Since October last year, the two relatively large adjustments in the US stock market have been mainly related to the US bond yield, rather than the individual stock fundamentals.

In October last year, due to the expansionary fiscal policy of the Federal Reserve in the third quarter, the excessive fiscal financing led to the US bond yield approaching 5% and stock prices falling. During this process, there were some large macro narratives:

a. Unrestrained borrowing operations, the credit of US bonds is on the verge of collapse, and no one wants to buy US bonds.

b. Reshaping of the global supply chain due to de-globalization + reshoring of manufacturing, implying that the potential economic growth rate and inflation level in the US will stay at higher levels for a long time. The long-term bond yield may stay above 4% for a long time.

Since the beginning of this year, the strong economic growth in the US has added a new logic to the process of the US bond yield approaching 4.7%:

c. The productivity revolution brought by AI led by US companies has increased labor productivity, further raising the potential growth rate of real GDP.

However, as inflation recedes and economic data slows down, these logics have gradually subsided.

During the Labor Day holiday, the decline in US bond yields and the rise in US stocks represent the process of this logic declining from its peak. Under the current macroeconomic background, the US economy will likely see US bond yields fluctuating in the range of 4-5%, providing opportunities for stock price adjustments within this range.

Looking back at the whole year of 2023 and the first half of 2024, amidst the rises and falls, each institution has tried to provide different explanations, most of which have a macro narrative nature that cannot be confirmed or refuted in the short term.

In fact, regardless of how macro narratives change, for equity assets like long-duration assets, as long as growth continues and dividends/buybacks are generous, the changes in macro narratives are just episodic adjustments, serving as regulators for a healthier long or slow bull market.

Let's first take a look at what factors have been driving the decline in US bond yields and the rise in US stocks since the end of April. Where does the resilience of the US economy really come from?

1. A clarification: Weak first-quarter GDP? Overly strong domestic demand

The first-quarter GDP increased by 0.4% quarter-on-quarter (which is actually reported as a year-on-year increase of 1.6%), while the market originally expected a year-on-year growth of at least 2%, which could have been roughly in line with or even faster than the 2.2% in the fourth quarter of last year.

This difference mainly stems from exports: Net exports in the first quarter made a negative contribution of one percentage point to the US GDP, and behind this negative contribution is the accelerated growth in imports of goods and services, coupled with a slowdown in the growth of exports of goods/services—when domestic demand in the US is overly strong and domestic goods cannot meet the demand, Americans increase their demand for imported goods In other words, excessive demand and insufficient supply have led to negative drag.

And in the domestic demand, reflecting endogenous demand, GDP - the two largest private/civilian demand categories:

a. Household demand: Total consumption contributed 1.7 percentage points (year-on-year) to economic growth;

b. Corporate demand: In corporate investment, real estate investment repair + IP investment continued to drive part of the corporate investment, which remains strong. However, private inventory investment was still in a slight destocking phase in the previous quarter, with the destocking process nearing completion, although the intensity has been very low.

Especially, the corporate demand, which has been relatively weak last year, has truly picked up. This is thanks to the sustained high fire of household demand, driving up corporate profits. Regardless of the interest rate, it is the real and most primitive driving force for expanding reproduction when companies have profits and money to make.

The combined picture of these two is very clear: in the first quarter GDP growth, excessive domestic demand is the real core information, while GDP growth lower than expected is more noise. As a domestic demand-oriented economy, the United States' strong domestic demand is the guarantee of economic growth.

2. Why is household demand still excessive?

When household demand is strong, it usually corresponds to the following basic situations: first, job security and predictable cash flow; second, surplus on hand, able to spend more than the current earning capacity; third, good future expectations, asset appreciation, and strong willingness to spend.

In the latter two aspects: in this wave of adjustment in the U.S. economy to date, under high interest rates, non-financial assets mainly based on real estate have not depreciated, and assets in the form of deposits in financial assets have mainly appreciated. Savings balances are high, and the ability to pay off debts is particularly strong. The main impact of the rate hike so far has been on incremental debt-based consumption (housing, cars), with little impact on others.

In the most critical first item - the current earning capacity, we can see that the first major source of nominal income for households - employee compensation, has been playing a stabilizing role under a high employment rate, with stable growth in monthly income (annualized).

