Budding Volatility Amidst Virus Variants and Chinese Regulation
Market volatility perked up again in July as sentiment has fluctuated between extremes. Generally favorable corporate earnings and low rates have helped propel equity markets to new highs, while worries about new virus strains and the Chinese government’s crackdown on private companies have been a shot across the bow of the global economic recovery narrative.
In China, the government has accelerated its pressure on the technology sector. The notable escalation began in November when the Chinese government blocked the IPO for Ant Financial, the digital payment platform started by Alibaba co-founder Jack Ma. This continued in recent weeks as government regulators barred China’s ride-hailing giant DiDi from app stores soon after its $73B IPO for “data security” reasons, and indicated that there would be greater scrutiny of companies listed on overseas exchanges. Conditions intensified further yesterday when Chinese state-media attacked online gaming, likening it to “spiritual opium”, which consequently sent the sector tumbling. These coordinated steps reminded investors of the fundamental differences in U.S./China views on markets and have given U.S. investors pause. JPMorgan CEO Jamie Dimon commented that he’s likely to make business decisions in China differently in the wake of the recent events and SEC Chair Gary Gensler noted that he remains “concerned” that American investors may not be getting enough information about Chinese companies listed on U.S. exchanges. The actions taken by the Chinese government have roiled emerging markets broadly as China represents the largest proportion in most emerging markets funds, and it presents a significant contagion risk for emerging markets broadly should this pressure persist.
Last week’s FOMC rate decision and press conference didn’t present the market with any surprises. The vote to hold rates steady was unanimous and they remain committed to achieving their dual-mandate targets of maximum employment and inflation at 2% over the longer run. The FOMC statement acknowledged that the economy has made progress toward the goal of maximum employment and price stability. The assessment of inflation was unchanged as “largely reflecting transitory factors.” They maintained the current pace of asset purchases and Fed Chair Powell indicated that the subject of tapering those purchases had come up, and that discussions will continue at coming meetings.
The strength and resilience of the Treasury market in conjunction with record highs for stocks and multi-year high CPI data is noteworthy. Risk-free real yields in dollars are the lowest on record meaning investors lending to the U.S. government can expect to lose money on an inflation-adjusted basis. This move has driven global negative debt back above $16 Trillion, and while this rate environment is highly advantageous if you’re a borrower, (as evidenced by companies flooding the debt markets to lock in cheap financing for the long-term, like Apple issuing $6.5B in new debt last week), it continues to be problematic for investors.
As a whole, corporate earnings have exceeded expectations and provided validity to a broader economic rebound. One metric to keep an eye however is earnings guidance. According to Bloomberg nearly one third of companies that have reported so far this quarter have lowered their estimates. If this trend continues this could prove to be a greater cause for concern in a market with stretched multiples, and could present a backdrop for further volatility. Overall, we remain constructive on risk assets for the balance of 2021 as the thesis of gradually improving economic fundamentals and accommodative monetary and fiscal policy remains intact.
Ryan Babeuf, CFA
Market Strategist
Ryan.Babeuf@EdgeWealth.com
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