Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
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Head of Fixed Income Strategy
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Earnings Watch, rally dynamics, and Chinese gaming restrictions
Peter Garnry
Chief Investment Strategist
Summary: In today's equity note we take a look at earnings this week from Fortescue Metals Group, Zoom, Meituan, and NetEase, with the latter two defying investors' nervousness over the potential impact from the ongoing changes of regulation in China of the private sector. The MSCI World has been on a remarkable run this year shrugging off everything and the current rally is now the second-longest since 1999 in terms of having a drawdown of 5% or less. These type of rallies have all the ingredients to end abruptly under the right conditions.
The earnings season has tapered off, but this week’s earnings have still been interesting. Take Fortesque Metals Group reporting yesterday annual (ending 30 June 2021) adjusted net income of $10.3bn, which is more than NVIDIA’s $7.1bn and on par with Visa’s $10.9bn. Keep in mind that this is for digging iron ore out of the ground, the lowest global value chain business activity. While iron ore prices are expected to ease somewhat, the Australian miner is still valued at a 2-year forward free cash flow yield of 10%. Whether it is the ESG trend that is causing this valuation, it is grossly out of line with the reality of the green transformation and urbanization in the developing world.
Zoom Video Communications that rose to fame during the pandemic reported FY21 Q2 revenue and earnings that were better than expected, but the guidance for the current quarter was in line with analyst estimates. However, investors were disappointed sending the stock down 16% in today’s session showing growth investors that there is a limit after all for growth stocks. The main question for investors is still whether Video can expand its business as Microsoft is going after its business.
Meituan and NetEase rally on result despite regulation
Meituan reporting 1H result yesterday defied investors’ nervousness over the impact of Chinese regulation and objective of ‘Common Prosperity’ showing revenue above estimates but still operating at a loss. At the same time the company said publicly that it agreed with all the of the governments initiatives, but essentially also saying it do not know the impact on its business. The new data privacy law and the upcoming monopoly law are the two most important laws that could severely impact Meituan. Nevertheless, investors bid up shares in today’s Hong Kong session.
NetEase showed in today’s earnings release that for now its gaming business is not impacted with revenue in line with estimates, but the new Chinese gaming rule of three hours of gaming per week for minors will have a negative effect going forward. NetEase is getting 74% of its revenue from gaming and China could impose stricter rules on gaming for other age groups as well. Despite two good earnings reports from Meituan and NetEase, we most likely see a path going forward with more regulation as outlined in our recent research note on Chinese technology stocks. Global investors should expect more regulation and uncertainty until next year’s Party Congress in October 2022.
An unstoppable rally or not?
Global equities have defied everything this year from the Delta variant, more signs of inflation, a slowdown in China, the first rate hike in Asia, and a Fed preparing to taper bond purchases. The MSCI World is now in its second longest rally since 1999 with a drawdown of 5% of less with today’s session increasing the count to 216 trading days. This type of market dynamic tends to lead to position concentration, investors becoming blind of risks, and increased leverage. These dynamics tend to get unraveled in a forceful manner under the right conditions. We do not know what the trigger will be but with more countries in Asia under pressure from Covid-19 the world might experience even more supply issues forcing prices higher. In our recent research note on tail hedging portfolios with market makers we argue that market makers are worth considering as an alternative to long VIX futures or put options which both have negative expected value over time, whereas there are good arguments for why market makers come with positive expected returns and tail hedging characteristics. However, the recent comment from the SEC Chairman that banning ‘payment-for-order-flow’ is on the table in the current discussions about the US market structure, is a negative for Virtu operating in US markets whereas Flow Traders are less impacted. Hence why tail-hedging with market makers has to be diversified across both market makers.
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