The U.S. stock market's rate cut expectations have come out with a "last-minute trick". Is it reliable this time?

The biggest driving force of economic growth - household consumption seemed to suddenly cool down in April, followed by a resurgence of rate cut expectations. So, is this turnaround reliable or not? In this article, we will explore the truth based on the latest disclosed data.

I. Do households have money or not?

According to the latest data, the proportion of serious credit card defaults among household consumption is increasing. By the end of the first quarter of this year, this conversion rate has exceeded a small peak during the 2020 epidemic, approaching the sad period of the household sector in 2008-2009.

So, at this point, how much momentum is left in household consumption, and has the ability of households to pay deteriorated? Here is the Dolphin's understanding:

As a whole, the household sector does not have. Let's take a look at the latest disclosed balance sheet of the U.S. household sector:

Although the savings rate of households has been low for some time (corresponding to almost zero growth in deposits among households), the ability of households' deposits to pay off relative to their liabilities (household savings/household liabilities) still far exceeds the pre-epidemic level - in the first quarter of this year, the amount of household deposits as a percentage of total household liabilities further rose to 89%, while during the time when deposits accounted for a high proportion of household liabilities before the epidemic, it only barely exceeded 79%.

Since deposits represent cash assets, and the balance of liabilities is a rigid number that does not fluctuate with market conditions like assets do, the rising coverage of deposits to total liabilities itself indicates that high interest rates have restrained households from leveraging up. At the same time, households have accumulated a larger amount of deposits during the epidemic, so even though the savings rate is relatively low, households' repayment ability has actually strengthened.

If households' repayment ability has strengthened, then what's the deal with the rising conversion rate of serious defaults among households? It needs to be clarified here that although the conversion rate from non-default to default of credit card repayments, representing households' liquidity repayment ability, has risen to a high level, the current default rate is still lower than before the epidemic, despite the current increase in the conversion rate.

So, how to understand the overall increase in households' debt repayment capacity, but the marginal deterioration in households' repayment ability? Perhaps some insights can be gained from the recent employment structure of households: Since the Lunar New Year in the United States, residents' employment has remained hot, with the latest data in May showing an increase of 270,000 non-farm jobs. However, starting from 2024, in addition to the continued hot employment in the catering, medical services, and manufacturing industries, the positions that have truly improved marginally are the white-collar positions in professional business services—such as management, technical consulting, engineering, architectural design, investigation, security, as well as financial services like real estate brokerage services.

However, administrative and support positions in professional business services, such as temporary help services, have been in a significant net layoff state since the end of 2023.

The continuous deterioration of temporary blue-collar employment + the increasing conversion rate of credit card severe defaults likely means that in the social resident structure, the group with the least savings and weak job security is gradually becoming sacrificial under high-interest permanence. After the savings are depleted, their repayment ability deteriorates, and their default rate increases rapidly.

Therefore, in summary, the apparent increase in residents' overall repayment ability may imply a polarization in the resident sector—those with assets and surplus are seeing their assets appreciate in an inflationary environment, while those without assets and poor job stability are gradually depleting their reserves. The high interest rates further exacerbate their cash flow crisis, and the harm of high-interest permanence makes them among the earliest victims.

Analyzing up to this point, in response to the earlier question of "how much consumer potential do residents still have": with the polarization of residents' repayment ability, the sword of high-interest permanence is falling on the group of residents with the worst repayment ability in the resident structure. This clearly implies a relatively poor outlook for overall consumption potential, because when wealth is marginally distributed to the poor, the overall savings rate of society will continue to marginally decrease, driving consumption growth faster than income growth.

Looking at the latest data from April, while the growth in residents' income has slowed down, the ability of consumption to squeeze savings in the direction of distributing new income to residents seems to be decreasing. Furthermore, with the increase in tax payments flowing back into the government's pocket from the incremental income of residents, the amount flowing into resident consumption in April has significantly decreased compared to the previous two months.

This consumption data may also be the fundamental reason for the resurgence of rate cut expectations.

II. Has the Fed's Rate Hike Really Failed? Is the U.S. Economy Indifferent to High Interest Rates?

The current rate hike cycle in the United States started in March 2022 and ended in July 2023, raising the policy rate from 0-0.25% to 5.25%-5.5%. However, the more important issue is that after reaching the peak interest rate, high-interest permanence has persisted for over a year, and there are signs that low-income groups are gradually becoming sacrificial victims of high-interest permanence However, the U.S. economy still presents a "golden age" scenario during this period.

Is the U.S. economy really indifferent to interest rate hikes? Of course, many people here also say that the easing of inflation is mainly due to the alleviation of supply-side issues, and the economy is driven by new AI technologies, bringing new growth points, reducing the deterrent effect of interest rate hikes.

But in the view of Dolphin, the deterrent effect of interest rate hikes remains as strong as ever. High-interest-sensitive industries, such as real estate, automobile sales, and even photovoltaic roof installations covered by Dolphin, can all see the suppression of demand by high interest rates.

