Is this overseas "stock and bond rally" too strong and too fast? Without fundamental and technical support?

Last week, the non-farm payroll data ignited expectations of an end to rate hikes, triggering a frenzy in the US stock and bond markets. The 10-year Treasury yield fell nearly 26 basis points for the week, hitting a one-month low, and US stocks experienced their strongest weekly gain since the beginning of the year.

However, this frenzy may ultimately be short-lived.

Morgan Stanley believes that US stocks still lack support from technical and fundamental factors, and last week's surge was mainly driven by the decline in bond yields. The current market conditions appear more like a bear market rebound rather than the start of a sustained rebound, especially in the face of weaker earnings expectations and macroeconomic data.

The rally in the bond market is mainly due to two reasons: first, the issuance of long-term bonds by the Treasury Department was lower than market expectations; second, economic data began to show signs of slowing growth, leading investors to imagine that the Federal Reserve may cut interest rates before the labor market deteriorates beyond expectations next year.

Barclays also believes that financial markets may be too optimistic, overestimating the weakness of the US labor market, while inflation remains sticky and the Federal Reserve itself is not yet willing to announce an end to its tightening policy (as evidenced by Powell's remarks at the IMF meeting on Friday).

Morgan Stanley and Barclays believe that the rebound last week may come to an end in the next one to two weeks. The US economy remains strong, and the Federal Reserve is unlikely to cut interest rates prematurely. In addition, the situation in the Middle East has not shown any signs of easing, and the risk of escalating war still exists.

As predicted by the two major Wall Street investment banks, both US stocks and bonds performed poorly this week. In particular, after Powell's hawkish remarks, US Treasury bonds plunged during the trading session, and the S&P and Nasdaq ended their longest winning streak in two years.

Financial markets may be too optimistic about the end of rate hikes

In a report released on Monday, Morgan Stanley's bearish analyst team led by Michael Wilson stated that last week's surge in the stock market was mainly driven by the decline in bond yields. There were two main reasons for the decline in yields:

1. The issuance of long-term US Treasury bonds by the Treasury Department was lower than market expectations.

2. Economic data began to show signs of slowing growth. Specifically, both manufacturing and services PMI fell short of expectations, and labor market data also indicated further slowdown, with an increase in the unemployment rate. Morgan Stanley believes that this indicates a slowdown in economic growth from the overheated state in the third quarter, which helps increase bond demand and drive down yields.

It is worth mentioning that many bulls interpret the strong rise in yields as a signal that the Fed has completed its rate hike cycle and predict that the Fed may start cutting rates next year, even if the labor market does not continue to deteriorate or other factors unfavorable to economic growth emerge.

However, Morgan Stanley stated that the current economic outlook clearly does not support a Fed rate cut or a significant acceleration in earnings growth. Barclays also warned investors not to overestimate the weakness of the US economy.

According to data released by the US Department of Labor, non-farm payrolls in the US increased by 150,000 in October, slightly lower than the general expectation, but this is mainly because the number of new jobs in the previous two months was revised down by 101,000.

The unemployment rate has now risen by nearly 0.5 percentage points from its low point in January, and the total weekly working hours have remained stable.

On the other hand, if the impact of strikes is excluded, the average number of new jobs in the past three months is 223,000, compared with 200,000 in May to July and 227,000 in February to April.

In addition, the victory of workers in strike actions also reflects a strong labor market.

The United Auto Workers (UAW) recently achieved victory in negotiations with the Detroit Three and plans to launch organizing actions with Toyota, Tesla, and other non-unionized US automakers.

Barclays stated that the current US economy still shows considerable resilience, and the scale of excess savings far exceeds previous expectations.

Last week, the Financial Conditions Index (FCI) eased, and the US successfully escaped the impact of monetary tightening since March. The market generally believes that the Fed is relatively dovish, and the possibility of a rate hike in December seems unlikely. However, Powell pointed out that the tightening of financial conditions needs to continue for some time to have a substantial impact.

Barclays stated that the Fed is not yet willing to announce the end of the tightening cycle, and the financial market has gone too far. The US economy still has strong upward momentum, and it does not believe that the Fed has entered an easing mode.

In the early hours of Friday Beijing time, Powell took a hawkish stance at the International Monetary Fund (IMF) meeting, stating that he is not confident that policy has been tightened enough to bring inflation down to 2%. He reiterated the need to remain cautious, but if appropriate, the Fed will not hesitate to raise interest rates.

With Powell's hawkish stance and the dismal performance of US bond auctions, US bonds plunged during the session, and the S&P Nasdaq Composite Index ended its longest consecutive gain in two years. Market lacks both technical and fundamental support, according to Morgan Stanley. The "stocks and bonds rise together" trend from last week may be difficult to sustain.

First, let's look at the third-quarter earnings of US-listed companies. According to Morgan Stanley's research report, third-quarter financial performance exceeded expectations, but company guidance was weak, leading to downward revisions in future earnings expectations. Companies are still in a phase of profit decline.

The profit of the S&P 500 index is significantly higher (7.5%) than the average level (4.5%), mainly due to profit margin elasticity. However, sales growth hit a record low in 2019 due to the continuous decline in pricing power, especially in retail goods.

Morgan Stanley pointed out that in the past two months, both the breadth of improvement in earnings expectations and the breadth of performance have significantly deteriorated.

The breadth of improvement in earnings expectations for 2024 continues to be negative (-10%), reaching the lowest level since March, which means that the number of companies with downward revisions in expectations is higher than those with upward revisions.

70% of the constituents of the S&P 500 index face negative breadth of earnings expectations. The insurance and consumer services industries have the strongest absolute breadth of expectations, while the automotive and transportation industries are the weakest. The earnings expectations for small-cap stocks have also deteriorated and are lower than those for large-cap stocks.

As the earnings season progresses, we see that on the first trading day after the earnings report is released, earnings expectations improve, now at 0%, an improvement from -0.8% two weeks ago.

Morgan Stanley stated that although profits remained stable in the third quarter, expectations for the fourth quarter have been significantly lowered since the start of the earnings season.

Weak sales in the third quarter and downward revisions in profit expectations are due to consumers' pessimism about the overall environment, leading to more conservative consumer behavior.

According to Morgan Stanley's latest consumer survey, consumers are more willing to spend money on necessities and home goods, with the lowest willingness to spend on small appliances, consumer electronics, and dining out.

Especially during the holiday season, 27% of surveyed consumers expect to spend less on holiday shopping this year compared to last year, while 25% expect to spend more.

Most holiday shoppers (69%) wait for retailers to offer discounts before starting their holiday shopping, and they are willing to spend money only when the average discount reaches 30%. More than half (53%) of consumers plan to travel in the next six months, slightly lower than last month's 55%.

With the end of the deferral period for student loan payments this fall, debt repayment has become a focus for consumers. The proportion of consumers who are overdue or have missed bills or loan repayments has increased from 34% in our previous survey to 40%.

Morgan Stanley maintains its recommendation for a barbell allocation of defensive growth stocks and late-cycle cyclical stocks. Specifically, Morgan Stanley is optimistic about traditional defensive stocks such as healthcare, essential consumer goods, and utilities, as well as late-cycle cyclical stocks such as industrial and energy stocks.