Last week, the market received further support from data, indicating that the U.S. economy not only achieved a soft landing, but also achieved stable economic progress without the feared rebound in inflation, thereby extending the Feds interest rate hike cycle. Markets have been debating the possibility of a soft landing for the economy while also considering the prospect of a long-term high interest rate environment. But that view has changed rapidly after the Feds dovish turn last week, as inflation accelerated and slowed, growth held firm, real yields fell, stocks rose in response, and financial conditions eased rapidly. Investors have shown strong interest in the stock recently. Bank of America said clients bought a net $6.4 billion in U.S. stocks in the latest week, the largest weekly net inflow since October 2022.

Last week, inflationary pressure continued to subside. In November, nominal PCE turned negative for the first time on a month-on-month basis. Core PCE prices increased by 0.1% month-on-month, lower than expected, and the annual rate dropped to 3.2%. Judging from the six-month annualized data, the Fed has basically achieved its price target.

And income and spending rebounded simultaneously:

On the economic data front, last weeks data - including a Philadelphia Fed survey and a consumer confidence survey - suggested the economy was still growing, but not too fast; meanwhile, U.S. durable goods orders for November exceeded investor expectations. New orders for durable goods rose 5.4%, above expectations of 2.2%. Durable goods orders shrank 5.1% in October. Third-quarter GDP was revised slightly downward last week to +4.9%, but that was still the strongest quarterly GDP growth since 2014 (excluding the post-pandemic reopening phase). Sales of new U.S. homes plunged in November as rising mortgage rates hurt homebuyers, but the market paid little attention to the data given that second-hand listings also shrank sharply and winter is already a slow season.

The current market theme is no landing for the U.S. economy. The so-called landing was originally expected to be marked by the trough of activity in the fourth quarter of 2023/the first quarter of 2024. However, during this period, the U.S. GDP is still expected to reach 2% and then accelerate again. .

U.S. stocks rose for the eighth consecutive week (the SPXs longest winning streak since 2017). Although it plunged 1.5% intraday on Wednesday, there was no obvious reason and no much discussion. There were sporadic comments attributed to the escalation or large-scale geopolitical tensions in the Taiwan Strait. SP 500 put options trading. The mainstream understanding is that the more reasonable explanation is still technical, and the market needs some room to calm down after a continuous rise.

China on Friday launched a series of new measures to curb players spending on video games, sending ripples through global stock markets. Not only Tencent and NetEase plummeted, but French Ubisoft and American Unity also fell. Naspers/Prosus, Tencents largest shareholder, fell 20%.

The CSI 300 index posted its sixth straight weekly loss on Friday, its longest losing streak since January 2012. The index is down nearly 14% this year, lagging most major national stock indexes around the world. The Golden Dragon Indexs decline will deepen to about 8% in 2023, far behind the 54% increase of the Nasdaq 100 Index. As policymakers ramp up support, some are rekindling hopes that 2024 will be better, especially given Chinas cheap stock valuations.

Crude oil net longs increased last week for the first time since late September, rebounding from record lows, largely as Houthi attacks on merchant ships crossing the Red Sea hurt companies transporting everything from manufactured goods to oil and commodities Shares rose and oil prices posted their biggest weekly gain in months.

Speculators are ramping up bearish bets on the Canadian dollar, boosting net short positions to their highest level in nearly five years. Mainly because inflation remains stubborn and growth is weak

U.S. bond yields continued to fall overall this week, but the decline was not as severe as the week before the Federal Reserve meeting released a dovish turn signal. The decline in short-term bonds was relatively large, with 10 Y still flat at 3.9% and 30 Y at 4%:

The market is betting that the Federal Reserve will start to cut interest rates by 160 basis points in March. To achieve the market pricing target, some indicators such as the labor force need to deteriorate significantly. There are currently no signs of this happening:

Recall that from July to September, the market was worried about the theme of fiscal discipline disorder, which caused the stock and bond markets to plummet. In fact, it will not get any better in 2024, but will only get worse. The net issuance of U.S. debt in 2023 will be 10,000 billion, but will soar to $1.9 trillion in 2024. The reverse repurchase facility may be exhausted in March and it will be difficult to provide more liquidity support. This may be a major reason why the market is betting that the Fed must cut interest rates sharply in addition to inflation. background.

