"The 'Anchor of Global Asset Pricing' Soars, Worries Mount over US Stock Earnings Prospects"

The yield on the 10-year U.S. Treasury bond remains high, and U.S. stocks are further under pressure. Analysts believe that this year's U.S. stock market earnings will "disappoint" investors, and the upward trend in the U.S. stock market is expected to end in 2023.

Overnight, U.S. stocks opened high and fell low again. The Dow Jones Industrial Average hit a six-week low, the S&P 500 approached its lowest level since June 26, and the Nasdaq Composite Index barely closed up 0.061%. However, the "Big Seven" continued to decline, dragging the Nasdaq down nearly 6% this month.

As the real yield on 10-year U.S. Treasury bonds exceeded 2% for the first time since 2009 this week, the continued rise in long-term interest rates continues to put pressure on the stock market.

The market has already lowered its forecast for corporate earnings in the U.S. stock market this year, but higher interest rates often delay the impact on the economy. Therefore, analysts believe that economic growth may further slow down, and both corporate profit margins and earnings will be affected.

Doug Peta, Chief U.S. Strategist at BCA Research, said that the upward trend in the stock market in 2023 is about to end, just like in the past.

He believes that this is not so much caused by the trend of interest rates, but by another key variable in the investment equation-corporate earnings:

At the end of last year, people's expectations "fell short." The threshold for corporate earnings was set very low, just above the dim expectations.

Now, the threshold for more optimistic estimates for the next year is increasing. Therefore, after experiencing a surprising rise in the first half of 2023, investors will be disappointed from now on.

Peta pointed out that investors initially expected earnings per share of the S&P 500 index to be around $190 to $195 at the beginning of the year, and the actual performance exceeded expectations by about 11%. Therefore, the market generally predicts that earnings per share in 2024 will reach an "exciting" $246.

However, he believes that such a far-ahead earnings expectation is unrealistic and predicts that the earnings of the S&P 500 index will fall by 5% to around $210 next year.

Reasons for the surge in U.S. bond yields

The yield on the 10-year U.S. Treasury bond, known as the "anchor of global asset pricing," has soared to its highest level since 2007, and the reasons for this result may be complex.

Wall Street economists have listed some factors that may drive up long-term U.S. bond yields, among which the two tightening policies of the Federal Reserve, interest rate hikes and balance sheet reduction, have played a significant role.

The minutes of the Federal Open Market Committee (FOMC) meeting in July showed that most officials believed that "inflation faces significant upward risks" and further interest rate hikes may be needed. According to data from the CME FedWatch Tool, the number of investors expecting the Federal Reserve to raise interest rates before the end of the year has increased by 10% compared to a month ago. Rosenberg Research & Associates President and Economist David Rosenberg said:

The answer is... the Federal Reserve. The end of the economic curve has already received the Federal Reserve's recent strong tone.

Although the Federal Reserve's current balance sheet reduction action has not reached the target of $95 billion, the $62.5 billion reduction last week was the largest weekly decline since early April. The balance of $8.146 trillion is also the lowest level since July 7, 2021.

Nicolas Colas, co-founder of DataTrek Research, said:

Although the Federal Reserve has unusually reduced the size of its balance sheet in the first few weeks of this year, which usually does not have a significant impact on yields, last week's significant reduction seems to have hit a key point.

In addition, analysts believe that weak loan growth and strong economic data may also affect long-term US Treasury yields.

Data released by the Federal Reserve last Friday showed that seasonally adjusted overall loan growth for small banks was 1.9% as of August 9, the lowest level in nearly 12 years. Since mid-July, bank loans in the United States have shown negative growth compared to the same period last year.

The US GDP growth in the second quarter exceeded expectations at 2.4%, providing "ammunition" for the Federal Reserve to continue raising interest rates.

Similarly, CICC also believes that the sharp rise in US bond yields is mainly due to three "unexpected" factors:

• Unexpected economic growth. The US GDP for the second quarter reached an annualized rate of 2.4%. Although the CPI announced in August was lower, data such as retail, real estate, and PPI were higher than expected.
• Unexpected US bond issuance. Against the background of infrastructure, chip, and inflation reduction spending and rising interest costs, the CBO's estimated future 10-year deficit rate in the United States has significantly increased compared to a year ago, and the expected deficit amount for 2023 has been raised by more than $500 billion compared to a year ago. The significant expansion of the deficit led the US Treasury Department to announce an increase in the issuance of long-term bonds on August 2, which is the first increase in the issuance of long-term bonds since 2021.
• Unexpected Fed attitude. The minutes of the Federal Reserve's July meeting, which were announced last week, showed that only two of the 18 Fed officials were inclined to stop raising interest rates, and most Fed officials believed that there were significant inflationary risks and that the rate hike was not over.

Compared with the above three factors, CICC believes that the market impact of Japan's adjustment of YCC and Fitch's downgrade of US bond ratings is limited.

The expected return of US stocks is higher than that of US bonds, which is not sustainable in the long term. The upward movement of US bond yields is negative for US stocks, and the downward movement of US bond yields may reflect risk aversion, which still puts pressure on US stocks.