US stocks enter a critical July: experiencing a pullback, it's a good time to enter the market! Pay attention to the realization of second-quarter performance expectations.

Looking ahead, the confirmation of the interest rate hike path in the United States after July is a crucial window period that will determine the future direction of assets.

It is expected that the U.S. stock market will remain volatile in the short term, with sentiment and valuations staying high, and growth stocks outperforming value stocks. The current high valuations and low equity risk premiums imply that future earnings will be particularly important for the contribution to the U.S. stock market. Whether second-quarter earnings can meet market expectations, which are already high, will be the key to short-term trends.

In terms of pace, compared to the third quarter when inflation rapidly declined but growth was not as weak, the fourth quarter will face a slight increase in inflation and greater pressure on growth. Based on static calculations, a 5% contraction in valuations and a 5% downward revision in earnings are expected around the 3,900 level of the S&P 500.

Compared to cyclical and value sectors that still face downward pressure on earnings, the earnings of growth stocks have already been revised downward by more than 25% since last year due to better earnings prospects. The pressure on the Nasdaq mainly comes from a deeper recession and unexpected interest rate hikes. The former is relatively less likely, while the latter's risks depend more on the timing and intensity of China's policy stimulus, with September being the main validation point for the interest rate hike path.

Macro Inflation

For the U.S. stock market, the third quarter is still a macro-friendly environment (rapid decline in inflation + minimal growth pressure), but there are some "hurdles" to observe and confirm in July: the market is still uncertain about whether there will be an interest rate hike in September. Our calculations show that the overall inflation for June, which will be announced in mid-July, will quickly fall to 3.2% due to a high base, but core inflation will hover around 4.8-5% due to a low base. If it exceeds expectations, it may provide "excuses" for concerns about a rate hike in September and a surge in interest rates.

Of course, July is also relatively quiet in terms of seasonality, as well as the realization of second-quarter earnings expectations.

It is expected that global markets may still experience wide fluctuations in July, so it is optimal to remain unchanged in the short term and "stay the course." If there is a pullback in U.S. stocks/U.S. bonds, it may be a good opportunity to enter again because once we pass the low base in July, core inflation will face two consecutive months of high bases in August and September, which is expected to initiate a phase of accelerated decline. Our calculations show that core inflation is expected to return to around 3.5% by the end of the third quarter, which will help alleviate inflationary pressures and concerns about a rate hike in September.

Earnings and Buybacks

In terms of second-quarter earnings, the focus is on whether they can meet market expectations that are even higher.

In an environment where technology leaders have once again reached new highs and overbought conditions are still evident, it is crucial for the second-quarter earnings, which will be released in mid-July, to meet and exceed expectations.

Based on current expectations, the market consensus is that the earnings growth rate for the S&P 500 may further decline to -7.1% (compared to -2.0% in the first quarter), while the Nasdaq's earnings growth rate is expected to quickly turn positive to 4.3% (compared to -9.2% in the first quarter). There is a significant divergence in earnings (downward for value stocks and cyclical sectors vs. The growth recovery is also one of the significant factors contributing to the structured market trend in the US stocks this year.

Looking ahead, with the risk premium at a low level and the downward space for risk-free interest rates yet to be opened, support from earnings becomes more crucial. From the perspective of high-frequency and leading earnings adjustment sentiment, the Nasdaq has been continuously rising recently, and the Nasdaq 100, which is concentrated with technology leaders, has turned positive. In addition, the current market consensus expects a significant improvement in MAAMNG's net profit in the second quarter (6.2% in the second quarter vs. -1.6% in the first quarter).

Furthermore, the company's share buyback behavior will also be affected by the blackout period before and after the disclosure of financial performance during the reporting period. The blackout period lasts for two weeks before the disclosure of financial performance and two days after the disclosure. During this period, in order to avoid the possibility of insider trading, share buybacks are often suspended.

Although share buybacks are not the dominant factor in the valuation and performance of US stocks, their short-term changes are still worth noting (over the past 10 years, share buybacks have contributed an average EPS growth rate of 8-10% and a market performance contribution of 5-6%; the technology sector, which is the main force in share buybacks, has contributed an average EPS growth rate of up to 22% and a contribution to stock prices of up to 11%).

Seasonal Factors

Due to factors such as holidays, July and August are usually the traditional off-season for trading and investment in the US stock market.

Looking back at historical data since 1996, the average daily trading volume of the S&P 500 index was 39.2 billion and 36.4 billion US dollars respectively (monthly average throughout the year was 41.8 billion US dollars), and this trading characteristic has also led to the summer months being relatively weaker in the US stock market on an annual basis (average monthly performance of 0.1% from July to September vs. average monthly performance of 0.8% throughout the year).