After a strong first-half performance amid the tech rally US stocks have weakened in August and the Nasdaq Composite has lost 8% while the S&P 500 is down 5.2%. Both the indices have fallen for three consecutive weeks as fears rise.
Incidentally, the fall in US stocks is coming at a time when the Bank of America August fund manager showed that fund managers are the least bearish since February 2022 and cash allocations fell to a 21-month low of 4.8% as compared to 5.3% in July.
Typically, fund managers lower their cash allocations when they are bullish on markets and vice versa.
US stocks rose sharply in the first half
Notably, while analysts were not too bullish on US stocks heading into 2023, the Nasdaq Composite rose over 31% and had its best first-half performance since 1983 and the third-best ever. The S&P 500 also rose 16% even as the rally wasn’t broad-based and mainly led by tech stocks. Energy, utilities, and financials were among the sectors that underperformed in the first half.
Meanwhile, US stocks weakened in August. Multiple reasons are weighing heavy on investor sentiments including the worsening slowdown in China, fears of a hawkish Fed, and banking risks. Fitch downgrading US credit rating by one notch did not help matters even as most economists believe that the downgrade won’t have much impact.
China slowdown concerns rise
China is the world’s second-biggest economy and analysts expected the country to lead global growth in 2023 as it reopened the economy late last year. However, the country’s economic rebound is sputtering, and recent economic data showed that its economic rebound continues to falter. The country’s retail sales rose 2.5% in July while analysts expected them to grow 4.5%. Similarly, industrial production rose 3.7% which was below the 4.4% that analysts expected.
The country’s fixed asset investment increased 3.4% in the first seven months of 2023, again below the 3.8% that analysts expected. While the rest of the world is still battling higher inflation despite multiple rate hikes, China is instead facing deflation and its CPI fell 0.3% YoY in July while wholesale inflation dipped 4.4%.
Chinese stocks have underperformed global markets in 2023 amid the disappointing economic rebound.
Brokerages lower outlook for China’s GDP growth
Most brokerages now doubt that the country would be able to grow at “around 5%” that it is targeting. Nomura for instance is doubtful that China’s economy would grow 5% in 2023 and said that it sees “downside risks” to its forecast of 4.9% annualized growth in the back half of the year. Nomura’s Chief China Economist Ting Lu and a team said in their report “In our view, Beijing should play the role of lender of last resort to support some major developers and financial institutions in trouble, and should play the role of spender of last resort to boost aggregate demand.”
Nomura is hardly the only brokerage that is raising an alarm over China’s growth outlook. Tao Wang, head of Asia economics and chief China economist at UBS Investment Bank said, “Prolonged weakness in property construction will add to destocking pressures in the industrial space and depress consumption demand as well.”
The slowdown in China is negative for US stocks as many US companies including Apple and Nike have significant operations in China.
US stocks fell after Fed meeting minutes
At its July meeting, the Fed raised rates by 25 basis points to 5.0%-5.25% which is the highest since 2001. While the rate hike was widely expected by the markets, US stocks fell last week after the Fed meeting minutes were more hawkish than expected.
The minutes said, “In discussing the policy outlook, participants continued to judge that it was critical that the stance of monetary policy be sufficiently restrictive to return inflation to the Committee’s 2 percent objective over time.”
The minutes added, “With inflation still well above the Committee’s longer-run goal and the labor market remaining tight, most participants continued to see significant upside risks to inflation, which could require further tightening of monetary policy.”
Fed’s rate hikes are generally negative for stocks and were among the reasons US stocks crashed in 2022.
The Fed’s previous dot plot called for one more rate hike of 25 basis points in 2023. However, most traders believed that Fed won’t hike rates any further. Even after the Fed minutes nearly 90% of traders believe that Fed won’t hike rates in September, the CME Fed Watch tool shows.
Even in the November meeting, only a third of traders believe that the Fed would raise rates by 25 basis points while around 64% expect rates to stay at current levels only.
Concerns over US banks
Fitch has warned that it might be forced to downgrade US banks. In June, it downgraded the industry by one notch to AA- but the move largely went unnoticed. Fitch analyst Chris Wolfe said, “If we were to move it to A+, then that would recalibrate all our financial measures and would probably translate into negative rating actions.” A downgrade of US banks could be negative for US stock markets.
Incidentally, on Friday, CNN’s Fear and Greed Index showed fear for the first time since March. Q2 13F filings showed that Michael Burry of “Big Short” fame also made a $1.6 billion bet that US stocks would fall.
Warren Buffett too net sold $8 billion worth of shares in Q2 which was preceded by a $10 billion net selling in the first quarter also.
Fundstrat advises buying the dip in US stocks
Meanwhile, Fundstrat’s head of research Tom Lee advises investors to buy the dip in US stocks. In a client note, Lee said, “In short, the inflation story in the US is taking a backseat. Instead, the factors of rising interest rates, which hurt P/E and the story of a strengthening US economy, which means risk of more hikes, are at the front of mind for investors.”
Meanwhile, Nasdaq is having its worst weekly stretch since December, and next week markets would watch retail earnings, economic data, and speeches of Fed members including that of chair Jerome Powell at the annual Jackson Hole summit.
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