CITIC Securities: U.S. stock market rise overdrawing optimism, beware of liquidity turning point exceeding expectations downward

According to the latest information from Zhitong Finance and Economics APP, CITIC Securities published a research report stating that the rise in US stocks since mid-September not only reflects the expectation of a preemptive interest rate cut, but also to some extent has overspent the expectation that if the Republican Party wins the US election, Trump may cut taxes and relax industry regulations. With the ongoing Federal Reserve balance sheet reduction combined with the debt ceiling issue, US stocks may face a downward inflection point of liquidity exceeding expectations towards the end of the year. Looking ahead, driven by optimistic sentiment, US stocks may still have room for short-term highs, with technology stocks, as well as the financial and industrial sectors, potentially benefiting more. As the election results settle and positive factors are already reflected, and with liquidity still shrinking, the risk of a US stock pullback is increasing. If the liquidity unexpectedly turns downward towards the end of the year leading to a US stock pullback, it is recommended to focus on the defensive and cash-rich healthcare and utilities sectors.

Recently, the Dow and S&P 500 have continued to hit historical highs, and the Nasdaq is also approaching its high point on July 11th. However, with further rise in risk-free interest rates, overnight US stocks saw a slight pullback, with only the information technology sector rising among the 11 primary industries. CITIC Securities believes that the rise in US stocks since mid-September not only reflects the expectation of a preemptive interest rate cut, but also to some extent has overspent the expectation that if the Republican Party wins the US election, Trump may cut taxes and relax industry regulations. However, after the election results are known and the Fed's interest rate meeting in November, I still advise investors to be cautious of the risk of a downward inflection point of liquidity exceeding expectations towards the end of the year leading to a US stock pullback.

Expectations of a "Republican sweep" are driving the rise in US stocks, with cyclical and semiconductor sectors leading the way.

Polymarket data shows that since October, the probability of Trump winning the US election and a "Republican sweep" has significantly increased, reaching 65% and 44% respectively as of October 22nd, up 16 percentage points from the beginning of the month. From an industry perspective, from September 9th to October 18th, apart from the three industries with the highest weightings in the technology sector, the most significant increases were seen in cyclical industries such as industrial (10.8%), materials (9.3%), and financial (7.8%), which are consistent with the performance during the "Trump trade" period from the end of June to mid-July. Within the technology sector, the main support for the industry's rise during this period comes from semiconductor-related stocks (Philadelphia Semiconductor Index up 15%) and companies with high growth expectations for the next two years. Overall, the recent rise in US stocks reflects resilience in economic data under a new round of interest rate cuts by the Federal Reserve, combined with investor expectations that a Republican victory in the election will benefit from further cuts in corporate income tax and relaxed industry regulations.

Third-quarter earnings expectations are "very low," but full-year expectations are being revised down, especially for cyclical sectors.

As of now, 52 S&P 500 component companies have disclosed their third-quarter earnings, with 60% of companies beating expectations, totaling a 7.4% surprise in net profit. However, the main driver of this round of surprises comes from the previously very low expectations of investors. As of October 15th, the year-on-year growth rate of single-quarter net profit was only 2.8%, much lower than the actual year-on-year growth rate of 12.9% in Q2. In addition, since the rise in US stocks from September 9th, Bloomberg's consensus forecast for 2024 S&P 500 net profit growth has been continuously revised down by nearly one percentage point to 9.2%, with the largest downward revisions being in cyclical industries that have shown significant increases during the same period, including energy (performance expectation down by -7.1%, the same below), industrial (-3.8%), materials (-1.6%), The recent rise in the US stock market to some extent lacks fundamental support. Looking ahead, CITIC Securities suggests that investors pay attention to the CAPEX plans of tech giants and their future performance guidance. If the CAPEX growth rate remains high but there is no significant improvement in future performance guidance, it is not ruled out that stock prices may come under pressure again during earnings season.

The liquidity environment in the United States is still contracting, and may face an unexpectedly sharp downturn towards the end of the year.

Although the Federal Reserve has slowed the pace of balance sheet reduction since June this year, and the reduction of Treasury holdings in August and September has significantly decreased, the average monthly reduction of Treasury and MBS from June to September reached $26.3 billion and $18.1 billion respectively. Therefore, despite the Fed initiating a new round of interest rate cuts, the continued balance sheet reduction means that liquidity in the US financial system is still contracting. This is also the main reason why long-term US Treasury yields rebounded by more than 50 basis points after the rate cut. In addition, CITIC Securities also observed that in early October, SOFR surged by 20 basis points, and the average weekly value of overnight reverse repurchase agreements fell from nearly $420 billion in early October to the current $260 billion, indicating that excess liquidity in the financial system is rapidly declining. Considering that the temporary suspension of the US debt ceiling will expire on January 1st next year, if the US Treasury chooses to issue a large amount of debt towards the end of the year to avoid potential government shutdown issues, it is not ruled out that the US stock market may face an unexpectedly sharp downturn in liquidity at that time.

US Stock Market Outlook: There may still be room for short-term highs, but the risk of a pullback is increasing.

Taking into account the trends in election expectations and financial performance mentioned above, driven by the optimistic sentiment of US stock investors (animal spirits), it is not ruled out that there may still be some room for short-term highs in the US stock market, with tech stocks, as well as cyclical industries such as finance and industry, benefiting more. However, the dynamic PE ratio of the S&P 500 has expanded to over 22 times, close to two standard deviations above the historical average. With the election results settled, positive factors already priced in, and liquidity still contracting, the risk of a pullback in the US stock market is increasing. If an unexpectedly sharp downturn in liquidity occurs towards the end of the year, leading to a decline in US stocks similar to the one from the end of July to the end of October last year, it is advisable for investors to focus on defensive sectors with strong defensive attributes and ample cash flow, such as healthcare and utilities.

Risk Factors:

Democratic victory in the US election; Federal Reserve monetary easing timing and pace lower than expected; US stock performance lower than expected; Rapid weakening of the US economy