Macro Weekly Report (8.21-8.27) China’s expected pessimism bottomed out, who are the long-term beneficiaries of AI?
Macro Weekly Report (8.21-8.27) China's expected pessimism bottomed out, long-term beneficiaries of AI?
The risk asset market stabilized in the past week, but the degree of indecision increased. Contradictory trends emerged in cross-asset markets, indicating that investors now lack further optimistic reasons after the surge in stock markets driven by the AI theme frenzy, better-than-expected earnings in the US stock market, and speculation that the Federal Reserve will turn to rate cuts once the economy cools down. Investor sentiment has recently seen a noticeable decline, but this is a benign signal. In addition, pessimism about the Chinese economy in July seems to have bottomed out and odds are rising. NVDA’s earnings report greatly exceeded expectations, but funds chose to exit as short-term beneficiaries of AI have already risen. So, which stocks of long-term beneficiary companies should be bought? Goldman Sachs has conducted a quantitative analysis.
US Market
Last week, long-term interest rates in the interest rate market paused their rise, while short-term interest rates caught up, especially after Powell’s hawkish speech on Friday, the 2-year Treasury yield reached the highest level since March.
Last week, major US stock indices rose, with wide fluctuations during Powell’s speech and eventually closing higher:
The yield spread between stocks and bonds has reached extreme levels not seen in decades, indicating that funds may become more cautious, specifically reflected in:
The current dividend yield of the S&P 500 is approximately 1.58%, while the 10-year bond yield is approximately 4.25%. The difference between the two is 2.66%, the largest since 2007.
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The difference between the current earnings yield of the S&P 500 and the 10-year bond yield is only 40 basis points, the smallest difference since 2004.
During Powell’s speech, the US dollar index hit an intraday low of 103.75. As soon as his speech ended, the US dollar rebounded to a new high of 104.45 since June 1; however, the renminbi stabilized last week and closed at 7.288 on Friday, failing to break the important psychological level of 7.3.
Crude oil slightly declined, while gold, silver, and copper all rose. Cryptocurrencies saw a slight decline. Gold had its best weekly performance since mid-July, as long-term US bond yields fell prior to Powell’s speech, providing support for gold prices.
Federal Reserve Chairman Powell’s speech at the 2023 Jackson Hole Conference focused on three key points, but there was no new information: First, the Fed remains committed to achieving a 2% inflation target, dismissing speculation about tolerance or raising the target. Second, officials are prepared to raise interest rates further when necessary and will maintain high borrowing costs until inflation convincingly approaches the target, which means rates may remain elevated for a longer period. Finally, after experiencing significant rate hikes since 2022, the Fed is currently in a cautious phase regarding the risk of excessive tightening and will approach future rate hikes with caution, not necessarily influenced by sustained economic resilience. In addition, there was no clear guidance on the core “neutral rate” that the market has been concerned about recently, so this speech has little effect on addressing the current market uncertainty.
Investors in the interest rate futures market are split on whether the Fed will raise rates once or keep them unchanged this year. On Thursday, the probability of another rate hike within the year was about 46%, which slightly increased to 53% after Powell’s speech on Friday. This week’s change is not significant, but significantly higher than the 32% from the previous week. By June next year, traders expect a 62% chance that the Fed will cut rates from the current level, lower than the 83% they predicted a week ago.
Combined with the contradictory performance of rising stock markets, large declines in short-term bonds, flat long-term bonds, and even slight gains in junk bonds, as well as the market performance of gold and cryptocurrencies stabilizing after fluctuations, it can be seen that investors’ viewpoints are highly divided and the market is in a state of uncertainty.
In terms of market comments, “bond king” Bill Gross said when talking about Powell’s speech on Friday that he believes the yield on 10-year US Treasury bonds could rise to 4.5% in the future, while short-term rates will remain relatively stable. He believes Powell’s implication is “higher longer”. Former US Treasury Secretary Summers believes that Powell’s speech indicates that the Fed may need to raise rates at least once, or even more. Summers believes that Powell’s remarks indicate that the Fed is open to the possibility of a higher neutral rate than in the past.
The US Economic Surprise Index fell slightly last week but remains at a high level since April last year:
US durable goods orders for July fell by 5.2% compared to the previous month, marking the largest drop since the outbreak of the pandemic, mainly due to a sharp decline of nearly 44% in non-defense aircraft orders after a surge in the previous month.
The preliminary value of the Markit Manufacturing PMI in the United States for August was 47, reaching a new low since February this year; the preliminary value of the Services PMI was 51, reaching a two-month low; the preliminary value of the Composite PMI was 50.4, reaching a new low since February this year. Analysts believe that weak consumer demand and stagnant business activities in August have raised doubts about the growth momentum of the US economy in the third quarter.
