Is This the Peak for US Stocks' Record Highs?

In 2025, the U.S. economy is likely to enter a relatively weak state. Considering the fiscal pressure, wealth disparity issues, and economic conditions in the United States, it is probable that the country will enter a rate-cutting cycle after the general election. The siphoning effect of the U.S. stock market will gradually come to an end, facing more downward pressure.

The Chinese equity market may be on the verge of a reversal. In fact, since 2018, assets denominated in Chinese yuan have shown the weakest correlation with U.S. stocks. Consequently, as long as the value of the yuan remains stable and domestic demand policies become more proactive, A-shares and H-shares are expected to continue to be favored by overseas investors.

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In May 2024, the U.S. stock market once again reached a historical high, with the Dow Jones Industrial Average closing above 40,000 points for the first time, and the Nasdaq Composite Index briefly breaking through 17,000 points. In our view, there are three foundations for the rise of U.S. stocks since 2023.

First, the relatively high nominal GDP growth rate and government leverage ratio in the United States have suppressed the level of risk-free interest rates. After the pandemic, the balance sheets and cash flow statements of U.S. residents are relatively healthy, which has kept their nominal GDP growth rate at a very high level and increased corporate profits. Additionally, economic growth is inseparable from fiscal support, and the high government leverage ratio has limited the room for interest rates to rise.

Second, the global economy is in a period of chaos, and U.S. stocks represent one end of the "barbell" strategy. In 2020, the global median age of the population exceeded 30 years for the first time, which may imply that the actual economic growth rate of the world after the pandemic should take a step down. However, breakthroughs in artificial intelligence may weaken or even offset the impact of population aging on global economic growth. In this chaotic period, the "barbell" investment strategy that has been popular since last year involves betting on both artificial intelligence and safe assets, with most of the best investment targets in artificial intelligence being in the U.S. stock market.

Third, the U.S. stock market is experiencing a siphoning effect again. In the 1990s, the U.S. stock market experienced a very typical siphoning effect. After the Asian financial crisis broke out in 1997-1998, it seemed that only the U.S. economic growth and asset performance stood out. Coupled with technological advancements in the U.S. internet industry, foreign capital bought a large amount of U.S. stocks, especially those related to the internet, causing their stock prices to soar. Since 2023, the U.S. economy has grown significantly, and the United States has become the center of a new wave of AI, leading to a resurgence of the siphoning effect in the U.S. stock market.

As of May 15, 2024, Berkshire Hathaway submitted a report on its holdings as of the end of the first quarter of 2024 (Form 13F), which showed that Berkshire is significantly reducing its holdings in U.S. technology companies and instead increasing its cash holdings. In the first quarter of this year, Berkshire cumulatively reduced its holdings of Apple stocks by 116 million shares, reducing the proportion of Apple in its portfolio value from 50% to around 40%, and completely sold out of HP. By the end of the first quarter, Berkshire's cash reserves reached $189 billion, a historical high, with a year-on-year increase of 44.7%. This may indicate that Warren Buffett believes that U.S. technology stocks have risen to an extremely high level, and their investment value is no longer significant.

How high is the current valuation of U.S. stocks? Its Shiller 10-year cyclically adjusted price-to-earnings ratio (CAPE) is currently near the second-highest level in history. On the eve of the Great Depression in 1929, the CAPE was 32 times; during the burst of the Nasdaq bubble in 2000, the CAPE of the S&P 500 reached the highest historical value of 44 times; after the pandemic, the peak of the CAPE was in 2021, reaching 38 times; currently, the CAPE of the S&P 500 is around 33 times. The current 10-year U.S. Treasury yield is at a similar level to that during the burst of the Nasdaq bubble in 2000 and is significantly higher than the level before and after the Great Depression in 1929. In combination, the current valuation of U.S. stocks has reached a relatively high historical position and is difficult to digest through simple rate cuts.Looking ahead, the inflation situation in the United States is showing signs of easing. Although this brings the U.S. closer to the conditions for interest rate cuts, it also implies a decrease in the economic pull of the "two tables" of American residents, leading to a weakening of consumer momentum. On May 14th, the White House issued a statement announcing an increase in tariffs on imported electric vehicles, lithium batteries, photovoltaic cells, critical minerals, semiconductors, steel, and aluminum from China, on top of the existing Section 301 tariffs. This means that for the "company" of the United States, looking into the next year, upstream costs are rising while downstream demand is weakening. Moreover, current U.S. stock valuations are at historically high levels, hence investors like Berkshire Hathaway have begun to diversify risks on the left side.

