US' 2023: "Suicidal" Rebirth?
As 2023 comes to an end, it can be said that compared to the expectations at the beginning of the year, there has been neither a decline nor a rise. Even for the most authoritative institutions, macroeconomic forecasts have mostly been proven wrong.
Entering the holiday season, economic data releases in the United States have been sparse. Dolphin Research takes this opportunity to focus on the situation of the US economy and provide an outlook for 2024, attempting to address the following questions:
2020-2021: In the past two years of the pandemic, the US implemented aggressive quantitative easing measures and utilized all available tools. So, what exactly has the pandemic impacted in the US?
2022-2023: With interest rates going from 0% to 5.5% in two years and a self-destructive quantitative tightening, how did the US achieve "negative growth"?
2024: Will there be another economic downturn in the US? After the continuous rise of the US stock market, is it a trap or a strong belief?
The following is a detailed analysis:
I. The Real Impact of the Pandemic: Labor Supply + Industrial Reshoring/Infrastructure Reconstruction
If the emergence of Omicron at the end of 2021 is taken as the observation point for the end of the pandemic, Dolphin Research believes that the long-term impact of the pandemic on the US can be summarized into two main areas after filtering out the noise: labor supply shock and infrastructure awareness shock.
1.1) Impact on Labor Supply
The impact of the pandemic on labor supply in the US is mainly reflected in the following aspects:
a) Restricting immigration: In 2020 and 2021, Trump implemented the 42nd immigration ban under the pretext of fighting the pandemic, resulting in a significant decrease in immigration.
b) Increased mortality rate: In 2021, infections from the strains before Omicron were fatal, leading to an increase in the mortality rate and a decrease in net population growth.
c) Decreased labor force participation: After the pandemic, the baby boomer generation, who were born in the 1960s, retired early, leading to a decrease in labor force participation that cannot reach pre-pandemic levels.
It can be said that the labor market issues in the US after the pandemic are not just a matter of demand but fundamentally a supply problem. The core solution to this problem lies in restoring the labor supply, and for the US, unlike countries relying on endogenous population growth, there is a more direct and effective solution - immigration. 2. Strategies for Labor Supply: Relaxing Immigration
Here, let's talk specifically about the aging population in the United States. "Premature aging" is the biggest fear of economic development, and the United States also faces this problem:
a. Since 2000, the annual population growth rate in the United States has gradually declined from 1% to around 0.2%-0.5%, and the total population has already stagnated.
b. In terms of age structure, the proportion of the population under 17 years old has been decreasing, and over the past 20 years, the young population (under 17 years old) that carries the hope for the future has decreased by 4 percentage points, while the population over 65 years old has increased by 5 percentage points, indicating a trend of "aging and declining birthrate".
c. Interestingly, among the population that can contribute to the labor force (between 18 and 64 years old), although the average age of the labor force has increased, the overall proportion of the labor force has remained basically unchanged over the past 20 years.
In other words, the age structure of the American population is characterized by a decrease in the younger population and an increase in the older population, but the population of the working-age group, which is in the prime of their lives, has completely deviated from the "independent market trend of age".
Upon closer examination, it is found that the "independent market trend of age" for the working-age population in the United States is actually due to "immigration":
a) In the past twenty years, the proportion of the number of green card recipients in the United States to the net increase in population has increased from 35% to 66% before the pandemic, and in 2022, it reached 80% of the net increase in population. It can be said that the current population growth in the United States, which is unable to be compensated by births, relies entirely on immigration to stabilize and slightly increase the total population.
b) Moreover, more than 85% of these immigrant populations are over 16 years old, which means that the majority of them skip the "developmental stage" and directly enter the workforce.
These three points clearly outline the demographic fundamentals of the U.S. economy: as an immigrant country, its aging population and declining birthrate are not so fatal to the endogenous driving force of the economy.
With the maintenance of comprehensive competitiveness, it is entirely possible to harvest overseas populations through the selection of immigrants (based on skills, capital, and labor force).
Therefore, in response to the issue of labor supply, the solution lies not in birth, but in immigration. Because of this, the labor supply problem in the United States is not a fatal problem. To some extent, immigration serves as a valve. As long as the comprehensive competitiveness remains, once the valve is opened, the supply problem will naturally ease over time.
