(Yicai) Aug. 15 -- An interest rate cut by the US Federal Reserve is not going to significantly change conditions in the US economy and will not prevent a downturn, said a chief strategist at Canadian investment research firm BCA Research after weak employment data led to a sharp drop in the country’s stock markets this month and raised expectations of a rate cut by the Fed.

There are cracks in the US economy, which means low-income households have begun to spend less, setting off a chain reaction whereby companies are making less profit and are letting staff go, Arthur Budaghyan, BCA's chief strategist for China investment strategy and emerging markets strategy, told Yicai. But an interest rate cut by the Fed cannot change this situation.

The US stock market has peaked and a bear market will form soon, Budaghyan said. Tech stocks are seriously overvalued and will come down significantly in the medium-term. The US dollar, though, should stay strong this year, he added.

Excerpts from the interview are given below:

Yicai: Could you please share your thoughts on the state of the US economy this year? What do you think about market concerns that the US economy is overblown? And which key indicators are you using to make this judgment?

Arthur Budaghyan: Cracks have opened in the US economy. And these cracks start with low income consumers. There is plenty of data showing that low income people in the US are struggling. They are starting to default on loans, on auto loans, on credit card loans. They are going to cut spending at some point. As low income people reduce spending, more companies will suffer, their profits will contract and they will start laying off people, both low income people and middle income employees.

So as the cracks spread from low income to middle income, middle income people will start spending less and saving more. So this kind of weakness in the US economy will widen. Although the cracks are still very small, they are going to expand over the next six to nine months. I think the US economy will slow down considerably.

I think the economy will be much weaker by the end of this year. Will the GDP technically be negative? I don't know, that’s why I don’t use the word “recession.” But even real GDP growth is technically not a recession, but it will feel like a recession, because corporate profits will contract, and the unemployment rate will go up.

Yicai: Will a rate cut change the situation?

AB: No, I don't think a rate cut by the Fed is going to change the situation. It might change the situation for one or two weeks, but not more than that. I believe a rate cut will “buy the rumor, sell the news.” Markets were betting on the Fed to trim rates two years ago and it never did. But I think in September the Fed will do so. But I don't think it's going to make a big difference for the market, because interest rates are still very high. Even if they trim by 25 basis points or 50 bps or 75 bps, interest rates still will be very high and restrictive for the economy.

So I don't think the Fed will cut interest rates fast enough or by a large enough amount for the economy to avoid this major slowdown that I'm talking about.

Yicai: You said that US stocks are expensive and overvalued. Do you think this overvaluation is only in tech stocks, or is it more widespread?

AB: It's more widespread, but non-tech stocks are not as overvalued as tech stocks. I would say that tech stocks are very overvalued and non-tech stocks are moderately overvalued. But overall, the US market is significantly overvalued.

Yicai: The US stock market could soon reach a peak and form a bear market, as you mentioned in the report. What factors do you think will determine the timing of this peak and how long would the bear market last?

AB: It's very hard to time these things precisely. I think the US stock market peaked in the middle of July. I don't think the rebound that we are seeing now will move above that level. When will the bear market start? It's hard to know. The timing of it is impossible. But I think if we look at the stock market at the end of this year, it will be considerably lower than today.

I think the key message from me is that for investors with a medium-term horizon, which is six to nine months, stock prices will be meaningfully lower than today.

Yicai: Do you think a potential interest rate cut could delay the coming of a bear market or make the decline smaller?

AB: As I said, if the Fed cuts interest rates starting September, it is not going to change conditions in the US economy over the next 6 months. Because remember, monetary policy works with a time lag and the Fed has been hiking for more than two years and the US economy is still strong.

So the same will happen on the downside. If the US economy slows down, even if the Fed trims rates, it will take time until it impacts the economy. So I believe the Fed will start lowering rates in September, but the economy will not show any sign of benefiting from these cuts until the middle of next year.

Yicai: What’s your view on the US dollar? Given the current situation, do you think emerging market stocks and bonds could become more attractive investment options?

AB: I’m bullish on the US dollar until the end of the year. I think the US dollar will continue to strengthen until then, but I don’t have a strong view on its performance next year.

Emerging market stocks and bonds are typically inversely correlated with the dollar, meaning they tend to move in the opposite direction. If the dollar remains strong, then emerging market stocks and bonds are unlikely to perform well. However, if the dollar changes course, which might happen next year, emerging markets could become a very interesting investment option. For now, I’m not changing my underweight, negative stance on emerging markets, but if my view on the dollar shifts next year, I may consider a scenario where emerging market stocks and bonds could perform well.

Editors: Dou Shicong, Kim Taylor