Outside the United States
The European Stoxx 600 index closed flat. Most Chinese stock indices fell, but the real estate sector rose due to policies such as “recognizing houses without recognizing loans” for first-home mortgages and tax rebates for improved housing sales. In addition, over the past weekend, the stock market has received a combination of policy support measures, including halving stamp duty, optimizing IPO and refinancing supervision, further regulating share reduction behaviors, and reducing the financing margin ratio. Many analysts expect A-shares to rebound significantly this week. In addition, there is news that stamp duty may be abolished in the Hong Kong stock market.
The pessimism about the Chinese economy seems to have bottomed out in July, except for the extraordinary period of nearly three years since the Covid pandemic in 2020. The low surprise index for the Chinese economy can be traced back to 2015, which coincides with the extreme situation in the United States:
In terms of the Chinese market, investors were actively deploying in July this year. The scale of public funds increased by more than 1 trillion yuan, with stock-type fund net assets increasing by 127.777 billion yuan from the end of June to reach 2.83 trillion yuan, and hybrid fund net assets decreased slightly by 41.431 billion yuan to 4.59 trillion yuan. The net asset value of bond funds increased by 178.69 billion yuan from the end of June to reach 4.94 trillion yuan. In addition, affected by the profit-making effect in overseas markets, the net asset value of QDII funds increased by 42.498 billion yuan in July, with the scale increasing to 401.302 billion yuan.
Fund Flows and Positions
Last week, the market was in a stalemate, and defensive and cyclical stocks did not show significant differentiation:
Last week, US mutual funds saw a net outflow of $4.3 billion, the first outflow in 12 weeks:
However, technology sector funds had the largest net inflow in 10 weeks last week:
Hedge funds’ net leverage in the US stock market peaked at 70% in the second quarter but has dropped to 65% last week, below the 50th percentile of historical data in the past five years. This indicates that the current position of hedge funds is not high and there is room for further increases in positions:
US bond funds have seen a net inflow for 28 consecutive weeks (+$5.2 billion), setting the longest continuous inflow record since 2010:
Sentiment Indicators
Goldman Sachs’ sentiment index for the US stock market dropped from 0.8 in the previous week to 0.6 last week, still in the neutral range:
Bullish sentiment in the AAII investor survey has dropped significantly, while bearish sentiment has risen sharply. This is the first time since early June that the proportion of bearish sentiment exceeds bullish sentiment. This adjustment is positive as the previous bullishness was too high:
The CNN Fear & Greed Index remained relatively stable last week after a significant drop in the previous week:
Cryptocurrencies
IRS Discloses Stricter Tax Requirements
The US Department of the Treasury and the Internal Revenue Service (IRS) have proposed new regulations that plan to require cryptocurrency trading platforms (such as Coinbase and Kraken) to report detailed information about customer transactions, such as capital gains and losses, starting from 2026. This is similar to the existing requirements for stock and bond brokers. This measure aims to combat tax evasion related to cryptocurrencies and increase transparency.
This news is obviously a significant negative for the cryptocurrency industry in the medium term as it will further reduce potential investment returns. However, since the implementation will not occur until January of the following year, the market may not be sensitive to it at the moment. But the long-term prospects are favorable for the industry as it will help bring more compliant use cases.
Stablecoin Liquidity
According to Glassnode’s statistics, the balance of stablecoins in centralized exchanges has remained almost unchanged, with a slight outflow of $4.4 million:
The total balance of stablecoins on the blockchain has increased significantly by $1.22 billion, the largest growth in ten months. However, almost all of it is contributed by DAI, so its impact on market liquidity is limited:
The MakerDao system’s financial pool has locked 1.26 billion DAI in the past month, accounting for 24% of the total DAI locked. Therefore, the growth of DAI is mostly due to the financial pool:
Hot Focus on AI Leader NVDA
Nvidia’s data center revenue exceeded expectations last Wednesday:
- Nvidia’s second-quarter revenue was $13.5 billion, surpassing the company’s guidance of $11 billion.
- Of particular note is the company’s data center revenue, which grew by 171% year-on-year, with cloud service providers accounting for 50% of the revenue, up from 40% in the previous quarter.
- Growth was strongest in the United States, while China contributed 20-25% of total revenue.
- The surge in demand allowed Nvidia to charge higher prices for its chips. The company’s gross margin for the second quarter was 70.1%, up from 43.5% in the same period last year.
- For the third quarter, Nvidia provided revenue guidance of $16 billion, dispelling concerns in the market about potential supply chain bottlenecks. Nvidia guarantees that even in the face of potential export restrictions from the United States, the company’s supply will continue to increase every quarter over the next year.
In addition, a $25 billion stock buyback also briefly excited the market, making it the fifth-largest buyback announcement among US companies this year. Although the amount is astonishing, the buyback represents only 2.1% of its market capitalization of nearly $1.2 trillion, even lower than the historical buyback yield of 2.58% for the entire S&P 500 index.