2. Revitalizing Manufacturing and Industrialization
From the employment structure shown in the above chart, it is very clear that the structural changes in the industry brought about by the onlineization of commerce and the reconstruction of logistics are the result of the post-pandemic era. During the pandemic, the progress of online commerce accelerated, placing higher demands on logistics in terms of warehousing, transportation, and distribution. The old docks have caused a logistics bottleneck, and the impact of outdated roads on transportation capacity has made both parties realize the need for capitalist industrialization. Biden's "Infrastructure Bill" after the epidemic is the first industry stimulus bill unanimously passed by both parties.
The shortage of supplies, including chips, during the epidemic has also made the United States realize the necessity of rebuilding key manufacturing sectors.
The real impact of the epidemic is actually the three major economic bills of Biden's economics: one manufacturing reconstruction bill and two industrial reshoring bills.
These three major bills, even under high interest rates in the United States, will still lead to a far greater recovery in the automotive and parts industries in manufacturing than in 2020. While the manufacturing industry as a whole is destocking, the reason why the upstream construction industry (building capacity) can still provide employment and recruit workers is because of its strong demand.
3. The policy choice behind the "flood" in the United States: preferring inflation over deflation
The supply-side impact of the COVID-19 pandemic on the labor force (blocking immigration, deaths from the epidemic, early retirement of the baby boomers) normally corresponds to the "internal demand" of these disappearing populations.
3.1) Blocking demand/expectation impact: helicopter money during the epidemic
At that time, Powell and Yellen did make a choice, or rather a risk assessment: from a retrospective perspective, it may have been a bit too aggressive, but the situation at that time was unprecedented, and the greater concern was deflation rather than inflation, especially given the bloody example of deflation in Japan (Note: This can be traced back to Powell's one-on-one interview after the Jackson Hole Global Central Bank Annual Meeting in August this year).
When the Federal Reserve and fiscal policy launched unlimited ammunition to support the economy, the most important thing in hindsight was to stabilize public confidence: rare natural disasters were backed by the government, and residents and businesses did not need to set aside "extra disaster reserves" for such disasters, which preserved the confidence of the public and businesses. After the liquidity crisis was resolved, the passive savings due to the epidemic began to take effect, and there was a boom in consumption.
After such demand-side inflationary stimulus measures, the possible demand deflation and consumption expectation impact caused by the epidemic were directly resolved by the preventive policy choices of the Federal Reserve and the Treasury Department, leaving the impact of the epidemic only on the supply side, without further spreading to the collapse of demand and expectations.
3.2) Post-epidemic industry stimulus
The supply-side impact of the population is gradually being resolved by opening the immigration valve, and the demand and expectation impact of the population is being resolved by helicopter money. As for the shortcomings exposed in the industry and infrastructure, the Democratic Party's approach is simple and straightforward: fiscal deficits and industry bills.
4. High Interest Rates + Reduced Liquidity: Who Can Still Leverage Against the Wind?
In the post-pandemic period, the United States has entered a phase of monetary tightening, with increased funding costs (interest rate hikes) and reduced money supply (Fed debt reduction). In theory, there should be few people willing to leverage under such high funding costs.
In practice, this is indeed the case for the economic entities driven by normal input-output relationships:
a) Industrial and Commercial Enterprises: The balance of commercial loans from banks currently stands at 2.7 trillion yuan, with net debt reduction.
b) Construction and Development Industry: The growth of development loans based on "land" partially corresponds to the infrastructure reconstruction and manufacturing industry reshoring in the United States, with a net increase of 160 billion US dollars.
c) Residents: There has been growth in mortgage loans and consumer credit, but not particularly significant, totaling 150 billion US dollars.
d) Only the government is still aggressively leveraging: In 2023, the leverage behavior of both enterprises and residents has weakened significantly. Under high interest rates, only the federal government is still aggressively leveraging: not only does it have the highest debt balance growth rate, but also the highest growth rate in net debt issuance, reaching a new post-pandemic high.
