CITIC Construction Investment: The subsequent decline in the US stock market may be limited to within 10%

According to the Zhitong Finance APP, CITIC Securities has released a research report stating that based solely on the expected impact of tariffs, there is a high probability that the subsequent decline in U.S. stocks will be within 10%, gradually entering a short-term bottom. Given the irreversible impact of tariffs on the economy, if tariffs are indeed implemented, there will be significant pressure for U.S. stock earnings to be revised downwards and for a second bottom to be explored, and the recovery path after the bottom reversal will be extremely tortuous, making it difficult to replicate the sharp rise and fall of 2020.

1. Under the catalysis of sentiment and expectations, the subsequent short-term decline may be controlled within 10%

(1) Under external shocks, the adjustment of U.S. stocks generally occurs in three steps:

The first step is a rapid decline driven by sentiment and expected trading, usually within a month;

The second step is a second bottom exploration, predicated on the realization of economic downturn, generally occurring in the following six months. If the economic deterioration is falsified or the economy recovers rapidly, this step may be skipped, similar to 2020;

The third step is trend recovery, with speed and intensity depending on the degree of economic improvement.

(2) Based on historical experience, the short-term expected decline may be limited to 10%

Comparing the 2008 financial crisis, the 2018 trade war, and the 2020 pandemic, the S&P 500 experienced short-term declines between 10-30%. Currently, the S&P is down 17%, volatility is high, the negative feedback pressure from derivative stop-losses is controllable, and panic sentiment is showing pulses, indicating that pressure is being released.

From the perspective of expected trading based on tariffs, the baseline expectation for remaining decline is within 10%, gradually entering a short-term bottom.

Whether a second bottom will occur depends on whether the tariff policy is realized, with significant uncertainty.

2. Has the market already experienced a liquidity crisis? It seems okay for now

(1) A declining U.S. dollar index is a bad signal, and the temporary decline in gold prices is of limited significance

Last week, global assets fell across the board, especially gold, which had previously benefited from tariffs, and the ultimate safe-haven asset, the U.S. dollar, both declined simultaneously, raising market concerns that we have entered a liquidity crisis mode.

When U.S. stocks plummet, if the dollar remains stable, it indicates that the pursuit of dollar assets has not systematically faded, but rather there is a rebalancing among assets (similar to the reversal of carry trades in July last year); conversely, if the dollar declines, it could mean either funds are withdrawing from the dollar market for regional rebalancing or a more severe liquidity exhaustion (as seen in early 2020 during the pandemic).

(2) Offshore and onshore dollar liquidity remains relatively safe

Therefore, the current decline in the dollar requires close attention. Based on indicators such as onshore and offshore interest rate spreads and basis, there is currently no evidence of systemic deterioration in dollar liquidity, and the probability of regional rebalancing is high (corresponding to the appreciation of the yen).

3. Historical similarities and differences in fundamentals: Earnings outlook for second bottom and recovery space

If equivalent tariffs are implemented, they will have far-reaching impacts on the U.S. and global economies. Looking ahead, there are two major perspectives for reference:

(1) The perspective of a major transformation in the international system: long-term

Two highly comparable historical periods include:

First, the 1930s, the Hoover Tariff. U.S. tariffs rose to around 60%, leading to retaliatory measures from major trading partners, a contraction in global trade, economic recession, and a bear market in U.S. stocks.

Second, the 1970s, when the U.S. abandoned the gold standard. The monetary system was restructured, U.S. stocks fell, and gold prices rose. At that time, the dollar was decoupled from the gold that supported it; currently, the dollar is decoupled from the consumer demand that supports it. In the long term, the dollar may trend downward, and U.S. stocks will also face pressure (2) Perspective on Economic Cycle Recovery: Short to Medium Term

The recovery of the U.S. stock market after the crisis has shown three paths, reflecting different patterns of economic recovery:

First, the 2008 financial crisis: the economy failed to return to trend, and the U.S. stock market rebounded slowly with little strength;

Second, the 2018 trade war: the economy did not deviate from the trend, and the U.S. stock market rebounded quickly, but with moderate strength;

Third, the 2020 COVID-19 pandemic: the economy exceeded the trend, and the U.S. stock market rebounded quickly and strongly.

Returning to the current round, if tariffs are implemented, the pressure on U.S. stock market earnings to be revised down and the risk of a second bottom will be very significant, and the path to recovery after a bottom reversal will be extremely tortuous, making it very difficult to replicate the sharp drop and rise of 2020.

First, currently, the U.S. stock market has not priced in a recession in terms of earnings. If a recession materializes, there will still be a round of earnings drag. Given the significant impact of tariffs, the severity of the second bottom is hard to predict.

Second, the impact of tariffs on the economy this round may be greater than in 2018, while the fiscal countermeasures may not be as strong as in 2020 and 2018, making it difficult for the economy to return to trend, resembling more the situation in 2008