After a week of intense geopolitical offensives by the U.S. against other countries, the market finally welcomed a positive conclusion, as President Trump seems to have made significant concessions, announcing that smartphones, computers, and other electronic devices will be excluded from reciprocal tariffs. The U.S. Customs and Border Protection also subsequently stated that these goods would be exempt from the 10% global tariff imposed on most countries.
The Chinese government responded positively, stating that this move is 'a small step towards correcting Washington's erroneous actions and canceling the remaining tariffs.'
Risk assets reacted enthusiastically, with the Nasdaq index rising 1.5%, and the Chinese stock market soaring more than 3% in early Asian trading. Even though Commerce Secretary Lutnick and the Trump administration later retracted some statements, it did not weaken risk appetite, as investors cautiously anticipated that the worst of the tariff storm had temporarily come to an end.
Despite a decent rebound in the risk market, U.S. assets have already suffered significant impacts throughout the tariff storm. Last week, the dollar fell by about 3%, and the 10-year Treasury yield soared nearly 60 basis points. According to a report by Citigroup, there have historically been about 13 similar occurrences where the dollar depreciated by over 2% and the 10-year yield rose by more than 30 basis points, including the late 1970s stagflation crisis, the early 1980s Volcker shock, and the early 2010s Eurozone crisis. Based on historical experience, the SPX index has mostly seen double-digit rebounds afterward, but is this time different? Only time will tell.
Over the past month, international official institutions have significantly reduced their net demand for U.S. stocks, as central banks around the world have cut their holdings of U.S. dollar assets in response to U.S. tariff policies. However, retail demand for U.S. and Chinese stock markets remains robust, with investors generally in a 'buying the dip' mode, which somewhat offsets the aggressive selling by hedge funds that has pushed the U.S. stock market into a deeply oversold area.
Setting tariffs aside, the most critical issue for the stock market is whether the U.S. economy is heading towards recession. Notable financial figures have started to issue warnings, indicating that the U.S. economy may fall into recession in the short term, with betting odds predicting a 40% to 60% probability of a recession occurring in 2025. Is this merely a scare tactic orchestrated by Wall Street to convince the president to rein in a hardline trade stance, or is it a genuine concern about the economic outlook? Our perspective is that the distinction between the two is not particularly important, as market sentiment is often the key to shaping reality, rather than the other way around.
As the U.S. earnings season gradually heats up, the market focus will shift to valuation, and any consideration of reasonable market value will ultimately depend on whether the U.S. economy falls into recession. Currently, the forward P/E ratio of the SPX is around 19 times, which is within historical range, but if it further revises down to around 15 times, it would suggest an opportunity for further declines of 25% to 30%.
However, if the economy does indeed fall into recession, and corporate profits decline further by 15% to 20%, then the SPX valuation could drop below 4000 points. Ahead of the earnings season, the market has already begun to revise down corporate EPS estimates.
Apart from the stock market, the biggest concern in the market last week actually came from the sharp sell-off in the fixed income market, which raised questions about whether the Trump administration's aggressive measures have already damaged the status of U.S. Treasury bonds as a global safe-haven asset. The market is worried that foreign central banks may sell U.S. Treasury bonds in response to tariff issues, leading to the largest weekly increase in U.S. Treasury yields in over 20 years. It is reported that last Wednesday's sell-off of U.S. Treasuries, led by Japan, was the trigger that prompted Trump to make his first tariff concession.
Despite the market's various speculations and concerns regarding China's massive sale of U.S. Treasury bonds, we remain cautious about this claim. First, the scale of U.S. Treasury bonds held by China has been declining over the past decade. Secondly, most recent losses have concentrated in long-term bonds (20-30 year bonds), which, in fact, are held at very low proportions by central banks of various countries.
Regardless of who sold off first (we speculate it may be Japanese life insurance companies and pension funds), the weakening of the dollar and the soaring 10-year Treasury yield are indeed concerning and signal potential warning signs. Capital account surpluses and current account deficits should complement each other; therefore, once the latter begins to normalize, it means that fewer dollars will be able to flow back into the debt financing market.
Adding insult to injury, consumer inflation expectations from the University of Michigan surged, creating a divergence with recent fundamental data, making the situation for the Federal Reserve and bond market participants more challenging. The market began to question whether the Fed still has room to maintain a dovish stance in the face of inflation pressures brought about by a new round of tariffs, and thus, short-term interest rate pricing rose again in the past week (less likelihood of rate cuts).
This wave of market turmoil unexpectedly turned cryptocurrency into a beneficiary; amidst this risk-averse sentiment, the volatility in the stock market was actually higher than that of BTC. In addition, the 'beggar-thy-neighbor' tariff policies among countries also pushed spot gold to reach an all-time high, and BTC took the opportunity to reclaim its long-lost narrative as a 'store of value.'
From a technical perspective, BTC has successfully broken through the trendline established this year and is expected to further challenge the $90,000 to $95,000 range. Additionally, this is the first time in months that memecoins and altcoins have regained momentum, with several memecoins beloved by communities seeing increases of over 100% in the past week.
Finally, from a long-term structural fundamental perspective, the market still has reasons to believe that cryptocurrency asset prices will continue to rise. According to reports from The Wall Street Journal, Binance is actively seeking to reach a deal with the U.S. government and cryptocurrency companies under Trump in exchange for a more lenient regulatory environment. Meanwhile, Bloomberg reports that market expectations for perpetual contracts to be listed on U.S. exchanges are rapidly heating up, with launches expected in the coming quarters, aligning them with products offered by existing offshore platforms, significantly enhancing leveraged tools and secondary liquidity in U.S. regulated venues, and accelerating the overall process of mainstream adoption.
