FOMC meeting Feder "temporary" After hiking interest rates 5bp, the market trading logic quickly switched from high inflation and fast tightening to weak growth, and concerns about recession heated up significantly. It is not surprising that the subsequent recession is in a context of the current rapid rate hike. So, what implications does the recession risk have for US stock and Fed policies? What experience in history is worth learning from? Summary
1. How big is the risk of recession? A slowdown in growth is a certain fact, and a recession is also quite possible, but the time and depth of the recession are more important
Under the combined effect of high base, high cost, high inventory, high interest rates and weak demand, US growth and corporate profits are already in a slowing channel and will continue to decline. This is also a general consensus in the current market. If you continue along this path, there is a considerable possibility of recession. Given the possibility of a slowdown in growth or even a recession, the time and depth of the recession arrives are more important. 1) For recession time, we use the two dimensions of 3m10s spread , the actual financing cost of the enterprise (investment-grade bond yield) and return on investment (real GDP growth rate). The pressure on growth of tightening financial conditions may occur at the end of this year and early next year. 2) Regarding the depth of the recession, 's current relatively healthy balance sheet status of the US non-government sector shows that at least there is no greater risk of a debt crisis. In other words, even if there is a recession, it may be likely that it will not be a deep recession similar to the 2008 financial crisis.
2. The current "correct" problem? If the probability of a deep recession is not high, when will the policy decline be more meaningful to the market
If the probability of a deep recession is small and may not come soon, then the more meaningful question for the market is not whether it will decline, but when will the policy decline be. Judging from the inflation and tightening path we calculate, this point may correspond to the third quarter. mainly considers that US inflation will once again usher in a high year-on-year base starting from September, and the current interest rate hike path may gradually slow down after September.
3. Market impact at different recession degrees: average decline of mild recession ~ 20%, valuation is supported below one standard deviation
Different recessions have different impacts on the economy and time, so the impact on the market will naturally be different. Referring to the definition of the National Bureau of Economic Research (NBER), the United States has experienced 15 recessions since the late 1920s, with a median duration of ~10.1 months. We define the degree of recession based on the decline of GDP from the peak. According to the empirical value, the callback amplitude exceeds 3% is a deep recession, and less than 3% is a mild recession.
Based on the above division, we found that there are also "clearly different" differences in market and sector performance. 1) Overall performance: During the deep recession, the median maximum recession of S&P 500 was 44%, which was much larger than the 19% recession during the mild recession. 2) time point: the starting point of the market decline in is closer to the recession period during a deep recession, while the decline begins earlier in a mild recession, but the end time is exactly the opposite. 3) Industry performance: daily consumption and defense sectors generally declined less during the recession, which was in line with the characteristics of a defensive sector; but the declines in real estate, financial services, media, utilities, insurance and other sectors declined more severely in the deep recession, which means that such sectors are more sensitive to the degree of recession, and in comparison, the growth-style technology sector is less sensitive. 4) Valuation and profit: The drag of profit is roughly the same, while the difference in valuation drag is even more significant. 5) Absolute valuation level: S&P 500 has basically maintained a double standard deviation below the mean in the past three decades; in contrast, deep recession will "break", such as during the 2008 deep recession period, the valuation fell to 9 times at a low of 9 times.
4. Is there any debt risk? The weak links of the US balance sheet
Overall, except for government departments, the macro leverage levels of the US financial and non-financial enterprises and residents' sectors are at a relatively healthy level, far lower than the 2008 financial crisis. Therefore, this is also one of the main reasons for us to judge that the current low probability of a deep recession like a debt crisis is occurring.1) Residents: 's overall balance sheet is healthy; middle-income people have greater exposure (high-income people have high asset growth, leverage is low; middle-income people have high leverage; low-income people have lower cash assets but not high debt). 2) Enterprise side: overall leverage improves, solvency improves; focus on high-yield bonds and small business exposure.
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Focus Discussion: Risk of the US economy vs. Bear market pressure of the US market
6 FOMC meeting after the Federal Reserve "temporary" rate hike of 75bp ("June FOMC: Radical and forward paths may be the current "optimal solution""), the trading logic of market quickly switched from high inflation and fast tightening to weak growth, and recession concerns heated up significantly. was affected by this, and the interest rate of US bond in 10 years fell from a high of 3.5%. At the same time, the rise in gold and copper ratio last week, the sharp drop in oil prices, and the growth style of Nasdaq leading the rise may also be related to this expectation. In the short term, we believe that the market's reaction to recession concerns cannot be ruled out as excessive. However, it is an indisputable fact that the current gradual slowdown in US growth, and it is not surprising that it will fall into recession in the context of the current rapid rate hike. So, what implications does the recession risk have for US stocks and Fed policies? What experience in history is worth learning from? We will analyze it in detail in this article.
