The U.S. is on the verge of a massive bond issuance. Can the U.S. stock market withstand it?

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In last week's Strategy Weekly Report, Dolphin Research mentioned that from a perspective one year from now, the macroeconomic outlook of the United States is likely to be an inflationary economic scenario under "large fiscal + loose monetary" policy, similar to the period during the pandemic and Biden's era, using inflation as a way for the public to pay off the accumulated national debt. However, the basic premise for this operation is the need for a cooperative Federal Reserve to achieve low interest rates, with the sooner the rate cuts, the better.

Meanwhile, what big moves can Trump still make? Can the high-level U.S. stock market withstand the upcoming challenges?

1. Heavy Debt Burden

Since the pandemic began, U.S. federal debt has surged: a. The debt balance is close to $30 trillion, compared to $17 trillion before the pandemic in 2019, a net increase of $12 trillion; b. The net interest rate (the proportion of annual net interest expenses to the debt balance) has soared from 2.4% in 2019 to 3.6%.

The result of debt inflation is that interest expenses have become the second-largest expenditure item in federal fiscal spending, severely squeezing the space for other expenditures. Especially from the perspective of the natural year 2024, the narrow deficit spending of $1.1 trillion is almost equal to the interest expenses of $0.9 trillion.

Dolphin Research roughly estimates that a. If the interest rate falls from the current 3.6% by 100 basis points to around 2.5% b. At the same time, tariffs are increased from the original 2.5% to 12.5%, tariff revenue can increase by approximately $300 billion annually (vs. June's tariff increase of about $21 billion, annualized equivalent to an additional tariff revenue of $250 billion).

These two measures, one increasing revenue and the other reducing expenditure, can collectively squeeze out $650 billion in fiscal funds for the federal government, which is roughly enough to cover the new deficit of $500-600 billion annually starting from 2026 under the "Big Beautiful Act".

In other words, the money squeezed out cannot stay on the federal government's books and is essentially returned to the real economy in the form of tax cuts and fee reductions. This process is essentially a combination of loose fiscal and loose monetary policy.

Obviously, the implementation of this policy requires the cooperation of the Federal Reserve, which is why there is constant pressure on Powell, with various "PUA" tactics. The latest threat has shifted from incompetence at work to extravagant renovations at the Federal Reserve headquarters, budget overruns, and Powell allegedly committing perjury during congressional hearings, demanding his resignation.

The market has not seriously priced in this issue, but Powell has made strong statements, saying he will not leave office early due to threats or inducements, making it unlikely to affect the market's expectations for the pace of rate cuts.

2. Two Challenges for U.S. Stocks: Fundamentals First, U.S. Debt Drain

From last week's tariff deadline negotiations, the situation is similar to what Dolphin Research previously anticipated, with notification letters effectively extending the negotiation period. Regardless of the new tariff rate announced at the end of the new deadline, the market has realized that tariffs are used for revenue generation.

Currently, with overall high valuations in the U.S. stock market, non-U.S. international stock markets threatened by U.S. tariffs are generally rising, while U.S. stocks themselves are in a hovering state as the earnings season approaches.

Fundamentals First: During the U.S. stock earnings season, current performance and subsequent guidance will become a major test point. From the current trend, since the dollar has weakened since April, corresponding to the entire second quarter, a certain judgment is that due to the dollar's depreciation (overall depreciation of 7% during the second quarter), technology stocks with high overseas revenue proportions (most U.S. tech stocks covered by Dolphin Research have overseas revenue proportions between 30-50%) will have a definite boost when converting non-dollar revenue into dollars, providing effective support for performance with a boost of around three percentage points.

However, for consumer companies primarily focused on the U.S. domestic market, whether in service consumption or goods consumption, the recent macro trend shows a relatively weak state. Whether they can deliver performance exceeding market expectations remains a question mark.

U.S. Debt Drain: After the "Big Beautiful Act" passed, the debt ceiling increased by $5 trillion. The Treasury will soon face the issue of fiscal debt issuance because the current Treasury General Account (TGA) has only $310 billion left, far below the reasonable level of $750-850 billion, struggling to meet daily expenses.

