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On August 5, the performance of global stock markets was enough to go down in history. After the shock, a miraculous counterattack was launched. The Nikkei 225 has completely recovered all the losses on "Black Monday", and the US stock market has also continued to rise.

Overseas markets were once extremely panicked about the economic recession because the July non-farm payrolls data in the United States triggered the Sam Rule. However, after the release of data such as the July service industry PMI and initial jobless claims, the recession was curbed and the market returned to calm.

So, has the potential black swan of US economic recession really been strangled?

01

The puzzle of economic resilience

The United States is the world's largest economy. Once an economic recession occurs, the impact on the global economy and financial markets will undoubtedly be huge.

Since the 1960s, the U.S. economy has experienced a total of nine recessions, each of which was accompanied by major stock market turmoil. There were three deep recessions, namely in 1973, 2008, and 2020, when the S&P 500 fell by 48%, 57%, and 34%, respectively. In total, the median decline of the S&P 500 index was 34%. During this period, global stock markets were deeply affected.

Historically, there are two main factors that trigger a recession in the U.S. economy. One is that the Fed’s interest rate hikes lead to a drop in asset prices, which in turn triggers a recession by affecting the contraction of residents’ and corporate assets and liabilities. The other is that the outbreak of the COVID-19 pandemic in 2020 directly impacts the real economy and then spreads to the financial market.

The rise and fall of asset prices directly affects the economic behavior of residents and enterprises, and their effect on indicating economic recession is becoming increasingly stronger.

(Total assets and disposable income of U.S. residents, source: China Merchants Bank Research Institute)

In 2002, the Internet bubble peaked in the US stock market half a year before the economic recession. From Q1 to Q3 of 2002, the sharp decline of the US stock market led to a significant decline in the wealth of US residents, resulting in a non-linear weakening of consumer retail, which in turn aggravated the economic recession and drove the market into a new round of recession trading, eventually triggering a spiral of economic and financial deterioration, and the Internet bubble burst completely.

The important factor that triggered the stock market turmoil was undoubtedly the Federal Reserve's interest rate hike policy. Between 1999 and 2000, the federal benchmark interest rate rose sharply from 4.75% to 6.5%.

In the 2007 subprime mortgage crisis, the housing market peaked three quarters before the economic recession. At that time, the final downward trend of US house prices was also triggered by the Fed's continued interest rate hikes. From Q3 2007 to Q1 2009, the wealth of US residents shrank sharply due to the housing and stock markets, which led to a severe contraction in residents' consumption and triggered a greater degree of economic recession, which seriously aggravated the subprime mortgage crisis and ultimately caused a disaster.

In this round of policy cycle, the Federal Reserve made the most aggressive rate hike in 40 years due to its early mistaken judgment of "temporary inflation". The capital market also responded. In 2022, the S&P 500 fell 19%, the deepest annual decline since 2008.

During this period, the wealth of U.S. residents also shrank to a certain extent, resulting in a significant weakening of core data such as consumer retail sales. GDP also showed consecutive negative growth in the first and second quarters, so that the market generally expects the U.S. economy to fall into recession in 2023.

However, the recession that the market expected never materialized, and the U.S. economy instead turned around and continued to maintain its strong momentum.The reasons include the continued rise in asset prices in the U.S. stock and real estate markets, which have largely offset the impact of high inflation and high interest rates on the economy, achieving counter-trend expansion. According to statistics from the China Merchants Bank Research Institute, from Q1 2023 to Q1 2024, the balance sheet of the U.S. household sector increased by 11%, and the financial assets of the corporate sector increased by 9%.

So, why have U.S. stocks continued to soar since the beginning of last year?

The most important engine comes from the emergence of the artificial intelligence revolution represented by Chat GPT, which has led to the market's continued hype about artificial intelligence, and then very optimistically expects that AI will improve production efficiency and support a new round of economic expansion.In addition, the market has begun to expect that the most aggressive rate hike cycle has passed and has fully priced in future rate cut cycles. These two points have led to the counter-trend outbreak of US stocks and also supported the counter-trend expansion of the economy.

But this could also be a trigger for a future market reversal or an economic recession.

02

Financial fragility

As history has shown, each round of large-scale interest rate hikes by the Federal Reserve often corresponds to a round of economic recession. Can this round of interest rate hikes escape the curse of recession?

Judging from the macro data disclosed so far, the US economy is slowing down significantly. In July, the US job market cooled nonlinearly, with the unemployment rate reaching 4.3%, and rising for four consecutive months, setting a three-year high. Among them, the number of employees in the information technology and financial industries, which are sensitive to the stock market, fell by 20,000 and 4,000 respectively.

In addition, the ISM manufacturing PMI in July was 46.8%, far below the expected 48.8% and the previous value of 48.5%, marking the largest contraction in eight months.

The slowdown of the US economy is an objective fact, but it cannot be inferred that the US will fall into recession in the next few months. If the US stock market undergoes a deep adjustment, it will almost certainly be transmitted to the real economy through the shrinking of residents' wealth, and then there is a high probability that a recession will be induced.

So, is there a high probability that the US stock market will experience a wave of adjustments?