Chart: The 10-year U.S. Treasury bond interest rate fell to 3.13%, down 34bp from the relative high of 3.47% in mid-June, of which the real interest rate fell 26bpppppppppcl7
Source: Bloomberg, CICC Research Department
Chart: With the recession expectation heating up again, the prices of industrial metals represented by copper fell rapidly, and the gold-copper ratio rose rapidly to 4.9
Source: Bloomberg, CICC Research Department
1. How big is the risk of recession? A slowdown in growth is a certain fact, and a recession is quite possible, but the time and depth of the recession are more important
Under the combined effect of high base, high cost, high inventory, high interest rates and weak demand, US growth and corporate profits are already in a slowing channel and will continue to fall back to ("US stock earnings enter a downward channel"), which is also a general consensus in the current market. If continues along this path, there is a considerable possibility of recession. Although Federal Reserve Chairman Powell said after the FOMC meeting and at the congressional hearing last week that it was not the Fed's subjective intention (it indicates that the possibility of an economic recession exists, and the soft landing is very challenging [1]), the rapid tightening of financial conditions brought about by the rapid rate hike will itself have a major impact on demand (the sudden rise in mortgage interest rates in 30 and 10 years has brought about an immediate negative impact on U.S. real estate demand, and the number of mortgage applications and home sales have fallen rapidly), At the same time, the aftermath of the sudden tightening of currency will inevitably gradually appear (as former US Treasury Secretary Summers' image metaphor on the delayed changes in faucet water temperature in a recent interview [2]).
Chart: High inflation has caused a significant inhibition on the actual consumption of individuals in the United States
Source: Haver, CICC Research Department
Chart: High inventory will also squeeze the profit margins of US companies
Source: Haver, CICC Research Department
Chart: 30-year and 15-year mortgage interest rates have risen to 5.81% and 4.92%
Source: Bloom berg, CICC Research Department
Chart: Mortgage interest rates have risen again with the rise in tightening expectations, and sales of houses are also continuing to curb (existing home sales continued to fall back to 5.41 million units in May)
Source: Haver, CICC Research Department
Given the possibility of slowing growth or even recession, the time and depth of the recession of are more important, because falling into recession too quickly will put the Federal Reserve policy in a dilemma, and the market will also bear the dual pressure of valuation and profit; while a deep recession will have a more severe and lasting impact on profits.
1) For recession time, we try to estimate the tightness of financial conditions (the degree to which financing costs exceed the return on investment) that 's advantage is that it is leading compared to economic indicators itself and can "observe" the Fed's intentions, because excessive interest rates and excessive tight financial conditions will inevitably bring greater growth pressure, and it also means that the Fed wants to control inflation by suppressing demand (looking back on history, when financial conditions turn positive, the Fed usually stops raising interest rates, with only the exception in the late 1970s). We use the 3m10s interest rate spread, the actual financing cost of enterprises (investment-grade bond yield) and return on investment (real GDP growth rate) respectively, and use the current Fed dot chart and CME interest rate futures to calculate the rate hike pace (75bp, 50bp and 25bp respectively from July to November). The tightening of financial conditions may lead to growth pressure on at the end of this year and early next year (corresponding to the inverted 3m10s in November, and the financing cost exceeds the historical experience threshold of 250bp return on investment at the beginning of next year) (How to understand the mechanism and impact of tightening financial conditions)). In addition, although the economic leading indicator of World Federation of Large Enterprises (Conference Board) has continued to decline since the beginning of the year, the year-on-year growth rate has not turned negative. From the perspective of its relationship with the recession, it also shows that there may be some distance.
Chart: The current market expectation peak of tightening is around November this year
Source: Bloomberg, CICC Research Department
Chart: CME interest rate futures are expected to raise interest rates in June 75bp, 9 interest rate hikes in July 50bp, 25bp rate hikes in November and December 25bp
Source: CME, CICC Research Department
Chart: Looking back on history, when financial conditions turn positive, the Federal Reserve usually stops raising interest rates, only the end of the 1970s was exceptional
Source: Bloomberg, Chicago Fed, CICC Research Department
Chart: Looking back at history, when financial conditions turn positive, the Federal Reserve usually stops raising interest rates, only exceptions in the late 1970s
Source: Bloomberg, Chicago Fed, CICC Research Department
chart: According to the current pace of interest rate hikes (CME interest rate futures are expected to raise interest rates 75bp in June, and continue to raise interest rates 75bp in July, 9 hikes 50bp in November and December, 25bp in November and December), 3m10s may gradually reverse
Source: Bloomberg, CICC Research Department
Chart: The actual financing cost of enterprises generally exceeds the "threshold" of the actual return on investment 250bp, and the recession pressure will increase. At present, it may correspond to the end of this year or early next year
Source: Bloomberg, Fred, CICC Research Department
Chart: Conference Board's leading economic indicators have continued to decline since the beginning of the year, but the year-on-year growth rate has continued to decline but has not turned negative yet. Source: Bloomberg, CICC Research Department
2) Regarding the depth of the recession, the relatively healthy balance sheet status of the US non-government sector shows that at least there is no greater risk of a debt crisis. In other words, even if there is a recession, it may be likely that it will not be a deep recession similar to the 2008 financial crisis.
Chart: The current relatively healthy balance sheet status of the US non-government sector shows that it is not facing a greater risk of debt crisis
Source: Haver, CICC Research Department
2. The current "correct" problem? If the probability of a deep recession is not high, when will the policy decline be more meaningful to the market
If the probability of a deep recession is small and may not come soon, , then the more meaningful question for the market is not whether it will decline, but when will the policy decline be. In the process of slowing growth, if the Federal Reserve policy can retreat or even turn after completing the "task" (if inflation shows a turning point and the federal funds rate effectively exceeds the neutral interest rate), then the market can enter the trading logic of slowing growth and loose policy. According to our "improved version" Merrill Lynch clock based on real interest rates and inflation expectations , inflation corresponds to bond assets and stock market growth styles relatively outperform.
Judging from the inflation and tightening path we calculate, this point may correspond to after the third quarter, mainly considering that US inflation will once again usher in a high year-on-year base starting from September, and the current interest rate hike path may gradually slow down after September. In fact, the market stabilization in early 2019 showed this characteristic. The opportunity for the market to bottom out was that Powell sent a dovish signal at the beginning of 2019, but the real interest rate cut occurred in July 2019, half a year later, and the growth will improve until the third quarter. The rapid rate hikes similar to those in the current period of Greenspan in 1994 did not lead to the market's "collapse", and to a certain extent it also benefited from the timely "stop" of policies.
Chart: Judging from the inflation and tightening path we calculate, this time point may correspond to the third quarter
Source: Haver, CICC Research Department
3. Market impact at different recession degrees: average decline of mild recession ~ 20%, valuation is supported below one double standard deviation
Different recessions have different impact on the economy and time, so the impact on the market will naturally be different. refers to the definition of the National Bureau of Economic Research (NBER). Since the late 1920s, the United States has experienced 15 recessions, with a median duration of ~10.1 months. The longest is the Great Depression (44 months), which started in 1929, and the shortest is the 2020 epidemic (only 2 months). We define the degree of recession based on the amplitude of GDP falling from the peak. According to the empirical value, the callback amplitude exceeds 3% is a deep recession, and less than 3% is a mild recession. Based on this definition, since the late 1920s, there have been 7 deep recessions (1929~1933, 1937~1938, 1945, 1957~1958, 1973~1975, 2007~2009, 2020), with a median duration of 13.2 months; 8 mild recessions (1948~1949, 1953~1954, 1960~1961, 1969~1970, 1980, 1981~1982, 1990~1991, 2001), with an average duration of 10 months. Generally speaking, a larger recession is usually accompanied by a balance sheet crisis, so the impact is slower and more difficult to repair (typical like the 2008 financial crisis), while a small recession has relatively limited impact on the balance sheet and is faster to repair.
Chart: Compared with deep recession, the maximum pullback of US stocks during mild recession is relatively lower; the starting point of the market decline is closer to the recession period during deep recession, but the end time is exactly the opposite
Source: Bloomberg, CICC Research Department
Based on the above division, we found that there are also "clearly different" differences in market and sector performance. 1) Overall performance: During the deep recession, the median maximum recession of S&P 500 was 44%, which is much larger than the 19% recession during the mild recession. 2) time point: the starting point of the market decline in is closer to the recession period during the deep recession period (1.5 months ahead of the high point), while the decline begins earlier in the mild recession (2.4 months ahead of the recession at the high point); but the end time is exactly the opposite, the market bottom is 6 months earlier than the end of the deep recession, and the market bottoms out 5.1 months earlier than the mild recession. 3) Industry performance: daily consumption and defense sectors generally declined less during the recession, which was in line with the characteristics of a defensive sector; but the declines in real estate, financial services, media, utilities, insurance and other sectors declined more severely in the deep recession, which means that such sectors are more sensitive to the degree of recession, and in comparison, the growth-style technology sector is less sensitive. 4) Valuation and Earnings: is limited by valuation data. We observe that the drag of profits during different recessions since the 1950s is roughly equivalent (median deep recession is 2.4% vs. median mild recession is 4.3%), while the difference in valuation drag is even more significant (median deep recession is 35% vs. median mild recession is 18%). 5) Absolute valuation level: The S&P 500 index has basically maintained a double standard deviation below the mean in the past three decades (corresponding to a dynamic valuation of about 13 times in 12 months, such as rate hike cycle in 1994, tech bubble lows in 2002, market turmoil in 2018 and the epidemic in 2020); in contrast, deep recession will "break", such as the valuation fell to 9 times during the 2008 deep recession expiration date.
Chart: Real estate, financial services, media, utilities, insurance and other sectors declined more severely in the deep recession, which means that such sectors are more sensitive to the degree of recession. In comparison, the growth-style technology sector has a lower sensitivity
Source: Datastream, CICC Research Department
Chart: Industry performance during the US stock retracement before and after the deep recession
Source: Datastream, CICC Research Department
Chart: Industry performance during the US stock retracement before and after the mild recession
Source: Datastream, CICC Research Department
Chart: Industry performance during the US stock retracement before and after the mild recession
Source: Datastream, CICC Research Department
Source: Datastream, CICC Research Department
chart: The drag of profit is roughly equivalent during the depth and mild recession.
Source: Bloomberg, CICC Research Department
chart: The difference in valuation drag is even more significant
Source: Bloomberg, CICC Research Department
Comparatively, the market's decline from a high point has approached the average of mild recession (the maximum recession of S&P 500 is 24%, and the maximum recession of Nasdaq is 34%). The current dynamic valuation of 16.3 times still has 20.5% downside space from the support level of mild recession. We estimate the reasonable level of 14 times based on the 3.5% 10-year US Treasury interest rate and the current growth environment.
Chart: Not all recessions will have a long-term suppression of market performance; compared with the deep recession of balance sheets before and after the financial crisis between 2007 and 2009, the impact of mild recession on economic growth and the duration will be relatively shorter. The decline or even shift of monetary policy can also boost market expectations
Source: Bloomberg, Haver, CICC Research Department
4. Is there any debt risk? The weak links of the US balance sheet
Overall, except for government departments, the macro leverage levels of the US financial and non-financial enterprises and residents' sectors are at a relatively healthy level, far lower than the 2008 financial crisis. Therefore, this is also one of the main reasons for us to judge that the current low probability of a deep recession like a debt crisis is occurring. Thanks to the continued deleveraging of US residents after the subprime mortgage crisis, and the three rounds of fiscal stimulus in the United States have protected the balance sheets of residents and enterprises in three rounds after the epidemic. The current leverage ratio of residents in the United States is at a relatively low level (75.1% vs. 74.2% in the fourth quarter of 2019), and the leverage ratio of enterprises in the enterprise is also close to the pre-epidemic level (77.7% vs. 75.1% in the fourth quarter of 2019), which is also the main reason why Powell previously said that the US economy can withstand the pressure of tightening. As the Federal Reserve accelerates its tightening, the overall debt risks are controllable, but there are also some weak links in the middle that need attention. Specifically:
1) Residents: The overall balance sheet is healthy; middle-income people have greater exposure. Since 2022, US residents' consumption has been quite resilient. Against the background that commodity consumption has begun to slow down, service consumption still maintains a high growth rate. However, the current abundant excess savings (US$2.3 trillion) and resilient consumption have diverged significantly from consumer confidence that has continued to fall to lows. For example, the University of Michigan consumer sentiment index in May 50.2, surpassing the subprime mortgage crisis and reaching the level in the 1970s; the World Conference Board consumer confidence index in was relatively higher in April, which may reflect the differentiation of people at different income levels. a) The assets of high-income people have high growth and low leverage. As of the first quarter, the top 20% of residents' cash assets (savings and money funds) increased by 41.4% compared with the fourth quarter of 2019, while the liabilities/assets were the lowest among all populations (3.8%). b) The middle-income population has high leverage, and the income percentage is between 20% and 80% of residents' liabilities/assets close to 20%, but is lower than the subprime mortgage crisis level. c) Low-income people's cash assets have declined but their liabilities are not high. The main problem of the people with the revenue percentage in the is that their assets are not high (cash assets in the first quarter fell by 1.2% month-on-month), and they are more susceptible to the squeeze of high inflation, but relatively positive is that their debt is not high (15%), so they do not face a greater risk of default.
