting the vulnerability of overvalued tech stocks. Elsewhere, European, British, and Japanese stocks closed higher, while Chinese and Hong Kong stocks closed lower.
The rise in the U.S. stock market since May has been largely driven by rising optimism about the Goldilocks scenario, in which the economy is neither too hot to prevent further declines in inflation nor too cold to fall into recession. Current corporate profits can also support these expectations.
It is noteworthy that small-cap stocks have risen nearly 7% in less than three weeks, undoubtedly a response to lower cost pressures and a vibrant economy. The ongoing strong performance of small caps is a significant signal of economic recovery expectations because smaller companies are typically more sensitive to domestic economic conditions, usually underperforming before and during economic downturns but performing well as the economic outlook begins to improve.
Measured by the Russell 2000 index, small-cap stocks have underperformed large-cap stocks since bottoming out in October last year. The Russell 2000 index is still nearly 18% below its 2021 peak, but the S&P 500 and Nasdaq 100 are only about 5% away from their 2021 all-time highs.
Geopolitical tensions between Russia and Ukraine have intensified, and international oil prices, already supported by additional production cuts from Saudi Arabia and Russia, continue to rise, maintaining an uptrend over the past month and diverging from precious metals and industrial metals:
Digital Currencies
Last week, real interest rates rebounded slightly, along with the U.S. dollar exchange rate. The rebound mainly occurred on Friday, suppressing both gold and BTC:
The U.S. dollar index fell 2.2% the previous week and fell below the 100 threshold, but the U.S. dollar index rebounded by over 1% last week, rising from a 15-month low, recovering nearly half of July’s losses, and posting the largest weekly gain in nearly three months. The main reasons are strong demand from U.S. residents and Japanese core inflation below expectations. Meanwhile, continued uncertainty about whether the Bank of Japan will adjust its yield curve control (YCC) policy pressured the yen. On Friday, reports suggested that the Bank of Japan is unlikely to change its YCC plan, causing the yen to fall, which further boosted the U.S. dollar.
Top 100 Tokens by Market Cap Increase:
Top 100 Tokens by Market Cap Decline:
The total on-chain volume of stablecoins dropped from $127.06 billion to $126.19 billion, marking the fourth consecutive week of outflows, a weekly decrease of 0.72%:
Centralized exchange stablecoin balances fell from $19.06 billion to $18.56 billion, the largest decline in 8 weeks:
Capital Flow and Positions
According to Deutsche Bank’s measurement standards, overall stock positions increased further last week and are now at a high level (z score 0.61, 82nd percentile):
This is largely due to substantial position increases by subjective investors (z score 0.69, 86th percentile), although it is at a high level, it is still lower than the peak of the previous cycle. However, it was also observed that the positions of systematic strategy funds have stagnated (z score 0.49, 72nd percentile):
Some indicators are nearing their historical highs. Specifically, the systematic strategies that have driven the uptrend over the past five months are now in high positions; futures are close to their historical upper range; the bull-bear sentiment spread has reached the top 10% level in history; short positions have been significantly reduced, and net bullish options trading volumes have risen to 2021 levels, mainly driven by small trades.
The AAII Bull-Bear sentiment spread has reached the top 10% level in history:
Net bullish options trading volume (buying options minus selling options) rose sharply last week to the 97th percentile in history, and individual stock options trading volume surged to a 20-month high:
Are the positions of subjective investors excessive relative to fundamentals? It depends on which cyclical indicator you look at. Certainly, it is far above the level implied by popular indicators like the ISM or LEI that have been falling, but it is consistent with several other indicators that have started to rebound: macro data surprises, hard data indicators such as manufacturing industrial production and retail sales, and earnings revisions. We continue to see a similar situation to 2019, where subjective investors chased the uptrend led by systematic strategies and stretched positions before fundamentals significantly improved.
For Q2 earnings season, the market expects earnings to grow for the second consecutive quarter, but price momentum may be weaker due to high positions. Preliminary results show that 80% of companies have exceeded expectations. However, since the start of the earnings season, the S&P 500 has only risen 0.6%, and even companies that exceeded expectations have averaged a decline of 0.5%. This trend of price declines after earnings exceed expectations is unusual, contrasting with typical historical patterns:
In terms of industry allocation, consumer staples (87th percentile), communication services (84th percentile), and technology (80th percentile) have high positions; consumer discretionary (67th percentile) is now slightly overweight, continuing to rise rapidly recently. Industry (61st percentile) is slightly overweight, and energy has returned to neutral. The financial sector (40th percentile) and the real estate sector (40th percentile) are still slightly underweight but are rapidly approaching neutral. Utilities (30th percentile) are underweight and have not broken the trend, as is the healthcare sector (26th percentile). The materials sector (26th percentile) remains underweight.