First, let’s look at valuation. The latest PE of the S&P 500 is 26.45 times, which is at the upper limit of the valuation range in the past ten years and far higher than the median of 23.2 times. The latest PE of the Nasdaq index is 41.82 times, which is at 78.7% of the 10-year percentile, and the median is 35 times.

The market structure is extremely unbalanced. In the S&P 500, the seven major stocks recorded a 75% increase in 2023, contributing about 77% to the index's increase, while the other 493 constituent stocks only rose by 12%. Currently, the total market value of the seven major stocks has exceeded 15 trillion US dollars, accounting for one-third of the total market value of the S&P 500 and more than half of the Nasdaq 100 Index.

As of now, Nvidia’s latest valuation is 67 times, Tesla’s is 53.6 times, Amazon’s is 40 times, and Apple and Microsoft’s are both over 30 times.

(Market capitalization and PE of the seven largest U.S. stock companies, source: Wind)

Among them, Apple, which ranks first in market value, has a valuation at an absolute high level in the past 10 years, with a median of only 18.7 times. However, performance expectations are not optimistic. Greater China is the world's largest iPhone market, but it recorded a poor performance of -8% in the first quarter of this year, and continued to decline by 6.5% year-on-year in the second quarter.

Apple won the top spot in China's smartphone sales in 2023 with a 17.3% share, but after just two quarters, it has fallen out of the top five and has become "Others". Huawei has made a comeback and has risen to second place in the market in the second quarter, a year-on-year increase of more than 50%.

Let's look at Nvidia. In the past fiscal year, its performance soared, thanks to several major US technology giants who really spent money to seize the AI ​​high ground. In the second quarter of this year, Microsoft's capital expenditure was US$19 billion (accounting for more than 70% of its expected operating profit in 2025), a year-on-year increase of 78%, almost all of which was used for AI-related expenses. In addition, Google and Amazon's capital expenditures in the second quarter increased by 91% and 54% year-on-year, so that their current profits are lower than Wall Street expectations.

Violent spending, but the prospects for AI commercialization are unclear.If the high-input and low-output situation continues in the next few quarters, the capital expenditure of technology giants may drop sharply, and the sustainability of Nvidia's future substantial performance growth remains to be discussed.

In addition, several major American technology companies are developing their own AI chips, such as Google developing TPU chips and Meta developing MTIA chips. Of course, this also includes China's strong rival Huawei, whose latest news is that a new generation of AI chip "Ascend 910C" is being prepared. The slowdown in the iteration of Nvidia's new products will naturally help its competitors catch up.

Last year, Nvidia's chip prices continued to soar, becoming the main engine driving its performance growth. However, this is somewhat due to the mismatch between supply and demand. With the potential marginal decline in capital expenditures of major technology companies and the catch-up of corresponding products by competitors, Nvidia's main chip prices may have a large room for decline in the future.

In this round, the seven major technology giants in the US stock market have achieved a rise far beyond expectations against the backdrop of high interest rates. The main driving force behind this is that the market has priced in an extremely optimistic outlook on the bright long-term prospects of artificial intelligence.

With the performance of most technology giants falling short of expectations in the second quarter and stock prices generally falling back, the market began to doubt the underlying logic of the development of artificial intelligence - huge investment, very small income, very unclear commercial prospects, and no complete business closed loop. There may be a significant time lag between the capital market's hype of AI and the industry's maturity cycle, just like the market boom of the Internet revolution in 2000, which really boosted productivity and economic growth many years later.

If the earnings of major U.S. technology companies continue to fall short of expectations, major U.S. economic data continues to cool, the Bank of Japan once again raises interest rates beyond expectations, or the geopolitical wars in the Middle East and between Russia and Ukraine become more intense, all of these may trigger a deeper pullback in U.S. stocks.

03

Keep to yourself?

In early August, the core economic data of the United States took a nonlinear cold turn, which shocked global stock markets. The Japanese, Korean and European stock markets were all significantly affected, while A-shares and Hong Kong stocks were much calmer.

The logic is not complicated. After continuous surges, overseas stock markets have repeatedly set new historical records. Valuations are at an absolute high, and major heavyweight stocks are very crowded. Once a major negative news such as economic recession hits, it is easy to get stampeded. The Hong Kong and A-share markets have been adjusting for more than three years, and valuations have hit a multi-year low, so the impact is naturally much smaller.

In the next six months, if the super black swan of the US economic recession really happens, the probability of a significant adjustment in the global stock market is not small. Then, under the big market, no market can be immune.

On the one hand, if the global stock market falls sharply due to panic, it will affect the flow of QFII funds, and emotions will be infected. On the other hand, once the external market falls sharply, it is often accompanied by economic recession, which will affect the fundamentals of the domestic economy through exports and put pressure on the market.

At present, the expectation of a good economic recovery has failed, and A-shares are also continuing to trade this logic. Just look at M1 and you will know:

(M1 and M2 year-on-year trend chart)

Therefore, we have to guard against the black swan of the US economic recession and be more conservative in strategy. The actions of the masters have given us the best guidance - Warren Buffett has cashed out half of his largest holding, Apple, and significantly increased his cash balance; Nvidia's Huang Renxun has been selling every day in just 7 trading days in August; Soros has also been increasing his short positions in various themes.

The storm is coming, but I am not worried because I have prepared for it.