Meanwhile, several other large technology and growth companies have announced their buyback plans for this year: Apple will buy back $90 billion, Alphabet will buy back $70 billion, and Meta will buy back $40 billion.
Nvidia CEO Jensen Huang predicts that around $1 trillion will be spent globally in the next four years on AI data center upgrades, including GPU upgrades. According to Huang, most of the costs will be paid by cloud service providers and other large technology companies, including Amazon, Microsoft, Google, Meta, and others. These companies are actively advancing generative AI.
However, some analysts point out that Huang’s pie is too big because the combined cash and cash equivalents of Amazon, Microsoft, Google, and Meta currently amount to only $334 billion. Even if future annual cash flows are added, it is still far from Nvidia’s estimated $1 trillion in four years.
Nvidia’s stock price rose steadily in the days leading up to the report, rising more than 6% on Thursday and reaching a new all-time high intraday, but the gains were pared back at the close, followed by a 2.4% drop the next trading day. However, the stock still recorded a 3.4% gain for the week.
Wall Street analysts collectively raised their price targets for Nvidia after the report was released. According to FactSet, the current target price for the stock is $640.71. The stock closed at $460.18 on Friday.
Famous investor Cathie Wood was not impressed by Nvidia’s impressive financial report. She sold nearly three million dollars’ worth of Nvidia stocks before and after the release of the financial report, stating that the valuation has already been reflected and she insists on selling at high prices. She said: “I believe that Nvidia, which can provide the basic tools needed for AI in the next five years, will be in a very favorable position. However, everyone knows this, and Nvidia’s value has already been evaluated accordingly.”
Last week, we mentioned that the market had high hopes for Nvidia’s performance to boost sentiment, but even with the release of historically better-than-expected financial results and future guidance on Wednesday, it ultimately failed to sustain market sentiment. Some analysts have pointed out that this is a signal that the rebound momentum for this year has already been “exhausted”, indicating that there will be further declines in the future.
Morgan Stanley strategist Michael Wilson said that despite Nvidia’s impressive financial report, Thursday’s stock market decline suggests that the market’s upward momentum for this year has already been exhausted and indicates that it will continue to decline in the future. The market reaction on Thursday is a perfect sign of a peak. Wilson explained, “The market tops due to good news and bottoms due to bad news. I can’t think of anything better than Nvidia. The fact that Nvidia’s financial report failed to boost the market is a negative technical signal that the overall market’s upward trend has already been exhausted. Now we need a new story to excite the market, but I don’t know what that is.”
Bank of America strategist Michael Hartnett agrees with Wilson’s view. He believes that as interest rates remain high for a longer period of time and the impact of reduced liquidity from the Federal Reserve becomes more apparent, the boost of artificial intelligence to the US stock market will fade in the second half of this year, and US technology stocks are expected to face difficulties.
Hartnett predicts that the second half of this year will be a time of trouble, not a new era of AI rules. The reason is that the correlation between Federal Reserve liquidity and technology stocks, the Nasdaq index is approaching its historical high, while the Federal Reserve’s balance sheet is declining significantly, which is inconsistent.
Institutional Views
Short-term beneficiaries of AI have already seen their gains, so which stocks of companies that will benefit in the long term should we buy?
Goldman Sachs economists calculated the share of companies’ wage bills facing AI automation. They used task content data for over 900 occupations in the ONET database in the United States, estimated the total amount of work facing labor savings for each occupation, and assumed that AI could complete tasks in the ONET “level” scale with the highest difficulty of 4.
Then, they weighted the importance and complexity of basic job tasks for each occupation and estimated the proportion of total work that AI has the potential to substitute for each occupation. They then calculated the labor cost as a percentage of total revenue for each company based on the company’s global employee count and median employee compensation reported in the annual statement. Combining these two indicators, they calculated the potential increase in earnings under the assumptions of maintaining stable profit margins and maintaining stable revenue.
Figure: Valuation Logic
Finally, two “Fortune Code” tables are obtained as follows. Of course, we have always advocated light conclusions and heavy logic. Interested people can conduct more detailed analysis or improvements based on this logic:
After the widespread use of artificial intelligence, the median EPS of the stocks selected by Goldman Sachs in this basket may be 72% higher than the market’s expectations. The performance of the stocks in this basket this year is only 6 percentage points higher than the S&P 500, much lower than those short-term benefiting stocks, indicating that most potential productivity improvements have not been priced in. The improvement in profit margins under this logic may not be permanent, but investors may speculate on this possibility.
Focus of the Week
US August non-farm payrolls, July PCE, progress on the US congressional budget agreement for the new fiscal year, US Treasury Secretary’s visit to China, PMIs of the US, China, and Europe, and Eurozone’s preliminary CPI for August, etc.
September, which is coming soon, has historically shown mediocre performance in the US stock market. Since 1945, the S&P 500 index has averaged a 0.7% decline in September, making it the worst-performing month of the year.