And in the three major directions of income distribution - personal consumption, savings, interest payments, and taxes:

a. Although interest payments have a high growth rate, they account for a small proportion (household balance sheets are healthy, with relatively few interest-bearing liabilities), so the impact is not significant.

b. Tax revenues show a slight upward trend entering 2024, but the current impact is not significant.

c. In terms of savings, since the ability of individuals to pay off debts with deposits in their balance sheets is already strong, there is no need to allocate a portion of current income to savings to a certain extent. Therefore, the savings rate is very low and continues to be squeezed by consumption The result of this series is that high employment guarantees steady income growth for residents, and with high excess reserves (aka high deposits), the proportion of income transferred to savings as excess reserves continues to decrease. This allows consumption to grow at a higher rate than income, ensuring that the entire domestic demand of the U.S. economy remains relatively strong.

Due to this reason, under the current high excess reserves guarantee, in order to have enough safety cushion, Dolphin believes that one should not have too high hopes for the extent of interest rate cuts—around 2 times is about right. Demand is already relatively strong, and current interest rate cuts further stimulate demand. Excessive interest rate cuts are clearly inappropriate.

Why is there no wage-inflation spiral when demand is excessive?

The answer to this question is simply the dividend of immigration. Normally, an aging society is usually associated with sluggish domestic demand, but the basic premise here is that the population growth is endogenous.

In the U.S., the increase in the labor force is basically unrelated to the birth rate of N years ago, but is accomplished through immigration. Immigrants are usually young and ready to work, without the "developmental process" from birth.

After the epidemic, in a situation of vigorous demand for labor, the supply of labor is mainly achieved through the introduction of immigrants and a slight repair of the labor participation rate. For this reason, the increase in the income of the entire resident pool is mainly achieved by increasing the number of employed individuals, rather than by raising the wages of individual employed individuals.

As a result, the labor market has employment but no uncontrollable labor inflation, which further cuts off the spiral transmission between wages and inflation.

Moreover, with immigrants as a valve for labor supply, when a large number of people retire, it will not necessarily lead to a decline in domestic demand, but will instead expand it: immigrants will create new domestic demand, and the increase in retirees will passively increase transfer payments (essentially a form of fiscal stimulus, especially under high deficits). In addition, the increase in retirees will increase the demand for social assistance, health care, and medical services.

Which industry is really supporting economic growth?

This can be seen from the distribution of new employment and the industries that have seen more employment growth compared to 2019 a. Transportation and warehousing: The further online consumption of residents' daily life brought by the epidemic has led to a significant increase in the employed population in transportation and warehousing.

b. Construction industry: Industrial reconstruction in the United States post-epidemic and amid deglobalization.

c. Healthcare: The increase in the elderly population post-epidemic leads to higher demand for medical care and elderly care.

d. Automobile and parts: The replacement and upgrade of automobiles driven by new energy and energy-saving technologies.

e. Business activities: The increase in employment in IT and information technology is driven by technological iterations led by AI.

From the underlying logic and cycle of the economy (1-4) above, after the stimulation and guidance by the government, the internal demand of the U.S. economy has gradually stabilized and started a positive cycle. Even with increased fiscal taxation in the current high-revenue, high-expenditure, and rapidly shifting payment system in the U.S., Dolphin believes that economic recession is a low-probability event within the current cycle.

Inflation can be regulated through the stimulus intensity of government finances and the monetary policy of the Federal Reserve to prevent inflation from resurging.

Looking at the economic data in April:

a. The monthly increase in non-farm employment fell to 175,000, and in March, companies finally stopped net job creation, indicating a more balanced labor market supply and demand. The slight increase in the unemployment rate implies that the economy is not experiencing overheating inflation. This type of economic data does not support long-term bond yields climbing to the range of 4.5%-5%.

b. The manufacturing sector's business climate index fell slightly, returning to below 50, but the sub-indices of the price index for the service and manufacturing sectors remain relatively high, which does not seem to support too high expectations of interest rate cuts in the second half of the year.

In summary of <1-4>, Dolphin believes that unlike in 2024, the significant growth of the U.S. economy is largely stabilized by fiscal stimulus. By 2024, the fiscal stimulus may relatively weaken (but still significant), while corporate domestic demand increases and residents' domestic demand remains strong. The U.S. economic growth in 2024 may be in a healthier state compared to 2023.

Fiscal and monetary policies that could ignite inflation have room for self-regulation from the government's perspective. Therefore, in this scenario, Dolphin believes that in U.S. stock investments in 2024, the risk of inflation should not be exaggerated, but economic stagnation or recession should also not be overlooked without careful analysis of the underlying support behind the resilience of the current U.S. economy.

In a macro environment where expected fluctuations are the main focus and there are no major risks in economic fundamentals, U.S. stock investments in 2024 should focus on two points: 1) industry competition cycles and company-specific operating cycles; 2) understanding the prices of individual stocks to profit from high-quality stocks amid macroeconomic fluctuations. Risk Disclosure and Disclaimer for this Article: Dolphin Research Disclaimer and General Disclosure

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