According to the Treasury's plan: financing will be done through issuing 4, 6, and 8-week Treasury bills , raising the TGA account balance to $500 billion by the end of July, and rebuilding to the normal level of $850 billion by the end of September.

In other words, under high interest rates, the Treasury led by Besant is essentially using short-term financing methods to supplement cash ammunition, but the pace is slightly more moderate. In the short term, with only half of July left, raising the balance to $500 billion by the end of July means net issuance of $200 billion in short-term bills in the remaining half month.

On the liability side of the Federal Reserve, it is likely to correspond to a decrease in bank deposit reserves or a decrease in the Federal Reserve's reverse repo balance. The reverse repo balance can be understood as extra liquidity placed at the Federal Reserve earning low interest, releasing it helps activate the real economy. However, the decrease in bank deposit reserves has generally corresponded to a correction in the S&P 500 since the pandemic.

Currently, the structure of the Federal Reserve's liability side significantly exceeds pre-pandemic levels, indeed with reverse repo balances and bank reserves. Solely reducing the reverse repo balance (proportion falling back to pre-pandemic levels) can provide about $200 billion, just enough to meet the $500 billion target by the end of July.

However, if the rebuilding by the end of July relies entirely on the reverse repo balance, then rebuilding to $850 billion by September (net absorption of $350 billion in liquidity) can only rely on bank reserves as the main supplement, and its reduction is likely to exert considerable pressure on stock prices.

The actual result is likely to be that the first half of the rebuilding primarily consumes the reverse repo balance, and the rebuilding in August and September, after the U.S. stock second-quarter earnings season ends, will primarily rely on bank reserves.

At that time, if the fundamentals presented during the U.S. stock earnings season, especially the performance outlook, are not strong enough, coupled with liquidity shocks, under current high valuations, there will still be significant downward pressure, and the only potential hedge might be an unexpected rate cut by the Federal Reserve.

In other words, for the upcoming U.S. stock market, without an unexpected rate cut by the Federal Reserve, the likely direction is either hovering at high levels or leaning downward, with the outlook not optimistic.

3. Portfolio Returns

Last week, the virtual portfolio Alpha Dolphin of Dolphin Research did not adjust positions, with a weekly movement of 0.2%, underperforming the observed market—CSI 300 (+0.8%), Hang Seng Tech (+0.6%), MSCI China (+0.8%), slightly outperforming the S&P 500 (-0.3%).

Since the portfolio began testing (March 25, 2022) until last weekend, the absolute return of the portfolio is 91.3%, with an excess return of 88.2% compared to MSCI China. From the perspective of asset net value, Dolphin Research's initial virtual asset of $100 million has exceeded $194 million as of last weekend.

4. Contribution of Individual Stocks to Gains and Losses

Last week, Dolphin Research's virtual portfolio Alpha Dolphin underperformed the U.S. stock index mainly due to the pullback of heavy-weight stocks TSMC and NetEase, with recent position growth overall in a stagnant state. However, the positions are not high, and adjustments will be made in real-time based on earnings reports and the impact of short-term debt issuance on the asset market.

The main explanations for the rise and fall are as follows:

5. Asset Portfolio Distribution

The Alpha Dolphin virtual portfolio holds a total of 18 individual stocks and equity ETFs, with 7 standard allocations and the rest underweighted. Assets outside of equity are mainly distributed in gold, U.S. debt, and U.S. cash, with the current ratio between equity assets and defensive assets like gold/U.S. debt/cash being approximately 53:47.

As of last weekend, the asset allocation distribution and equity asset holding weights of Alpha Dolphin are as follows:

6. Key Events This Week

Starting this week, U.S. stocks will officially enter the earnings season, with semiconductor companies ASML and TSMC leading the way, and subscription model king Netflix also announcing its second-quarter results. These three are the key focus of Dolphin Research. Especially as semiconductors officially enter the performance realization period, the outlook and expectations are very important, and are the key focus of this quarter's earnings reports.

The important focus points of these three companies' earnings reports are organized by Dolphin Research as follows: