US' Equity Market Confidence is Back, is It Reliable This Time?

Hello everyone, here is Dolphin Research's summary of the core information on this week's portfolio strategy:

1). The October social retail and CPI data indicate that the interest rate hike cycle has reached a point where it has effectively suppressed prices and suppressed discretionary consumer demand, without "breaking" any industry. The economy is currently in a soft landing phase.

2). The apparent "braking" of US fiscal spending in October is actually a feint. Although the fiscal deficit has narrowed, it is not due to reduced spending, but rather the disruption of tax revenue rhythm caused by natural disasters.

From the current situation, fiscal spending is more rigid, and it will be very difficult for the US to make up for it on the fiscal spending side, especially with the consensus on the reconstruction of the manufacturing industry. Increasing revenue next year may require increasing taxes on individuals and businesses.

3). Looking at the marginal liquidity changes last week, although the Federal Reserve has sold a large amount of medium and long-term nominal bonds, after replenishing its own small treasury with a large amount of debt issuance, the TGA account has started to sell a large amount again. In addition, the reduction in reverse repurchase agreements has injected liquidity into the market. From the increase of more than 120 billion US dollars in bank reserve balances in a single week, the liquidity in the market has become more abundant.

4). Therefore, overall, last week's rise was a combination of favorable timing, conditions, and people. However, Dolphin Research still maintains that this may be the last upward cycle for US stocks before entering the perfect data crossover period in the second quarter of 2024. The risks of fiscal pressure shifting to taxation next year and the depletion of remaining liquidity from the epidemic may bring significant uncertainty to US stocks after the first quarter of 2024.

In the short term, although the pressure this week is not significant, it is not as perfect as last week. It is a macro window period with no heavyweight data, but there will be the issuance of 10-year and 20-year government bonds, which may put pressure on the yield of 10-year government bonds, which has already fallen below 4.5%. In addition, NVIDIA, a giant in the AI arms race cycle, will release its earnings report, and it is necessary to pay attention to the sustainability of its performance.

Here are the details:

Last week, two heavyweight economic data points were released for the US economy in October - CPI and social retail. As this wave of economic prosperity is directly related to consumer spending, Dolphin Research carefully analyzed the social retail data.

1) Cooling of consumption:

- High-interest rate sensitivity is the hardest hit area: The category with the highest weight and high sensitivity to interest rates, motorcycles and parts, seems to have exhausted its consumption momentum, with a significant decline in MoM sales. This is consistent with the large decline in new and used car prices in October's CPI, but we need to consider the impact of the automotive industry workers' strike on sales. The real estate category, including furniture & home furnishings, as well as building materials & garden equipment, also experienced significant declines.

- Two major drivers of high consumption growth losing steam: The other two major drivers of retail growth in this cycle, catering and online retail, have also seen a significant slowdown in growth this month, with growth rates falling to between 0.2% and 0.3%. In particular, the slowdown in catering consumption is corroborated by the rare negative turn in employment in the non-agricultural catering industry. 3) Only two major essential categories are thriving: Currently, among the high-weighted categories, only the essential categories of food and beverage retail stores are still experiencing increasing growth, as well as health and personal care stores.

Overall, the seasonally adjusted MoM social retail sales in the United States for October showed a negative growth of 0.11% compared to the high base in September, indicating a clear slowdown in consumer spending for October.

However, it is important to note that the MoM decline in consumer spending only represents a weakening of marginal momentum. Compared to the same period last year, the seasonally adjusted data for October still shows a growth rate of 2.5%. Taking into account the impact of the automobile strike on the largest category of automobile sales, even with negative growth, the October social retail data still indicates a slowdown in consumer momentum rather than a prospect of recession.

2. CPI: Fast Cooling

Due to the decline in oil prices, the market expected a cooling of the CPI in October, but the actual cooling was significantly faster than market expectations. In fact, each fluctuation in oil prices not only affects the price of energy itself, but also has an impact on the prices of many service categories, as energy costs are an important component of service costs.

This was the case for the October CPI, with three key indicators: a seasonally adjusted MoM CPI growth rate of zero, continuous price reductions in new and used cars leading to a negative growth rate of 0.1% for core goods; and the fundamental source of the expectation gap lies in core services, with a MoM growth rate of 0.3%, not only significantly lower than the growth rate of the previous quarter, but also lower than the previous two months.

Among the three key categories of core services, the increase in medical insurance costs for the new year was offset by the decrease in the cost of specialist doctors, resulting in overall stability in medical service prices. Similarly, transportation services faced upward pressure from motor insurance, but this was offset by the decline in airfare prices. As a result, the price increment for these two categories remained stable.

What truly dragged down core services this quarter was the cost of housing: The downward trend in new rental costs has finally begun to seep into the CPI, with the MoM growth rate of housing costs returning to 0.3% this month.

3. Is the fiscal slowdown in October just a feint?

By now, most of the market is probably aware of the unconventional stimulus policies in the United States, which involve tight monetary and loose fiscal measures during economic upturns. However, in October, the federal fiscal deficit in the United States unexpectedly narrowed, with a deficit of only $670 billion, compared to the usual monthly deficit of over $200 billion. From the perspective of revenue and expenditure breakdown, it is not that the US fiscal expenditure has started to be restrained. Looking at the various sub-items of expenditure, such as the high expenditure on commercial and housing credit support this year (mainly supporting the intellectual property industry and mortgage support), it has continued to grow. At the same time, income security has decreased YoY due to a decrease in the unemployment rate.

However, in other areas, such as 1) social security and pension insurance, which have rigid growth due to population retirement; 2) interest payments, which are rigid expenditures; and 3) defense expenditures, which are also rigid expenditures.

The reason for the narrowing of the deficit in October is mainly due to the increase in corporate and individual taxes. One driving factor is that the tax payment period was delayed in natural disaster areas such as California, and now tax payments are being made up, resulting in temporary income growth.

Therefore, although the fiscal deficit has narrowed this month, it is not due to expenditure, but rather due to the disruption caused by natural disasters in terms of income. It is not a true sense of fiscal restraint.

Moreover, from the current situation, whether it is the expenditure caused by aging and retirement, interest payments, or industry stimulus expenditures, they are more rigid. Under the consensus of rebuilding the manufacturing industry, it will be very difficult for the United States to make up for the fiscal expenditure shortfall, especially if the unemployment rate rises next year, the expenditure on income security may also need to increase.

Therefore, if we want to narrow the fiscal deficit next year, it is likely that we will need to focus on increasing revenue. If it is the Democratic Party, we need to consider the possibility of higher taxes for residents and the corporate sector, thereby suppressing the potential for residents' expenditure to a certain extent.

However, overall, under the background of marginal improvement in the federal fiscal situation in October, the weakening but still confident US social zero and significantly declining CPI data together still indicate that the interest rate hike has indeed achieved the goal of suppressing prices and suppressing discretionary consumer demand, and it has obviously not "broken" any industry. The economy is in the process of a soft landing.

Long-term economic growth expectations have cooled down, while short-term interest rates are anchored to rate cut expectations, and the inverted yield curve of long-term and short-term US government bonds has widened again.

4, Liquidity assistance, US stocks are pricing in next year's "bright prospects"

This combination of economic data indicates that rate cuts may come earlier while the economic fundamentals are still intact, and the valuation of US stocks can be repaired. Moreover, the liquidity last week was also very comfortable.

Looking at the marginal changes in liquidity last week, although the Federal Reserve sold a large amount of medium and long-term nominal bonds, after replenishing its own small treasury with a large amount of debt issuance, the TGA account started to sell a large amount again, and the reduction in reverse repurchase agreements injected liquidity into the market.

From the increase of more than $120 billion in bank reserve balances in a single week, it can be seen that liquidity in the market was even more abundant last week.

All these factors combined, it's almost like the perfect timing and conditions for a rise. From the data, we can see that after the decrease in tax payments, education subsidy reduction, and savings rate hitting bottom, there has been a rapid slowdown in consumption.

The next major consumption data will include overall household consumption expenditure, including service expenses, as well as changes in the savings rate. This will further reveal how much momentum is left in household consumption.

As for macroeconomic data in the United States this week, it is relatively light, with no major economic data releases. The key focus is on the issuance of 20-year and 10-year Treasury bonds by the Treasury Department on the 20th and 21st Eastern Time, to see if it will disrupt the yield of 10-year Treasury bonds.

Overall, as Dolphin Research has mentioned, the U.S. stock market will still be in a festive mood until the end of the first quarter of 2024.

5. Portfolio Adjustment

No portfolio adjustment was made last week.

6. Portfolio Returns

On November 17th, the Alpha Dolphin virtual portfolio had a 1.6% increase in returns, weaker than the S&P 500 (+2.2%) and Hang Seng Tech Index (+2.3%), but stronger than MSCI China (+1.3%) and CSI 300 (-0.5%).

Since the start of the portfolio testing until the end of last week, the absolute return of the portfolio was 27%, with an excess return of 48% compared to MSCI China. From the perspective of asset net value, Dolphin Research's initial virtual assets were $100 million, and it is currently $129 million.

7. Individual Stock Contribution

Last week, with the perfect timing and conditions, the U.S. stock market saw a significant recovery. However, the fundamentals of the Hong Kong stock market are relatively weak, especially for leading stocks like Alibaba, which were also affected by setbacks in international relations. This wave of Chinese assets clearly showed a characteristic of rising first and then falling, with relatively poor performance in terms of returns.

Regarding the companies in Dolphin Research's portfolio and watchlist that experienced significant changes in their stock prices last week, the analysis is as follows:

8. Distribution of Combined Assets

This week, the Alpha Dolphin virtual portfolio did not make any adjustments and held 27 stocks, with four of them being standard holdings and the rest being underweighted equity assets, with the remaining assets being gold and US dollars.

As of last weekend, the asset allocation and equity asset weightings of Alpha Dolphin were as follows:

9. Key Events this Week

Last week marked the end of the earnings reports for Hong Kong's internet giants, but the second-tier internet companies have entered the earnings season. In addition, NVIDIA, the last giant in the US stock market, will release its earnings report this week, which is worth paying attention to.

Risk Disclosure and Statement for this Article: Dolphin Research Disclaimer and General Disclosure

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