Furthermore, the "positive" correlation between gold and U.S. stocks is strengthening, which is also evidence that international funds are diversifying risks. Starting last year, assets that were previously weakly correlated or even negatively correlated with U.S. stocks, such as gold and upstream resource products, have begun to show a "positive" correlation with U.S. stocks.

The prices of gold and U.S. stocks should theoretically diverge, yet since 2023 (especially this year), we have observed an increased "positive" correlation between gold and U.S. stocks. We conducted a 90-day rolling correlation analysis between the NASDAQ and gold, and the results show that in the past six months, the "positive" correlation between the two has been extremely strong. This may reflect that international investors are gradually implementing risk diversification strategies by increasing their holdings of gold to balance the adjustment pressures of the Nikkei, U.S. stocks, or other assets.

02

How to view the subsequent trend of U.S. stocks?

In the short term, the adjustment of U.S. stocks may not have ended. The continuous postponement of interest rate cut expectations and the rapid rise in the yield of 10-year U.S. Treasury bonds are the triggers for the recent adjustments in U.S. stocks. If the yield of 10-year U.S. Treasury bonds reaches the level of 4.8%-5% in the second and third quarters, U.S. stocks may still face adjustment pressures.

Historical experience shows that in the years of re-election campaigns, the S&P 500 Index has closed higher in the year. From current polls, the election situation is not favorable to the ruling party, and the Biden administration still needs to work hard to win re-election. Although short-term adjustments in interest rate cut expectations put pressure on U.S. stocks, suppressing these expectations could also boost the siphoning effect of U.S. stocks. Therefore, after short-term fluctuations, it is still possible that U.S. stocks could reach new highs before the election. Recently, a series of policy moves by the United States against non-American countries may be paving the way for the next round of siphoning effects.

Since 2018, the performance of global major country stock markets can be roughly divided into four groups. The first group consists of the United States, India, and Japan, with stock markets far ahead in performance; the second group is resource countries, such as Brazil; the third group is European countries; and the worst performing are emerging manufacturing countries.

Regarding the performance divergence of these four groups of countries' stock markets, we believe it can be understood from two points.Firstly, starting from 2018, the United States began to promote the transfer of manufacturing and the reshaping of the value chain, attempting to shift from "global integration" to "trade regionalization." Resource-rich countries are the beneficiaries of this phase, hence the stock market performance of resource-rich countries has been better than that of emerging manufacturing nations.

Secondly, when examining the performance of the U.S. stock market, its siphoning effect seems not as strong as it was during the Asian financial crisis up to the year 2000. One reason is that the process of reshaping the global value chain has created attractiveness for the stock markets of some other countries, rather than the U.S. stock market being the "only standout" as it was in the late 1990s. On the other hand, the process of de-dollarization has accelerated globally, with the currency composition for global trade settlements and foreign exchange reserves becoming more diversified. The proportion of the U.S. dollar in global foreign exchange reserves fell below 60% in 2020 and dropped to a historical low of 58.4% in the third quarter of 2023. This reflects a weakening of the status and influence of the U.S. dollar within the monetary system.

In the future, interest rate cuts may become the inflection point for the siphoning effect of the U.S. stock market. Looking back at the siphoning effect of the U.S. stock market from 1998 to 2000, from the second half of 1999 to May 2000, the Federal Reserve raised interest rates from 4.75% to a high of 6.5%. However, during this period, the U.S. stock market continued to rise. It was only after the expectation and implementation of interest rate cuts, signaling a downturn in the U.S. economy, that the U.S. stock market fell and the siphoning effect receded.

Looking ahead, by 2025, the U.S. economy is likely to gradually enter a weaker state, and its advantage over other developed countries will diminish. Just as there are shadows under the sun, the "prosperity" of the economy in the past two years has further revealed two internal contradictions that the United States already had after the pandemic: first, a sharp increase in fiscal pressure, and second, a low real interest rate, which has pushed the wealth gap to an all-time high. The side effects of the post-pandemic prosperity on the U.S. economy may gradually become apparent after the elections.