5. Where Does the Leverage Money Come From?
If in 2020, the US federal government leveraged with the full support of the Federal Reserve, which was essentially printing money, then in 2023, when the US federal government leverages again, who is it borrowing money from?
During the pandemic, the US printed too much money, resulting in the current money supply in the US economy still being above the historical trend. If we follow the historical trend and the current pace of real economic growth and liquidity reduction, it may take another year of quantitative tightening to squeeze out the excess money supply in the US economy.
The excess currency is reflected in the reverse repurchase balance on the Federal Reserve's balance sheet. These funds cannot find better returns in the real economy, so they choose to lend to the Federal Reserve. Since the Federal Reserve is a stronger borrower than the US government, the interest rate it borrows is almost the lowest in the market, essentially surplus liquidity.
The net financing amount of the US federal government so far is 2.3 trillion, and the reverse repurchase balance of the Federal Reserve has decreased by 1.5 trillion, contributing to more than 65% of the financing amount.
These reverse repurchase balances, which originally lay in the Federal Reserve's account, earned the lowest risk interest income without participating in the currency derivative. Now they are invested in the real economy, creating tangible workloads. Of course, the US economy can withstand it.
6. Strategic Insights
From a sociological perspective, the United States has almost created a humanitarian disaster in its handling of the epidemic. However, from an economic perspective, in the United States' response, it stabilizes and meets the demand and expectations of the entire society by stimulating demand strongly and suppressing the impact on the supply side.
The supply-side shortcomings exposed by the epidemic are being addressed by efforts to fill the gaps through fiscal and industrial stimulus driven by three major bills. The core issue that accompanies this is the sustained inflation caused by excessive currency issuance.
But for this result, it is more of a proactive and voluntary choice rather than a consequence. Between deflation and inflation, they chose inflation, which comes with a cost, but currently, it is not considered a long-term problem.
Equity assets are determined by both fundamentals and liquidity. Just as we saw the combination of a weak economy and a bullish stock market in 2020, we can also see a combination of a strong economy and a bearish stock market.
Looking back at the performance of equity assets under the combination of liquidity and fundamentals in the US stock market in recent years:
2020: A bull market with a weak economy and excessive liquidity.
2021: A bull market with economic recovery and excessive liquidity.
2022: A bear market with fiscal and monetary tightening.
2023: Fiscal expansion, reverse repurchase/liquidity crisis of small and medium-sized banks to hedge against monetary tightening, and bullish fundamentals.
From the current deduction, resident demand and expectations have not changed due to the epidemic. Assuming that 2024 is still on a normal track, Dolphin Research believes that the possible combination in 2024 is:
Fiscal expansion, economic security: Aging population fiscal spending + continuous investment from the three major bills. After the expiration of Trump's tax cuts and fee reduction bill in 2024, if the Democratic Party is in power, it may actually shrink to increase fiscal revenue, thereby bringing about a certain tightening effect, but overall, it will still be loose.
Monetary easing with slight tightening, pressure on liquidity: Compared with the loose price in 2023, it is conducive to credit derivatives, but the total supply of money is still tight, and reverse repurchase has no room for hedging. Liquidity is essentially tightening. 3) In this case, the corresponding combination is: The economic fundamentals are still intact, EPS is still there, but the reverse repo no longer has the power to hedge, and liquidity will begin to tighten substantially in 2024.
Therefore, the performance of actual equity assets throughout the year is likely to depend on the degree of liquidity tightening. However, in the first and second quarters of next year, when the hedging effect of reverse repo tightening ends, there may be a comprehensive devaluation of the US stock market.
If we calculate based on Dolphin Research's estimation of returning to the level of normal economic growth, which is a monthly currency contraction progress of $95 billion continuing until the end of 2024, even if US stock EPS performs well, it is difficult to expect equity assets to have the same level of performance as the "bullish fundamentals" this year.
Overall, in terms of the strategy for the US stock market, Dolphin Research's judgment on the rhythm remains: look for fundamentally strong stocks during the first quarter earnings season (January and February), wait for the tightening of US stock market liquidity (February and March), and then take action when these stocks are undervalued. Currently, the valuation of the US stock market is relatively unattractive.
Risk disclosure and statement of this article: Dolphin Research Disclaimer and General Disclosure