But why is U.S. inflation still hard to contain with such high interest rates? The "magician" who truly distorts the role of interest rates in the market is the U.S. government, more precisely, U.S. fiscal policy.

It can be clearly seen that starting from the second quarter of 2022 interest rate hike cycle, residents, enterprises, the federal government, and local governments are all deleveraging. However, starting from the second quarter of 2023, the federal government began to re-leverage, and as of the latest first quarter of 2024, it is still in the process of leveraging up, with leverage continuing to rise.

In other words, residents and businesses without the ability to print money are indeed deleveraging in a high-interest environment, as borrowing heavily in this environment is not cost-effective. However, the federal government, which is insensitive to interest rates, cannot be stopped by high interest rates from borrowing and leveraging up.

The borrowed money is injected into economic activities in the form of various fiscal subsidies (three major bills), leading these enterprises to continue hiring and investing, offsetting the negative impact of high interest rates on many industries.

3. How far can this game go?

Analyzing up to this point, a contradictory situation is revealed: if the federal government continues to borrow heavily to offset the impact of interest rate hikes on the economy, a very likely result is persistent inflation + sustained high interest rates as a macro combination.

And with this macro combination, coupled with deteriorating blue-collar employment, the likely situation going forward is: asset inflation + poorer debt repayment capacity, leading to the intensification of contradictions between the two major classes in American society, the haves and have nots. In an election year, social contradictions intensify, which is clearly disadvantageous to the Biden camp.

Therefore, from the perspective of top-level policy design, Dolphin believes that the continuous large-scale fiscal stimulus to offset the gradual weakening of endogenous power from interest rate cuts, but with the three major bills + aging population + rising social security payment costs due to inflation, where to cut expenditures and how to increase taxes are major challenges currently facing.

As of the end of May this year, the net debt issuance of the U.S. Treasury has reached 0.7 trillion. It is feared that in the second half of this year, the U.S. Treasury will intensify efforts to reduce borrowing or increase taxes (increase secondary distribution efforts), and only then will the possibility of sustained downward movement of current high interest rates from the root cause continue Otherwise, even if there is a rate cut this year, it may be a hawkish rate cut similar to Europe - a rate cut that the market fully expects, but with hawkish guidance off the expected path.

Overall, with the deterioration of some residents' ability to repay, the pressure on the United States to reduce the deficit further increases (whether it is through increasing taxes, increasing transfers to the poor, or directly reducing fiscal expenditures). However, the current actions to reduce the deficit are still insufficient. Before the deficit significantly decreases, Dolphin Jun does not have a high estimation of the rate cut this year, keeping it around 25 basis points to provide enough safety cushion for equity investments.

Therefore, Dolphin Jun still holds a "short-term" investment opportunity judgment for US technology and other assets, not suitable for chasing highs, but can look for opportunities after a pullback to find short-term profit opportunities.

After the overseas Chinese assets have emerged from undervaluation repair, the key is still to see whether there can be unexpected marginal improvements in macro fundamentals, and to find Alpha companies capable of outperforming their peers at the individual stock level.

IV. Portfolio Rebalancing and Returns

Dolphin Jun did not rebalance before the Dragon Boat Festival. At the end of last week, the portfolio return increased by 1.3%, underperforming MSCI China (+1.5%) and Hang Seng Tech Index (+2.2%), but matching the S&P 500 (+1.3%) and outperforming the Shanghai and Shenzhen 300 Index (-0.2%).

Since the start of the portfolio testing until the end of last week, the absolute return of the portfolio is 35%, with an excess return compared to MSCI China of 53%. From the perspective of asset net value, Dolphin Jun's initial virtual assets of USD 100 million have now risen to USD 137 million.

V. Individual Stock Profit and Loss Contribution

Last week, semiconductor assets saw a higher increase, while assets with poor fundamentals that have undergone valuation repair could not sustain their gains. Among them, Huazhu's fundamentals deteriorated marginally, while Bilibili was already weak. Pinduoduo's main driver was the event-driven TEMU business.

However, as funds begin to flow back into large technology stocks, the rise in high-volatility sectors due to liquidity diffusion is significantly limited. Chinese concept assets still need to be carefully selected, focusing on high-value stocks with improving fundamentals and real repurchase support.

For Dolphin Jun's holding pool and watchlist, the companies with significant increases or decreases last week and possible reasons are analyzed as follows:

VI. Allocation of Combined Assets

The Alpha Dolphin virtual portfolio holds a total of 20 individual stocks and equity-type ETFs, with 5 core holdings and the remaining equity assets being underweighted, with the rest in gold, US bonds, and US dollar cash. Currently, there is a surplus of cash and cash-like assets, and in the coming weeks, consideration will be given to increasing positions in equity assets with reasonable valuations.

As of the end of last week, the asset allocation and equity asset weightings of Alpha Dolphin are as follows: