The Fed’s Monetary Tightening Triggers Global Market Collapse as Valuations Adjust

Global markets are falling.

On August 18, the U.S. Nasdaq index fell 1.17%, Germany’s DAX index fell 0.71%, France’s CAC index fell 0.94%, Japan’s Nikkei index fell 0.68%, and South Korea’s index fell 0.23%.

Indices of developing countries also fell, with China’s Shanghai Composite Index down 1% and Vietnam’s index down more than 4% intraday.

Crude oil, gold, bitcoin, and even real estate prices in various countries are also falling.

For example, South Korea’s real estate market has been falling for a year in a row. Housing prices in Seoul, the hottest place, have already plummeted by more than 30%, housing prices in some areas have dropped by 40%, and transaction volume has plummeted by 70%.

Global markets appear to be on the brink of collapse.

Buffett, the world’s stock god, has sold stocks in the past three quarters, with a total net sales of US$33 billion in stocks and an increase in cash reserves of US$38 billion.

Buffett currently has about $353 billion in stocks and about $147 billion in cash. In a rough conversion, Buffett’s stock position is almost 70% of the position, and his cash position is almost 30% of the position, which is a typical defensive state.

According to a report from Sina Finance, Michael Burry, the prototype character who shorted the subprime mortgage crisis in the movie “The Big Short”, has once again held a full position in put options on the US stock index.

why?

The answer is: US interest rate hikes! The interest rate hike in the United States has changed from a quantitative change to a qualitative change, from boiling frogs in warm water to boiling frogs in boiling water.

That is to say, the cost of borrowing globally began to be higher than the return on investment, that is, the return on low-risk bonds began to be higher than the return on risky assets such as stocks and houses. People would rather save cash and buy bonds than invest and consume.

01

On August 17, the Federal Reserve released the minutes of its July meeting.

This record is too important.

Because it is a record and summary of the Federal Reserve’s July monetary policy meeting, the content is more detailed than Powell’s speech, and the amount of information is more comprehensive and objective.

Therefore, it more fully demonstrates the thinking of the insiders of the Federal Reserve, and plays a guiding role in predicting future trends in the capital market.

The Fed’s minutes are generally hawkish.

The meeting almost admitted that the high inflation in the US market is still very stubborn, and the data on employment and wages are relatively strong. It is difficult for the US economy to see any signs of recession during this year’s interest rate hike cycle.

Therefore, most policymakers believe that interest rates can continue to rise. In addition, almost all policymakers believe that even if interest rates are lowered in the future, it may not stop shrinking the balance sheet.

Simply put, if inflation does not fall, interest rates will continue to rise.

The key point is that the current high inflation in Europe and the United States is not only the result of monetary easing, but more of the result of deglobalization. Therefore, continuous interest rate hikes may not necessarily reduce inflation, but may directly lead to a hard landing of the economy.

Just like a tug-of-war, once the balance of power between the two sides is broken, there will be a trend of defeat like a mountain, and it will never be a slow pull.

The impact of the Fed’s current interest rate hike on the global stock market, commodities, real estate and other markets is the same. It cannot effectively alleviate the real pain point of inflation, so once it goes too far, it will inevitably bring about a hard landing of the economy, not a soft landing.

for example.

Apple Inc. of the United States is the world’s largest company by market value, with a market value of more than $3 trillion at its peak.

Calculated at the RMB exchange rate of 7.3, the market value exceeds 21.9 trillion yuan, which is higher than the combined value of Kweichow Moutai, China Mobile, Industrial and Commercial Bank of China, Ningde Times, BYD, PetroChina, and Sinopec.

Most of the revenue and profits of Apple, a giant company, are related to China.

According to Tencent News, China has become the largest market for the iPhone. In the second quarter of 2023, China’s shipments surpassed the United States for the first time and became Apple’s largest market in the world.

That is to say, whether the Chinese market is good or bad can affect Apple’s revenue, profit and other financial conditions, which in turn will affect Apple’s valuation.

As Apple is the largest stock in the U.S. stock market, its ups and downs will eventually affect the entire U.S. stock market.

Therefore, we can know that if Sino-US trade remains unsmooth and mutual sanctions are imposed, the economies of both countries will be affected.