Red Sea crisis sends shipping inflation soaring

Perhaps the biggest theme in global financial markets last week was the crisis in the Red Sea shipping industry. Due to the continued risk of Houthi attacks, 158 ships carrying approximately $105 billion in seaborne cargo were forced to leave the Red Sea, causing cargo prices to soar.

A report released by the Ningbo Shipping Exchange on December 22 showed that 85% of container ship liner companies have notified them to suspend the pickup of cargo on the Red Sea route. More and more freighters will choose to go around the Cape of Good Hope, which means that transportation distance and transportation costs will increase significantly. According to media estimates, the overall voyage distance has increased by 40% and transportation costs have increased by more than 40%. This has driven the domestic container shipping index and market freight rates to continue to rise. The main contract of the Shanghai International Energy Trading Center Container Index (European Line) futures has hit the daily limit for five consecutive trading days, with a cumulative increase of more than 50% in a week.

Shipping companies stand to benefit financially as Red Sea disruption drives up freight costs, with the combined market capitalization of the worlds largest listed shipping companies jumping about $22 billion since the attacks really intensified on December 12.

The Red Sea-Suez Canal corridor accounts for 12% of international trade and nearly one-third of global container traffic. The routes near-standstill portends a return to global supply chain disruptions in the short term. According to media reports last Friday, sea freight from Shanghai to the UK rose to US$10,000 per 40-foot container. Just the previous week, the price was only US$2,400. Industry experts analyze that once logistics is tight for more than a month, inflationary pressure will be felt and seen at the supply chain and even the consumer level.

Money Flow and Sentiment

Data from EPFR Global said cash funds attracted $1.3 trillion in inflows, dwarfing the $152 billion that flowed into global equities. Investors are also investing more than ever in U.S. Treasuries, reaching $177 billion. The data illustrate how this years stock market rebound has surprised most investors after a dismal 2022. That could mean theres still plenty of money sitting on the sidelines in the new year, waiting to be pushed into stocks and bonds, if the central banks forecasts live up to expectations.

Bank of America wealth management clients hold 60% stocks, 21.4% bonds, and 11.8% cash. The proportion of stocks is increasing, and the proportion of bonds and cash is decreasing:

Both gross and net leverage for GS hedge fund clients have accelerated over the past two weeks.

However, the total long-short ratio hovers at a historical position:

In recent weeks, GS clients have been overweight defensive stocks (staples, healthcare, utilities) and consumer discretionary, significantly underweight cyclicals (energy, materials, industrials, financials, real estate), and slightly underweight TMT. The operations of GS customers are not completely consistent with the recent market trends. The recent rebound in the real estate, consumer discretionary, industrial, and financial sectors has been very strong, but GS customers have chosen to reduce their holdings. The performance of defensive stocks has been weak, but GS Clients choose to increase holdings:

The financials sector, for example, rebounded 19% from November levels, but bulls turned to selling last week:

Bank of America’s bull and bear indicator continues to rise:

Optimism among individual investors about stocks short-term prospects rose to its highest level in two-and-a-half years in the latest AAII sentiment survey. Meanwhile, pessimism has increased slightly but remains at unusually low levels.

The bull-bear differential reached a new high since March 2021, at 32, and the historical average is 6.5%, indicating that retail investor optimism has become quite extreme:

The CNN Fear and Greed Index has remained at the extremely greedy level for two weeks in a row:

institutional perspective

DB: 2024 the year of valuation repair

Over the past five years, several European and Asian countries that accounted for around half the market share during our analysis (roughly speaking) have had price-to-earnings (P/E) ratios 0.75 standard deviations below their average over the past five years. Even in the United States and Japan, multiples are only now reaching their average levels. If risk appetite patterns persist in markets in 2024 amid a more certain macroeconomic backdrop, it is likely to support cheaper assets. Many of them are located outside the United States, they can provide diversification benefits, and they are also gaining momentum right now:

Comparing the valuation of GS, you can see that the valuation is not high except for US stocks. As the most expensive developed market, the U.S. had a P/E ratio of 17 times at the beginning of 2023 and is now 20 times. The historical median P/E ratio when the inflation rate is 1 – 3% is 20 times, so the market has priced in a scenario where inflation returns to normal. :

