The resilience of the U.S. economy has once again become evident, and what signals do the U.S. and Japanese stock markets reveal?
Since late December, global demand has been hovering at low levels, and the crisis in the Red Sea has disrupted global energy transportation. While U.S. credit has expanded, the manufacturing sector has contracted, but the service sector continues to expand. Employment has strengthened once again, and core inflation has slowed down. Overall, the U.S. economy has demonstrated a certain resilience. Federal Reserve officials have indicated a reluctance to quickly cut interest rates, and U.S. bond yields have notably rebounded, with the U.S. dollar also showing some recovery. The relative resilience of the U.S. economy is expected to continue in the short term, and the U.S. dollar may see a slight increase in the short term.
Now, let’s turn our attention to the Eurozone economy. It remains in a significant contraction, with a preference for employment and a continuing trend of core inflation cooling. The relatively weak economic conditions are driving the Euro against the U.S. dollar downward. The short-term weakness of the Eurozone economy may increase, and the Euro against the U.S. dollar is expected to depreciate. The Japanese economy is further slowing down, with economic expectations hit by a strong earthquake. Meanwhile, nominal wage growth in Japan has significantly declined, inflation continues to cool, and the market has lowered expectations for further easing by the Bank of Japan, causing the yen to sharply fall. The Japanese economy is expected to remain weak in the short term, and the yen against the U.S. dollar is expected to be weak.
Since the beginning of the year, the S&P 500 has reached new highs, leading the Japanese stock market, but other Asian indices, especially in China, have taken a different path. How should we interpret these “disconnections”? What insights do the surges in the U.S. and Japanese stock markets bring?
Specifically, regarding U.S. stocks, the economic resilience has created the fundamental conditions for the rise of the U.S. stock market. Since the beginning of January, better-than-expected employment and retail sales in the U.S. have helped the market confirm the reduced risk of a recession in the face of a favorable macroeconomic environment. Coupled with the fall in gasoline prices and a significant cooling of new lease rental prices, both short-term and long-term inflation expectations have steadily declined. The growing anticipation of “anti-inflation” interest rate cuts has received further confirmation.
Powell’s “absence” in suppressing expectations of tightening is the key to the bullish trend in the U.S. stock market.
The accommodative environment undoubtedly creates very favorable conditions for the stock market: the market aggressively anticipates loose policies, sparking speculation that Powell will “pour cold water” on expectations of loose policies. Since the December monetary policy meeting, numerous Federal Reserve officials have expressed a desire to correct expectations, but Powell has chosen to remain “silent” and has not made any public statements. A typical counterexample can be seen with the European Central Bank, where similarly rapid expectations of interest rate cuts occurred. The difference is that the ECB President directly took action to “dampen” market bets on rate cuts, and subsequently, European stocks performed relatively poorly.
AI + semiconductor, shaping the rise in the stock market in the short term.
The technology theme has powerfully stimulated the rise of the U.S. stock market from events to emotions. On the event side, the release of Apple Vision Pro on January 19 and the Head of Meta’s Global Business Division stating at the World Economic Forum that, with the help of AI, advertising returns have averaged a 32% increase; on the emotional side, TSMC’s optimistic guidance for overall recovery in 2024, raising expectations for AI, Google Cloud’s announcement of collaboration to empower Samsung phones with AI models, Meta’s increase in capital spending on Nvidia’s computing cards, and more. With the comprehensive boost and stimulation from the AI market, the U.S. stock market has surged under the leadership of “FANNG+.”
“Some new audiences might not be familiar with what FANGNG is, so today we’ll give everyone a brief introduction. FAANG is actually composed of the first letters of five leading American tech giants: Facebook, Amazon, Apple, Netflix, and Google. Seizing on this trend, the New York Stock Exchange also introduced the FANG+ Index (NYSE FANG+ Index). In addition to the aforementioned main component stocks, it also includes companies like Tesla (electric car manufacturer), Twitter (social media platform), and Nvidia (artificial intelligence computing company). This group possesses characteristics of innovation, high growth, and a departure from traditional tech industry models, making it a globally influential benchmark for technology leadership.”
The key question arises: with the significant surge in the U.S. stock market, is it still a good time to invest, and when should investors who already hold U.S. stocks consider exiting? We believe the sustainability of the sharp rise in the U.S. stock market is indeed questionable due to several destabilizing factors:
Firstly, the depth of the market’s rise may not be sufficient. Looking at the chart, the declining proportion of trading above the 200-day moving average suggests that the sustainability of the U.S. stock market’s upward trend may be relatively short-lived. Additionally, it’s worth noting that the current uptrend in U.S. stocks is driven primarily by a few major giants, and other S&P stocks with equal weighting do not exhibit the same strong upward momentum as these leading stocks.