Although the US dollar is a strong currency, it can reduce the impact of Sino-US conflicts on itself through financial means; however, it cannot change the transmission of the real economy.

For example, if China’s economy encounters challenges and consumer confidence recovers slowly, it will inevitably affect Apple’s business in China. The sales of Apple mobile phones in China are less, so Apple’s revenue will inevitably decrease.

To sum up, raising interest rates in the United States will ease inflation far less quickly than globalization. If the anti-globalization stalemate continues, the negative impact of China’s consumption downturn will eventually affect the US stock market and even the global financial market through the financial statements of multinational companies such as Apple, Nvidia, and Tesla.

02

Next, let’s talk about how the Fed’s interest rate hike will further affect the global financial market through valuation.

As we all know, the 10-year U.S. Treasury bond is the anchor of the world’s major financial assets, and the valuation (PE) of various financial assets is based on the 10-year U.S. Treasury bond.

Still use Apple as an example.

On August 17, the yield on the US 10-year Treasury bond broke through 4.2%, and hit the highest closing price since June 2008. If calculated by valuation, it is almost 24 times PE.

The credit behind the 10-year U.S. Treasury bond is the U.S. government and the overall credit of the U.S. country. Although Fitch has recently downgraded the U.S. Treasury rating, it is undeniable that the U.S. credit is still one of the strongest in the world.

Even if it is a powerful Apple company, its long-term reputation cannot compete with the US government. After all, companies and countries are not of the same order of magnitude.

On the one hand, the financial market has to consider that enterprises are not countries, and on the other hand, equity is not a debt; therefore, companies are often given a certain discount, that is, the rate of return of enterprises is required to be more than twice the rate of return of 10-year treasury bonds.

That is to say, if you benchmark the US 10-year Treasury yield, Apple’s yield should be about 4.2%*2, and the valuation should be about 12 times PE.

At present, the static valuation of Apple is 27.26, and the dynamic valuation is 28.71. Far greater than the 12 times valuation of anchored 10-year treasury bonds.

The implication is that Apple has to fall by at least 50% for the valuation to be reasonable.

In addition, according to wind data, Apple’s performance in the third quarter report for fiscal year 2023 (that is, the performance in the second quarter of the 2023 natural year) is not as good as market expectations.

The financial report shows that the total revenue was US$81.8 billion, a year-on-year decrease of 1.4% from US$83 billion in the same period last year, and a drop of nearly 14% from the US$94.84 billion in the previous quarter. This is Apple’s third consecutive quarter of year-over-year revenue decline since 2016.

It is worth noting that Apple’s revenue in Greater China this quarter was US$15.758 billion, an increase of 7.9% over last year. In contrast, revenue in the Americas, Apple’s largest market, fell 5.6% year-over-year, and revenue in the rest of Asia-Pacific fell 8.5%.

Apple still has growth potential in China, and the growth rate in other regions has been obviously exhausted. In terms of valuation, it may be necessary to give the valuation of mature companies, not growth companies.

In summary, the Fed’s interest rate hike has suppressed the valuation of the financial market, making the global stock market need to fall to digest the valuation bubble. The more the Fed raises rates, the more downward pressure on stocks.

In the end, I personally think that funds are all profit-seeking, and they will flow wherever the profits are high.

Buffett continued to sell stocks and obtained a large amount of cash. In fact, he did not really hold cash, but mostly bought short-term U.S. bonds.

Buffett’s current choice is that he would rather increase his position in treasury bonds with a yield of 5.25% to 5.50% than buy stocks with lower revenue and profit growth.

For easy understanding, you can also imagine that the one-year deposit yield of domestic banks is 5.5%. Would you deposit the money in the bank, or would you use it to buy stocks with declining revenue growth and valuations above 25PE?

Therefore, most of the global capital will do the same action, just like Buffett, selling risky assets such as stocks, commodities, real estate, etc., and buying high-yield bonds.

Although the sell-off risk of global risk assets is gradually increasing, following Buffett’s logic, the odds and winning rates of saving money to buy bonds (government bonds, interbank certificates of deposit, large certificates of deposit, etc.) should be better than borrowing to invest in companies, stocks, real estate, etc. merchandise etc.

What do you think?