Fed has no choice
Only violent rate hikes can curb inflation
The consumer price index (CPI), which represents inflation, has hit a 40-year high in the United States. The United States is deeply afraid of repeating the mistakes of the super recession in the 1980s, forcing the Federal Reserve to raise interest rates six times so far this year to curb it. It has risen from 0.25% to 4.00%.
Quantitative tightening
Not only that, the Federal Reserve also intends to start quantitative tightening (that is, shrinking the balance sheet) to reduce the capital released to the market during the financial tsunami, European debt crisis, and the market collapse due to COVID-19 pandemic, lead to drive up the market in the past 13 years.
The result of raising interest rates and shrinking the balance sheet will definitely hit U.S. stock market.
All indicators have been confirmed
The U.S. has entered a recession at the start of 2022
The U.S. GDP growth rate in the first three quarters of this year was negative 1.4%, negative 0.6%, and positive 2.6%, which by definition has entered a recession. Except for Canada, the G7 and South Korea have all had trade deficits in May 2022, with Germany running a trade deficit for the first time in 30 years. The current manufacturing index (PMI) of major economic powers has also fallen below the 50. According to data from the Semiconductor Industry Association (SIA), global chip sales fell for the first time since 2020 in September. Even China’s imports and exports in October, 2022 began to show a negative growth of 0.3% for the first time in nearly two years.
What do leading indicators say?
Tesla CEO Elon Musk led a group of business leaders to blurt out on May 16 that the U.S. may be in a recession, and on October 23 he said the recession would last until the spring of 2024. Another Dow Jones Transportation Index (ticker: DJT, FedEx is a constituent stock), which has been used to predict the future trend of U.S. stocks and the economic situation in the past 100 years, is known as the prosperity canary.
Fedex’s second quarter earnings report confirmed that FedEx’s chief executive believes the global economy is about to fall into a recession and global transportation demand is weakening, announcing the withdrawal of full-year forecasts and a massive cost-cutting plan. The next day, the stock price collapsed by 21.44%, the largest one-day drop since 1980, and it triggered an overall slump in U.S. stocks that day.
What do the American and business community say?
According to a new U.S. poll conducted in early November by Morning Consult and Politico, 65 percent of registered voters believe the U.S. economy is currently in recession. According to a Conference Board interview of 136 U.S. business executives from September 19 to October 3, as many as 98% believe that the United States will fall into a recession within the next 12 to 18 months. Almost all well-known listed companies have begun to tighten capital expenditures, suspend recruitment, and resort to more than one round of layoffs. All kinds of spending cuts are standard steps for companies that have already felt the economic downturn and are preparing to tighten their pockets and survive the recession.
Impact of rate hikes
Impact on US stocks
The Fed’s current priority is to raise interest rates to curb inflation, not to save the stock market. The reason is that the amazing inflation rate will affect everyone. All daily expenses have skyrocketed, currency devaluation will shrink assets, the resulting social unrest, rising unemployment, and damage to the country’s competitiveness are far worse than the stock market decline.
But not everyone is an investor in U.S. stocks (58% of Americans own stocks according to Gallup’s May 2022 survey), and it’s easy to judge which is more important. There is no precedent in the history of U.S. stocks, during the period when the Fed raises interest rates all the way, U.S. stocks can continue to rise.
Hot money returns to America
The strong dollar policy pursued by the United States for a long time, coupled with the continued interest rate hikes in 2022, has caused hot money to continue to flow back to the United States. End up another extremely serious side effect caused by the US stock market multinational companies because of the rapid appreciation of the dollar this year, corporate profits due to the exchange rate caused substantial losses.
The year-over-year growth rate, which was originally boosted by the COVID-19 pandemic in past two years, compared to the base period originally made it difficult for revenue to grow again. In addition, the U.S. economy has essentially entered a recession, and customers cut expenses, causing the annual revenue growth of many companies to become negative.
Foreign exchange losses erode corporate profits
To make matters worse, U.S. companies convert their revenue into US dollars, which makes the unsightly annual growth rate revised downward. Moreover, listed companies with larger scales have a relatively high proportion of foreign revenue, so they will not be able to do so. The impact is also greater. The dollar has appreciated 17 percent against a basket of currencies of developed countries in the first three quarters of this year, hitting a more than 20-year high.
