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One-week flash back on US economy: real strong or just bubble?

(People's Daily)    09:09, October 15, 2018

With the mid-term elections in US approaching, the global trade is getting more uncertain, an inflection point for US stock market and the US economy might emerge, analysts concluded.

Wednesday witnessed Facebook, Apple, Amazon, Netflix and Google parent company Alphabet (FAANG) stock decline, falling 6 percent and hit the deepest drop on one single day since 2012. Shao Yu, chief economist at Shanghai-based Oriental Securities, told the People’s Daily that US economic indicators are now showing some signs of slowing down.

Restless markets

FAANG’s total market value lost by $125 billion overnight, surpassing any market value of approximately 460 companies in the S&P 500 listed companies. Within one week, 80 percent of the US technology stocks are already in a correction, digesting 10 percent drop from their highs.

“The most remarkable risk is the contraction of liquidity brought about by trade friction and interest rate hikes, because the entire US economy has benefited from liquidity over the past decade,” Shao noted.

The rapid growth of mobile internet companies led by FAANG capitalized from innovation in both software and hardware, for instance new smartphone value chain have created many development opportunities. The valuation of these technology stocks is very high.

Being the driving force, liquidity is the key factor, once it shrinks, the pain point of the US economy is roused, Shao pointed.

That explains why Trump was blaming the Federal Reserve Chairman Jerome Powell – his own nominee. In return, those bubbles in high-tech stocks are getting more obvious, Shao reminded.

Besides the troubled stock market, the US Treasury Bond, known as “safe assets”, which is usually function as the best choice for investors, will have to rein in risk. While the stock raised the flag, US treasuries also suffered an unexpected sell-off, pushing 10-year bond yields up until the end of the day to 3.19 percent.

“Suppose the emerging market dumps more US Treasury, with the US Fed Reserve contracting its balance sheet, next the liquidity will be short in provision, pushing the 10-year Treasury yields hiking to 3.5 percent or even higher,” Shao continued.

It is noteworthy that only one month ago, the US 10-year bond yield exceeded 3 percent. Last week, the figure climbed to 3.26 percent, thanks to the address by Powell. But that is not the end of story yet, the bond ETF has suffered the same fate, and the Blackrock ETF (AGG) has a $2 billion outflow of funds, marking a new record.

Along with the long-term loose monetary policy of the Federal Reserve in the past decade, the market bubble is gradually accumulating, and the value of the US stock market is overestimated to some extent. In its latest Global Financial Stability Report, the International Monetary Fund (IMF) has expressed concern over high valuation of assets in the US.

As of October 8, the Dow Jones stock index's overall price earnings ratio is 33, indicating buying a basket of stocks from the 30 largest listed companies in the United States now yields about 3.03 percent a year, less than 3.22 percent of US Treasury bonds, according to current net income estimates, which naturally triggers capital flight from the stock market.

US corporate tax revenue at 75-year low, leaving another black hole to be filled, according to FOX business.

Trade talks pending

J.P. Morgan chief Jamie Dimon's warning on Friday that geopolitical issues could threaten US economic growth, paired with softer results from key inflation indicators like the consumer price index.

To predict the lead time for US to get back to negotiation table with China, Shao said that it depends on the impact of the stock market to the US financial market. In case of relatively large impact, the above supposed scenario takes place; the bubble might be popped due to US economic “success” owed too much to a monstrous stock market.

In face of tremendous financial risks, US might be reduced to initiate the trade negotiation, Shao noted.

After all, ten-year cyclical liquidity contraction, and globalization are the reality. Big countries are supposed to work on trade friction solutions to avoid potential financial risks. The worst scenario is without trade talks, both emerging markets and the FAANGs in US market to perish together in the bursting of the bubble, Shao stressed.

What else

China last Sunday decided to cut the reserve requirement ratio (RRR) by 100 basis points, which will take effect on Monday. The move is expected to pump another 750 billion yuan ($108 billion) into the market.

Jiang Han, a research fellow at Suning Financial Research Institute, told the People’s Daily that although the central bank’s RRR cut is strong, it is within the market’s expectations, which has been there in the market since September.

For the macro economy, the central bank’s monetary policy has solved the problem of lacking market liquidity and achieved the overall development of the market, Jiang pointed out.

From market perspective, with the continuous improvement of liquidity, financial institutions have more funds and strength to support the real economy, especially the development of small and medium-sized enterprises, Jiang added.

RRR cut is a gesture that China is focusing on its own economic growth, Shao said.

While other emerging markets, with far smaller market scale might be more susceptible to the US Fed’s interest rate hikes, Shao compared.

In the future, the real economy financing will be easier, and the real economy will get better recovery, Jiang predicted.

As a large economy, China is of more independence, its steady and neutral monetary policy will not follow up with interest rate adjustment. Rather to avoid capital outflows through functional control and to increase internal momentum, Chinese government has already taken measures to do so, Shao reaffirmed.

From a holistic perspective, the RRR cuts boost market confidence with a positive effect on alleviating the endogenous contradictions in China economy, Jiang said. 

(For the latest China news, Please follow People's Daily on Twitter and Facebook)(Web editor: Wen Ying, Bianji)

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