Cinda: Style and Industry Allocation Patterns in the Downward Cycle of US-China Interest Rates

Cinda released a research report stating that interest rates have a limited overall impact on the market. In terms of A-shares, interest rates are not the core factor affecting style changes. At the peak inflection point, interest rates are usually short-term positive for growth, while at the bottom inflection point, they are usually short-term positive for value. The core factor influencing the style change between growth and value is the comparative advantage in profitability, while the core factor influencing the change between large and small caps is fund behavior. In terms of the US stock market, long-term declining interest rates over a 40-year period are positive for growth, but the impact of short-term declining interest rates on style is limited. In addition, for certain interest rate-sensitive assets, interest rate declines are not usually the sole determining factor for excess returns, with industry alpha having a more significant impact on sector excess returns. For A-shares, interest rates are not the core factor affecting style changes. Cinda believes that the core factor influencing the switch between growth and value styles is the comparative advantage in profitability, while the core factor influencing the switch between large and small caps is fund behavior. Interest rate declines typically do not affect the trend of growth and value styles over 2-3 years and large and small cap styles over 5-8 years. However, in the six months after a decline in interest rates, the growth style usually becomes more dominant, while in the six months after a rebound from the bottom interest rate point, the value style may become more dominant. Since 2008, the probability of small cap style dominance during interest rate declines is 4/6. In the US stock market, long-term declining interest rates over a 40-year period are positive for growth, but the impact of short-term declining interest rates on style is limited. The probability of a turning point for growth, value, and large and small cap styles is around 50% near the inflection point of a short-term decline in interest rates. For certain interest rate-sensitive assets, interest rate declines are not necessarily the sole determining factor for excess returns, with industry alpha having a more significant impact on sector excess returns. (1) During an interest rate decline, dividend stocks do not necessarily show continued strength in excess returns, with utility stocks in the power and water sector being relatively noteworthy due to their long-term high dividend yields. The dividend index behaves similarly to short to intermediate bonds, with limited excess returns during historical periods of declining 10-year government bond rates. Since 2014, the excess returns of the dividend strategy have shown stable synchronous fluctuations with the 10-year US bond rate. Utility stocks, due to their perpetual operational conditions, stable profitability, ample cash flow, and long-term mid-high dividend yields, exhibit characteristics similar to long-term bonds, performing well during periods of declining risk-free rates. (2) In the early and late stages of an interest rate decline, bank stocks may have excess returns. Excess returns in the banking sector tend to occur in the early and late stages of an interest rate decline, with excess returns typically weaker during the mid-term of an interest rate decline. Credit risk exposure in the banking sector has a lagging effect, and if short-term credit risks are gradually controlled during an interest rate decline, excess returns may occur. (3) An interest rate decline has a certain impact on the profitability of insurance and cyclical sectors, but industry alpha is more important. In theory, an interest rate decline affects the profitability of the insurance sector, but if the industry has a strong industry alpha, it may counteract the impact of the interest rate decline. The insurance sector performs very well during an upward interest rate phase and may benefit from small excess returns during a declining interest rate phase due to the equity market beta. If the industry alpha is weak, the sector may perform poorly during an upward interest rate phase. Historically, cyclical sectors have had weak performance during periods of declining interest rates, but there may be long-term industry structure improvements from 2021-2024. The probability of a style change occurring after the first interest rate cut by the Federal Reserve is around 4/6. The turning point for changes in style between growth and value usually occurs within a year before the first interest rate cut by the Federal Reserve, and for growth and value styles, the turning point usually occurs within a year after the first interest rate cut. In the four interest rate cutting cycles by the Federal Reserve since 1995, if the economy experiences a soft landing, the S&P 500 typically continues to rise within a year after the first interest rate cut. If there are significant downturn risks in the economy, the majority of the time the S&P 500 falls within a year after the first interest rate cut. In a soft landing scenario with an interest rate cut, within a quarter after the first interest rate cut, the healthcare, utilities, and financial sectors show strong excess returns, with healthcare continuing to show strong excess returns within a year. In a scenario with a significant economic downturn and an interest rate cut, the utilities sector typically performs well within a quarter after the first interest rate cut, and commodities and core consumption sectors show continued strong excess returns within a year.