Equity funds saw outflows last week (-$2.1 billion) after three consecutive weeks of inflows. Outflows mainly came from the US (-$2.3 billion), while Europe (-$1.6 billion) suffered redemptions for the 19th consecutive week. Emerging markets ($1.7 billion) and Japan ($0.6 billion) saw inflows:
By industry, the technology sector ($1.8 billion), the financial sector ($1.1 billion), and the consumer goods sector ($0.9 billion) received a large amount of inflows. Telecom, energy, and industrial sectors each received $0.5 billion in inflows, while the materials sector received $0.3 billion. Other industries didn’t change much:
This week’s bond fund inflows ($1.4 billion) slowed significantly, and money market funds received moderate inflows ($7.5 billion) this week:
In the futures market, overall positions of US stock index futures remained stable, the decrease in net longs of the S&P 500 was offset by the increase in net longs of the NASDAQ 100 and the Russell 2000, and the Russell 2000 net longs last week hit the highest level since January 2022:
The overall net short position in bonds increased but is still slightly lower than the historical high. The short position of the dollar rose, the net long position of oil remained stable, and the net long positions of gold and silver both rose, and the net long position of copper also increased.
Market sentiment
According to the AAII investor survey, the bullish ratio refreshed a new high since November 2021, reaching 51.36%, while the bearish ratio refreshed a new low since June 2021, to 21.49:
CNN’s Fear & Greed Index hit a new high last week:
Goldman’s institutional sentiment indicator has maintained extreme levels for two consecutive months:
Bank of America’s bull-bear indicator rose from 3.5 to 3.8 last week, still in the neutral range:
This week’s focus
1. Three major central banks will hold policy meetings, with markets expecting the Federal Reserve and the European Central Bank to continue to be hawkish, and the Bank of Japan unlikely to adjust policy at this meeting under lower-than-expected inflation data. The Federal Reserve will meet on Wednesday, the European Central Bank on Thursday, and the Bank of Japan on Friday. The CME Fed Watch Tool shows that the probability of the Fed not raising interest rates in the remaining three rate-setting meetings this year is over 60%, and the possibility of a rate cut in March next year is 40%.
The recently released US retail data and unemployment benefits claims both point to an undeniable inflation resilience in the US employment market and inflation. Whether the Federal Reserve will officially provide guidance to end the interest rate hiking process at the July meeting still remains uncertain.
2. This week US stocks will face another earnings test from three major tech companies Meta, Microsoft, and Google. Netflix’s performance has cast a shadow over Meta’s quarterly outlook, which heavily relies on digital advertising business. Currently, the market expects Google to achieve 9% earnings growth this quarter after four consecutive quarters of decline; Microsoft’s adjusted operating profit margin is expected to rise from 40% a year ago to 42%; after six consecutive quarters of contraction, the market expects Meta to resume growth in the second quarter, with earnings per share growing by 19%.
3. The US June PCE price index will be announced on Friday. The market expects the US June PCE price index to fall from 3.8% in May to 3.1% year-on-year, and the core PCE price index to fall from 4.6% in May to 4.2% year-on-year.
4. NASDAQ will adjust index weights on Monday, which may cause passive selling of large tech stocks. But given that many funds have established larger tech short positions or previously missed the opportunity to get in, they may use this rebalancing as an opportunity to increase positions and narrow the gap, which may provide some buying support.
Institutional views
[Goldman Sachs: Do not believe there will be a rate cut before Q1 2024, market pricing is overly aggressive]
David Mericle (Chief US Economist): We do not anticipate a rate cut before the emergence of growth risks or a significant decline in inflation. In our forecast, we foresee the first rate cut when the core PCE inflation rate falls to 3% annually in the second quarter of 2024, and to 2.5% annually. Even if inflation is reduced, they may not cut rates. If growth exceeds potential, the unemployment rate continues to hit new lows, and financial conditions further loosen, a rate cut may feel like an unnecessary risk. We assign almost as much probability to the upside scenario in a non-recession situation as we do to our benchmark. We expect rate cuts in non-recession scenarios to gradually occur at a rate of 25 basis points per quarter.
[Bill Gross: US bond yields are unlikely to fall soon]
Legendary investor Bill Gross wrote in his latest investment outlook that although US bond yields may have peaked this year, a bond bull market is unlikely to come. Gross expects the 10-year US bond yield to remain above 3.5% for a long time and may break 4% over the next two years. This is mainly due to the Fed’s balance sheet reduction, the soaring deficit of the US government, further increasing the supply pressure on the bond market.
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