From the perspective of different types of liabilities on the residential side, the scale and proportion of student loans, auto loans and consumer credit have increased much higher than that of mortgages since the financial crisis (as of the first quarter, the mortgage/GDP was 50.2%, and the consumer loan/GDP was 18.6%, but the increase was faster), so it may be a weak link that is more worthy of attention.
Chart: The savings/GDP of the private sector in the United States in the first quarter are still basically at the pre-epidemic level (3.9% of enterprises, 4.2% of residents)
Source: Haver, CICC Research Department
Chart: The current leverage ratio of residents is at a low level, and the leverage ratio of enterprises has not expanded or even declined after the epidemic
Source: Haver, CICC Research Department
Chart: The consumption of residents in the United States has been quite resilient since 2022 (actual consumption in April increased by 0.7% month-on-month in April) (actual consumption in April increased by 0.7% month-on-month in the previous year)
Source: Haver, CICC Research Department
Chart: The consumption of residents in the United States has been quite resilient since 2022 (actual consumption in April increased by 0.7% month-on-month in the previous year) (actual consumption in April increased by 0.7% month-on-month in the previous year)
Source: Haver, CICC Research Department
Chart: Since 2022, US residents have been quite resilient (actual consumption in April increased by 0.7% month-on-month in terms of consumption in April) , 0.5% faster than last month)
Source: Haver, CICC Research Department
Chart: Under the pressure of high prices, residents' savings rate dropped to 4.4%, and the excess savings retained in the past have been withdrawn for several months
Source: Haver, CICC Research Department
Chart: University of Michigan Consumer Sentiment Index May 50.2, exceeded the subprime mortgage crisis, reaching the level in the 1970s
Source: Haver, CICC Research Department
Chart: Resilient residents' consumption has a clear contradiction with consumer confidence data that has continued to fall to lows
Source: Haver, CICC Research Department
Chart: Residents with income in the top 20% only looked at cash assets (savings and money funds) compared with the fourth quarter of 2019
Source: Haver, CICC Research Department
Chart: People with income in the bottom 20% have a lower growth rate of cash assets, and cash in the first quarter in the first quarter The stock of assets of a kind has decreased by 1.2% month-on-month
Source: Haver, CICC Research Department
Chart: The income percentage is between 20% and 80% of residents' liabilities/assets exceeds 15%, but the level of subprime mortgage crisis has been degraded
Source: Haver, CICC Research Department
Chart: The proportion of cash buying in 2021 rises to 30%
Source: Redfin, CICC Research Department
2) Enterprise side: overall leverage improves, solvency improves; focus on high-yield bonds and small business exposure. Although the US corporate side has not experienced a significant deleveraging process like the residential side, the leverage ratio of non-financial enterprises in the first quarter was 78%, and the net leverage ratio of S&P 500 non-financial enterprises was 74%, both higher than the subprime mortgage crisis period, it has improved compared with the epidemic and its solvency has also been repaired ("US stock earnings enter a downward channel").
In "Looking at the Weakness of Turbulence in the European and Japanese Bond Markets", we pointed out that the US credit spread has risen rapidly recently (high returns and investment grades are 5.3ppt and 2.0ppt, respectively), the highest since 2015. Credit bonds, especially high-yield bonds, have significantly underperformed treasury bonds recently, and are accompanied by obvious capital outflows, so the potential risk exposure is worth paying attention to. But relatively positively, the maturity scale of US high-yield bonds is only US$80 billion as of the end of 2023, and the repayment pressure is not huge. In addition, small American businesses are also worth paying attention to the high costs and tightening of financial conditions. We use current assets/ short-term liabilities to observe the short-term liquidity pressure and default risks of enterprises, and found that among US listed companies ~17% are less than 1, with energy, raw materials, and consumer services accounting for the highest proportion; however, the market value accounts for only 0.6%, which shows that the risk exposure is more mainly small businesses and is concentrated in sectors such as utilities, finance and communications.
Chart: Among the more than 7,000 listed companies in the United States, 17% of the companies have this ratio less than 1
Source: Factset, CICC Research Department. Data As of June 25,
Chart: From the perspective of market value, only 0.6% of the market value faces the risk of default, and utilities, finance and communications account for the largest proportion.
Source: Factset, CICC Research Department.Data As of June 25
[1]https://www.ft.com/content/3e3dedc4-5ece-4a35-84c7-e3e670c29c72
[2]https://www.barrons.com/articles/larry-summers-economy-fed-hard-landing-inflation-recession-51655402216
Article source
This article is excerpted from: "The Historical Relationship between Recession Risk and the US Stock Bear Market" published on June 26, 2022
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The "2H22 Overseas Outlook: From Recession Worries to Soft Landing Possibility? 》
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