After the elections, there are two issues to observe: first, how much will the global potential economic data center decline as the median age of the population crosses 30 years old, and whether the development of artificial intelligence can reverse this situation; second, how the United States will resolve the two internal contradictions of high government leverage and wealth disparity. Considering the fiscal pressure, wealth division issues, and economic conditions of the United States, it is likely to enter a phase of interest rate cuts after the elections, the siphoning effect will gradually end, and the U.S. stock market will face more downward pressure.

03

China's equity market may be on the verge of a turnaround

This year, when investors diversified the risks of the Nikkei and U.S. stocks, due to the limited investment value of the U.S.-Japan bond market, they turned to assets such as gold, Bitcoin, and globally priced commodities, which have all shown impressive performance in phases this year. However, these assets are all non-income-generating and highly volatile. In fact, from 2018 to now, in the global equity market, A-shares, Hong Kong stocks, and U.S. stocks have the weakest correlation. The current low-positioned Chinese equity market may be the best choice for risk diversification.

Recent cross-border capital flows have shown some positive changes, with foreign capital beginning to pay attention to China's capital market. According to the International Institute of Finance (IIF), in March of this year, both Chinese stocks and bonds achieved net inflows of funds. If according to the口径 of China Central Depository & Clearing Co., Ltd. (CCDC) and the Shanghai Clearing House (SHCH), all domestic bonds, including government bonds, policy financial bonds, and interbank certificates, have been continuously net increased by foreign capital for 7 months. This indicates that the global market may be starting to pay attention to some value-low areas (such as the current Chinese capital market), and is transferring more funds allocated to U.S. and Japanese equity assets to diversify risks. After the U.S. elections, if the Federal Reserve implements interest rate cuts and the U.S. dollar is likely to depreciate, the siphoning effect of the U.S. stock market will collapse, and it will face significant downward risks. If risk diversification is needed, then A-shares and H-shares, which have a turnaround logic in adversity, may be an excellent choice.However, for foreign capital to flow into China's equity market in large amounts, two prerequisites are needed: first, the stability of the renminbi's value, and second, more proactive domestic demand policies.

Firstly, in the wave of Asian currency devaluation caused by a strong US dollar in April this year, although the renminbi depreciated slightly against the US dollar, it performed strongly among Asian currencies. Looking ahead, the pressure for renminbi devaluation is limited, and there is even a possibility of appreciation, which will maintain its attractiveness to foreign capital.

Real estate policies have been as proactive as expected, and if necessary, there may still be room for further strengthening. Over the past four years, the core of domestic policy has been employment. Due to the slowdown in real estate investment and the containment of the service industry by the pandemic, domestic policy has been tilted towards manufacturing based on the employment demands of the middle and low-income groups. During this period, the core contradiction in the United States has been inflation. China and the US are in a complementary state: external demand drives Chinese manufacturing and exports, which is beneficial for cooling down US inflation. However, after the elections, as the US inflation issue eases, foreign trade policies may become more hawkish. Coupled with the possibility that some overseas industries may enter the final stage of the capital expenditure cycle next year, the global inventory cycle will also shift from passive restocking to active destocking. It is highly likely that China's external demand will weaken next year, and employment pressure will need to be alleviated through domestic demand.

In terms of domestic demand, only when real estate stabilizes can it effectively offset the weakening of external demand. Consumption is indeed recovering at present, but it is a slow variable with a gentle recovery slope. The potential for further expansion of infrastructure is also relatively limited, and the development of manufacturing is constrained by external demand. At present, the largest drag on domestic demand is real estate investment, which is significantly more sensitive to policy than consumption. In terms of volume and elasticity, only when real estate stabilizes can it take over exports and resist the pressure of economic and employment deterioration. Currently, real estate policies have been accelerated and implemented, and there may still be room for further strengthening in the future.

Therefore, summarizing the beta ranking of major asset classes, first, from the perspective of the equity market, domestic equity assets are superior to the stock markets of the United States, Japan, and India; second, from the perspective of the domestic equity market (i.e., A and H shares), assets related to domestic demand will perform better than those related to external demand; third, from the perspective of upstream resource products, resource products related to domestic demand will perform better than those related to external demand, that is, the performance of non-ferrous and black metals should be better than that of precious metals and energy.