DB: 202 X ushering in the next bubble era

Historically, asset bubbles tend to re-form over a period of time following economic turmoil and falling bond yields. This was true in the 1990s, 2000s, and early 2020s. Now that yields have fallen and the global economy is recovering from the impact of the coronavirus pandemic, there is reason to believe that a new round of asset bubbles will emerge at some point in the 2020s. Systemic risks in the credit market are not significant in the short term, and private equity funds have plenty of cash ammunition. The short-term risk is that if the US hits a recession in mid-2024 + the European economy has also slowed, market sentiment could deteriorate again, at which point many investors will reexamine risk appetite. (Political risks don’t just come from the United States. In 2024, voters in a country representing 41% of the world’s population and 42% of global GDP will participate in the leadership transition)

CICC: How long can reverse repurchase be sustained? The current pressure is not great, and U.S. stocks still have support; it may turn to contraction again in the second quarter of next year unless the balance sheet reduction is stopped.

The Feds balance sheet reduction is still continuing, and TGAs replenishment has been completed. Reverse repurchase will naturally become the key to future liquidity changes. Currently, there is still US$1.15 trillion in reverse repurchases. The net issuance of short-term debt exceeding US$460 billion in the first quarter may reduce it by US$390 billion, which can still offset the scale of balance sheet shrinkage in the same period; however, the net issuance of short-term debt in the second quarter will slow down significantly or even Turning negative, this may slow down the release of the remaining reverse repurchases. If the balance sheet reduction continues during the same period, financial liquidity will begin to shrink in the second quarter. Therefore, the current liquidity pressure on U.S. stocks is not great, but it may face some pressure in the second quarter of next year unless the Fed stops shrinking its balance sheet.

(It feels like the theme of fiscal chaos + massive supply will reoccur in 2024, especially during the U.S. presidential election. People’s attention will easily be drawn to the huge deficit, especially as the space for downward long-term bond yields may be very limited. , if the central bank cuts interest rates significantly, the yield level itself will not reach such a high level this year, but will manifest itself as a higher risk premium and a steeper curve, that is, the inversion returns to normal. Money market funds may be a potential successor to RRP. capital pool, but this requires interest rates to drop significantly otherwise bonds will not be more attractive to ordinary investors)

Cathie Wood: 2024 is about the deflation trade

Deflation will be a key theme in 2024 and is expected to prompt the Federal Reserve to cut interest rates significantly. Technological advances combined with this economic environment create the conditions for significant expansion in the coming years for companies that adapt to deflation and focus on innovation. Although it was previously skeptical about its Metaverse strategy and reduced its holdings, interest in Meta is rekindling due to optimism about its CEO Zuckerbergs strategy of using open source AI. She also highlighted the transformative potential of gene-editing technology, specifically mentioning CRISPR therapies. As this field is still in its early stages and the industry is very cash-burning, the industry has inefficient pricing and attractive investment opportunities. .

Bank of America Fund Manager Survey

BofA monthly survey of global fund managers shows investor sentiment most optimistic since January 2022, with cash levels falling to 4.5% (2-year low)

Stock allocation rose to net 15% OverWeight, a monthly increase of 13%, the largest monthly increase since November 2022. The stock-cash net allocation ratio hit the highest since January 2022. Now fund managers OW stocks have just 2 Month time:

Fund managers are comfortable with the level of risk they currently take, with risk tolerance rising 21 percentage points over the past two months, but there are no signs of overheating:

Investors are still pessimistic about global economic growth, but it has improved, and the possibility of a global economic slowdown is expected to decrease;

91% of respondents believe the Feds rate hike cycle is over; 89% expect short-term interest rates to fall, the highest proportion since November 2008, and 62% expect bond yields to fall

Bond allocations are now 20% net long, the highest level in 15 years:

If the Fed cuts interest rates in the first quarter, the most promising trades will be long-term Treasury bonds first, followed by long-term technology stocks (such as biotechnology, renewable energy), and then long-term value (such as banks, real estate investment trusts, small-cap stocks... …):

The most crowded trading positions are long “Magnificent 7” (49%) and short Chinese stocks (22%); Chinese real estate is seen as the most likely systemic credit event (29%):