Secondly, the market’s aggressive expectations for a full-year interest rate cut (140 basis points, approximately 6 times) in 2024 are contradictory to the remarkably resilient economic fundamentals. Therefore, the future risk lies in the possibility that even if Powell, unusually, does not immediately suppress interest rate cut expectations like the European Central Bank, he might not maintain silence in the January policy meeting. However, trading around “FANG+” is currently extremely crowded, and the rise has significantly deviated from the fundamentals, warranting caution against the risk of a sharp correction from the overinflated levels.
So, the sustainability of the continued surge in the U.S. stock market remains to be observed. On the other hand, looking at the Japanese stock market, the silence of the Bank of Japan and the Federal Reserve has a similar connotation. Coupled with the recent softening of expectations regarding the Bank of Japan’s shift, which extends the timeline for easing expectations, Japanese stocks have greater resilience compared to U.S. stocks. Additionally, improvements in Japan’s economic fundamentals and corporate profit expectations contribute to the positive performance of Japanese stocks.
Japan has transitioned from deflation to reflation, but considering the low probability of the Bank of Japan abandoning negative interest rates and adjusting Yield Curve Control (YCC), the market’s shift in expectations in January has led to a yen depreciation, guiding the rise in Japanese stocks. Furthermore, with the initial success of Japanese corporate reforms leading to improved profit expectations, and given that the global allocation to the Japanese stock market remains relatively low, further foreign capital allocation and increased domestic participation have jointly created a remarkable performance in Japanese stocks.
Additionally, the recent decrease in expectations for a rapid interest rate cut by the Federal Reserve has boosted the price of the U.S. dollar. Since late December 2023, the U.S. dollar index has seen a slight rebound. As the U.S. economy demonstrates resilience once again, Federal Reserve officials have indicated a lack of urgency for a swift interest rate cut, leading to a market correction in expectations. Long-term U.S. Treasury yields have also rebounded, contributing to the U.S. dollar’s appreciation. As of January 16th, the U.S. dollar index closed at 103.3, a 1.9% increase from the end of December, resulting in respective appreciations of 1.5%, 0.8%, and 4.4% against the Euro, Pound Sterling, and Japanese Yen. Short-term expectations suggest a modest strengthening of the U.S. dollar. In the short term, the relative resilience of the U.S. economy and a delayed expectation for Federal Reserve interest rate cuts may drive a continued short-term appreciation of the U.S. dollar.
In contrast, the Japanese Yen has significantly depreciated against the U.S. dollar since late December. With a rise in long-term U.S. bond yields and an expanding U.S.-Japan interest rate differential, coupled with the impact of a severe earthquake on the Japanese economy, along with a substantial decline in nominal wage growth and cooling inflation, market expectations for further easing by the Bank of Japan have diminished, leading to a sharp decline in the Yen. As of January 23rd, the USD/JPY exchange rate closed at 147.5, marking a substantial depreciation of 4.3% from the end of the previous month.
Short-term expectations for the Japanese Yen against the U.S. dollar are anticipated to be weak. The current slowdown in the Japanese economy, stagnant nominal wage growth (with a year-on-year increase of 0.2%, significantly lower than the previous 1.5%), and weakened inflationary support pose challenges for achieving sustained inflation at the target level. It is expected that the Bank of Japan will maintain a significantly accommodative stance in the short term, making it challenging for negative interest rates to end soon. Therefore, a short-term weakness in the Japanese Yen against the U.S. dollar is anticipated, and considering short positions near the peak may be advisable.
Let’s take a look at the situation in the Middle East. The recent turmoil in the Middle East has created a hedge against the global demand downturn, leading to volatile fluctuations in global oil prices. Since late December, the crisis in the Red Sea shipping has continued to escalate. Against the backdrop of the ongoing Israel-Palestine conflict, Houthi rebels in Yemen have launched frequent attacks on Red Sea ships to express support for Palestine. In response, the United States and its allies initiated joint escort operations, resulting in confrontations between Houthi rebels and the U.S. and UK navies.
On the nights of January 11th and 12-13th, the U.S. and UK conducted consecutive attacks on Houthi rebels, and in retaliation, the rebels launched counterattacks, posing constraints on global crude oil transportation. Simultaneously, the U.S. plans to replenish its strategic petroleum reserves, contributing to a temporary uplift in international oil prices. In early January, a series of explosions occurred in the southeastern Iranian city of Kerman, with the extremist group “Islamic State” claiming responsibility for the incidents. This further complicated the situation in the Middle East. On the other hand, due to global demand still being suppressed by high interest rates, Saudi Arabia’s significant reduction in crude oil prices has raised concerns in the market about the outlook for global demand, temporarily weighing on international oil prices.
Amid the intertwining of geopolitical tensions and global demand weakness, international oil prices have experienced wide fluctuations, with the Brent crude oil price oscillating around $77 per barrel, slightly on the higher side of the central range. Constrained by demand, the overall level of international natural gas prices remains relatively low, and there hasn’t been a recurrence of a supply crisis in European natural gas. As global energy prices stabilize and the base effect decreases, the slowing of inflationary pressures on the global production side is evident. However, there is a risk of further escalation in the Red Sea crisis, which needs close attention.