According to Bank of America estimates, every 10% appreciation in the U.S. dollar index will reduce the earnings of S&P 500 companies (29% of their profits are derived from overseas) by 3%, and the third-quarter earnings alone are estimated to have evaporated by 10 billion U.S. dollars.
| Company | Q3 revenue performance | Next day share performance after Q3 earning release | Stock performance from 1/1/2022 to 11/08/2022 | Impact of foreign exchange losses |
| Apple | +8.1% | +7.6% | -23.63% | Lose net profit by 6%, Q4 revenue will be reduced by 10% |
| Microsoft | +10.6% | -7.7% | -31.45% | Q2 net profit lost 1.5%, revenue decreased by 1.15% |
| Alphabet | +6% | -9.1% | -38.62% | Revenue growth slowed to 6% from 11% |
| Amazon | +14.7% | -6.8% | -47.22% | International e-commerce revenue growth slowed from 12% to 5% |
| Meta | -4.5% | -25% | -71.78% | Q4 revenue growth will lose 7% |
| Tesla | +55.9% | -8.6% | -52.89% | Lost cash flow of $529 million in the past year |
| Nvidia | +2.9% | -9.23% | -52.04% | 84% of revenue comes from overseas |
Table 1: The day after the Q3 financial report results of the top seven companies in the US stock market were released, the stock price performance so far this year, and the impact of foreign exchange losses (data from Google Finance, financial reports of various companies, earning call content)
The trend of U.S. stocks this year
Growth stocks drove in first half
From the fourth quarter of 2021 to the second quarter of 2022, the main groups that fell were growth stocks, small-cap stocks, and listed companies without earnings. The drop ranges from 50% to 95%.
Large blue-chip stocks have been hit so far since end of the second quarter
From the second quarter to now, the main groups that have fallen are large blue-chip stocks, which are the main force of the continuous rise and stability of US stocks. The fall of these group has been indicating that the decline of US stocks is not short-term or only affects some industries, but the recession has certainly spread to the rest of industries.
Only defensive stocks remain
In contrast, there are actually very few industries that stock price has not fallen sharply so far. Most of them are large pharmaceuticals, health care, communication services, and consumer discretionary. They are the most typical defensive stocks, plus oil stocks. If even the defensive stocks of this type start to fall sharply, and the large blue-chip stocks of the second largest category do not stop falling and continue to fall, it will inevitably lead to a complete collapse of the U.S. stock market.
| Company | Ticker | Q3 revenue performance | Stock performance from 1/1/2022 to 11/08/2022 | Dividend yield |
| Johnson and Johnson | JNJ | +2% | +1.19% | 2.60% |
| Eli Lilly | LLY | +2.5% | +34.03% | 1.07% |
| UnitedHealth | UNH | +11.8% | +9.44% | 1.20% |
| AT&T | T | -4.2% | -2.76% | 5.95% |
| Hershey | HSY | +15.7% | +20.34% | 1.78% |
| Mastercard | V | +18.9% | -8.89% | 0.88% |
| Visa | MA | +16% | -11.32% | 0.60% |
| Exxon Mobil | XOM | +51.9% | +78.79% | 3.21% |
Table 2: Representative stocks whose share prices have not been hit in 2022, the rate of decline since the beginning of 2022, and the results of Q3 financial reports (data from Google Finance, financial reports of various companies)
How much will it fall
According to Wells Fargo’s analysis, in the past with the economy entering recession, the average duration of the decline in US stocks was 20 months, with an average decline of 37.8%.
Conclusion
According to FactSet statistics, for large companies that have reported third-quarter results so far, and the estimates of those who have not yet announced, the average earnings per share rose only 2.1% from the same period last year, the slowest growth rate in two years.
As of October 28, only 1934 of the 11,725 U.S. stocks (16.49%) had positive returns so far this year. All signs point to hard times ahead for investors.
I am the author of the original text, the abridged version of this article was originally published in Smart monthly magazine.
I am the author of the original text, the abridged version of this article was originally published in Smart monthly magazine.
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