Decoding Fund Flows: Predicting the US Stock Market
Over the next few months, funds are expected to continue flowing into the US dollar market (US stocks & US bonds). Let’s have a look at some figures:
US June inflation rate: 2.97%, interest rate: 5.50%
UK June inflation rate: 7.90%, interest rate: 5.25%
EU June inflation rate: 5.50%, interest rate: 4.25%
With only the US dollar having an interest rate higher than the inflation rate, it means holding the US dollar will earn interest and not depreciate, resulting in a return of 2.53%. However, holding the British pound or the Euro would yield interest lower than inflation, leading to a real depreciation. This obvious difference allows anyone to easily compare and make a choice.
The GBP/USD exchange rate recently reached a high of 1.29, marking its highest appreciation of 6.83% this year, but still only 1% below the inflation rate. This means the purchasing power of the British pound in the international market hasn’t significantly declined. Furthermore, since the exchange rate appreciation has already offset the interest return, the GBP/USD exchange rate is now close to its peak (if adjusted with inflation, the rate would be around 1.31). If funds flow into the US dollar market, increasing demand for the currency, the US dollar is expected to appreciate, and the GBP/USD exchange rate might fall to 1.21 (its level at the beginning of the year) in the next 1–2 months.
As for the US stock market, even though it entered a downturn in October last year, with high energy prices and the ongoing conflict between Ukraine and Russia, the stock market kept rising. The S&P 500 index is not far from its peak at the end of 2021. The question remains whether this is a rebound or confirmation of a new round of upward trend.
Since the beginning of 2022, the S&P 500 index has been declining (represented by the green dashed line), reaching its lowest point on October 13th (the first pink arrow). After that, it experienced a rebound, with the first low point at 3764 (the second pink arrow), and another rebound on March 13th this year, with the second low point at 3808, which didn’t fall below 3764. This suggests a potential turnaround, but it hasn’t been confirmed yet.
Whether assets will appreciate depends not only on fundamental factors but also on whether there is a chase for funds and if the market is active.
On June 14th of this year, there was a significant inflow of funds into the US equity ETFs. Historically, whenever there has been a substantial influx of funds into US Equity ETFs, and there is no immediate outflow to offset it, the stock market would experience an upward trend. Moreover, on July 17th, another large inflow of funds was recorded in US Equity ETFs, indicating a potentially positive outlook for the US stock market.
The inflow of funds on June 14th seems to be the first signal confirming the turnaround, but it was necessary to observe if there would be any short-term outflows. The substantial inflow of funds on July 17th likely confirms the turnaround for the US stock market.
Overall economic data shows that the US is indeed outperforming globally — GDP has grown 2.6%, the unemployment rate remains low at 3.6%, wages have increased by approximately 4%, inflation has decreased to 2.9%, and overall consumer spending has shown growth without any signs of a recession. In Hong Kong, with interest rates rising, monthly mortgage payments will also increase. However, in the US, especially after the 2008 financial crisis, most property mortgages are fixed-rate, meaning they are not affected by market interest rate fluctuations. As a result, the daily spending patterns of Americans are not significantly impacted by changes in interest rates.
The entities that are genuinely affected by Federal Reserve rate hikes are corporates. Higher interest rates can lead to reduced borrowing and slower expansion, causing a decline in bank profits and a substantial reduction in available capital for institutions. Despite the slowdown in growth for businesses, enterprises can still record profits, and this may not necessarily lead to a recession.
After the Federal Reserve announced a 0.25% interest rate hike on Wednesday, there was a press conference. Chairman Jerome Powell remained tight-lipped about whether there would be further rate increases, emphasizing the need to assess the economic data in the next two months before deciding on continuing rate hikes or maintaining the current rates. It was pretty intriguing to watch the live online broadcast and observe the immediate reaction of the US stock market.
Many reports and analyses in the media indicate that expectations of rate hikes can impact the rise and fall of the stock market. In my opinion, in the short term, if the US economy continues to grow and interest rates remain higher than inflation, an inflow of funds is likely to have a more positive impact on the economy. With a strong currency and a preference for US dollar-denominated assets, this bodes well for the US stock market.
