U.S. stocks are likely to have a bumpy ride this year. The Nasdaq 100 index rose 26.63% last year but has also fallen more than 11% in the past three weeks. Investors used to be fear of missing out opportunities but now they are worried about their positions. They are taking advantage of all the rebound to reduce their positions rather than bottom fishing. The volatility of recent weeks has made confidence fragile seeing failed rebound during a sharp pullback in a short period of time.
The rise in stock prices in the U.S. in the last two years is more of a monetary phenomenon. It is the result of the expansion of the Fed’s balance sheet, which is also a manifestation of the monetary policy transmission mechanism. From February 2020 to December 2021, the size of the Fed’s balance sheet rose 115% from USD4.1 trillion to USD8.8 trillion, while the size of the U.S. broad money M2 rose 38% from USD15.5 trillion to USD21.4 trillion. Over the same period, the S&P 500 is up 113% from its trough and the Nasdaq is up 128%. The gains in U.S. stocks over the past two years have also been supported by economic fundamentals such as a strong rebound in household consumption after the epidemic and record corporate profits. Yet, it is not difficult to find out after careful analysis, an important source of the rebound in consumption is the wealth effect, which in turn has something to do with the Fed’s “release” of pushing up asset prices.
Due to inflationary pressures, the Fed has to speed up tightening, which has created a “sudden brake” situation. The fall in U.S. stocks is a knee-jerk reaction to the sharp U-turn in Fed policy and its potential impact. The Fed accelerates tightening and increases the risk of recession in the medium term. However, the possibility of systemic financial risk in the U.S. is small but the probability of financial crisis in some emerging market countries is on the rise.
The upcoming January 25-26 FOMC meeting is a key verification point. Whether it implies that interest rates will be raised in March and the time table on future tightening path will be the basis for the current market correction to take into account expectations.
Historically, U.S. recessions are generally caused by two reasons. One is the monetary tightening caused by inflation and the other is the financial crisis caused by the bursting of asset bubbles (the epidemic is an exogenous shock and an exceptional case, so it is not representative). In the decade after the subprime crisis in 2008, the financial supervision in the U.S. was strengthened, the leverage ratio of financial institutions decreased and the ability to resist risks increased. So even if U.S. stocks plummet, the probability of a systemic financial crisis is likely to be small. Yet, rising inflation “forces” the Fed to accelerate tightening, which will increase downward pressure on the economy and increase the risk of a medium-term recession.
However, financial conditions in some emerging market countries may be tightened as a result of the Fed’s monetary tightening and the likelihood of a financial crisis in these countries will rise. For example, Turkey’s stock and exchange rate have adjusted sharply in the past two months, highlighting the fragility of financial markets. We need to continue to pay attention to the impact of the Fed tightening on the U.S. economy and the spillover effects on some emerging market countries.
The earnings season for large technology stocks is about to begin. In recent days, the focus of the U.S. stock market is turning to financial results. Streaming giant Netflix Inc. announced its results for the fourth quarter of 2021 last week. Although the company’s Q4 performance was in line with market expectations, it plunged over 20% as the growth guidance for new Q1 subscribers in 2022 was to add just 2.5 million which is far below the nearly 7 million expected by analysts.
United Airlines also announced results. Strong holiday travel demand at the end of the year pushed the company’s revenue in the fourth quarter of 2021 to USD8.2 billion, which was still nearly 25% lower than the same period in 2019 but it was the highest quarterly revenue since the Covid19 outbreak began to weaken travel demand. It lost USD646 million in the fourth quarter and USD1.96 billion for the full year.
Against the backdrop of the increasingly aggressive outlook for the Fed to raise interest rates, these startling declines raise concerns about corporate earnings prospects and increase the fragility of the market. Upcoming this week will have tech giants Tesla, Apple, Microsoft’s Q4 results. Market expects Apple Inc. to earn USD1.85 per share on revenue of USD117.8 billion up. Market would focus on positive signs that could be shown in the results, including improvement of supply chains, continued strong end-user demand, product portfolios and growth in services and subscriptions.
The International Energy Agency raised its global oil demand growth outlook for full-year 2022 due to easing Covid-19 restrictions despite the surging cases of the Omicron variant of the coronavirus.
Goldman Sachs lifted the Brent oil futures prices forecast from USD81/ 85 per bbl in 2022/ 23 to USD96/ 105 per bbl, citing low global inventory under pandemic. The broker projected the OECD inventories to hit troughs since 2000 by summer 2022. Besides, OPEC spare capacity may also drop to its lowest points since 2004. As a result, oil prices were expected to rise to shore up inventories. In addition, with geopolitical tension rising between Russian and Ukraine, oil prices will be likely to continue to stay high.
In case of market demand/supply rebalance, the long-dated oil prices may climb to USD90 per bbl, bringing Brent spot to USD105 per bbl in 2023. Since Asian oil producers such as PetroChina, CNOOC, Thailand’s PTTEP have one of the highest exposures to spot oil prices in lack of an active hedging plan, higher oil prices were predicted to entail notable free cash flow from Asian oil producers this and next year.
At a time when most central banks are tightening policy in a bid to curb inflation, China is easing monetary policy to spur economic activities. While the country’s economy expanded by 8.1% last year, the slowdown in the last three months in 2021 is expected to spill over into 2022.
Market forecasts that China’s GDP will grow 5% to 6% in 2022. While industrial production is looking positive, disappointing retail sales are still a concern. What’s more, the possibility of Omicron threatening China’s zero-Covid stance and headwinds in its property market are added pressures. To help boost the economy, the People’s Bank of China (PBOC) cut its loan prime rate again by 10 bps to 3.7%. This came just days after the central bank reduced medium-lending facility rates (MLF) by 10 bps to 2.85%.
On this backdrop, China may outperform other markets this year, given its easing cycle has already started. Valuations are also more reasonable and there will be less selling pressure from global investors. The immediate effect of the common prosperity goal was to slow down China’s economy, which softened throughout 2021. It was further exacerbated by Covid-19 variants outbreaks, cooling property markets, power shortages and slowing exports, sending markets into bear territory last year. This slowdown has led to many betting on policy easing this year, on Beijing loosening monetary and financial measures to shore up the economy. Signs have emerged, as the PBOC started to free up liquidity for lenders last month and may even cut interest rate in the future. In this case, banks and those preferred property developers which are going into property consolidation, would be the biggest beneficiaries. Green energy would still be one of the bright spots in the market.
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