Good morning. Its Jenn Hughes standing in for Rob today. When even a fifth consecutive blowout quarter and share jump from Nvidia can’t hold up the broader market, it suggests investors are casting about elsewhere for their next AI-related bets. Got ideas? Email me: jennifer.hughes@ft.com.

A quick programming note: There will be no Unhedged on Monday, but Rob will be back in your inboxes next week.

What now?

There was a back-to-school feeling to stock markets yesterday. After weeks in which it’s been about the next big earnings report and the anticipation of fresh information, Nvidia’s blasting past bullish expectations on Wednesday marks the end of the headliners.

When even a 9 per cent rally for Nvidia can’t encourage a daily gain for the S&P 500, it’s time for investors to hit the books again in search of fresh drivers for a market that, despite new record highs this week, feels uneasy.

Sure, market gauges don’t obviously suggest jitters — but bear with me.

Volatility nudged off lows during Thursday’s market slide, but with the Vix around 13, it is still extremely low.

If Wall Street’s fear gauge isn’t fearful, why should I think there are jitters out there? Take IPOs. Vix at 13 and stocks near record highs should in theory have tempted a steadier stream of companies to launch initial public offerings than we’ve seen in recent weeks. June and July have a heavier listings calendar, bankers say, but the fact that wannabe market darlings have held back during earnings season implies a degree of nervousness.

It’s not just stocks that look calm, either — bond volatility as measured by ICE’s MOVE index, below, is at its lowest since the Fed began raising rates.

MOVE at these levels roughly implies daily changes in yields of 0.05 percentage points, down from about 0.08 percentage points last year. In bond world, that’s a return to something more normal, which should in theory help stocks by easing the risk of being whipsawed by outsized yield swings. Perhaps it’s a background support to stocks but even with the threat of interest rate rises receding, bonds don’t seem to have as much power to boost stocks as they did to hurt them last year.

Then there are the overall earnings that have been reported. By a pre-Nvidia count from Bank of America strategists, on average, companies have beaten analyst expectations by 7 per cent. That’s the biggest gap, or beat, since the US was emerging from the pandemic.

But were those beats down to a great performance, or ground-down analysts having grown too gloomy? It might be more the latter.

Nine months back, Q1 earnings per share for S&P 500 stocks were expected to have risen 9 per cent year on year, according to JPMorgan. That was cut heavily as this season neared, only for companies to actually produce about 6 per cent in the end. So better than feared, but not enough, it seems, to instil investors with fresh confidence.

Early last month, Rob wondered in this newsletter why analysts weren’t being more bullish given the unexpectedly strong economy. He feared it was because their bottom-up models factored in potential nasties that were hidden by a more general, macro view of corporate profitability.

The way stocks are trading, he’s not alone in wondering what lurks beneath.

When dragons roar

There’s always a point when the pain in a trade switches from the longs to the shorts. Not many people predicted anything good from China this year. Yet the Hang Seng China Enterprises index is up 16 per cent this year matching Japan, an international market darling. That makes the world’s second-largest economy and second-largest market harder to ignore.

Is this the year of the particularly auspicious fire dragon writ large? Or a large, dead cat bouncing? 

Sitting in New York as presidential election campaigns gear up, it’s hard to feel fired up. Last week’s decision by President Joe Biden to slap an additional $18bn of tariffs on Chinese goods reignited debate over whether Washington was “de-risking” (the administration’s phrase) its relationship with its rival, or targeting a harsher economic decoupling. 

“It’s about the risk you want,” says one senior investment banker. “If you have growth in the US and a bounceback under way in Europe and Japan, why put money in China with so much geopolitical risk?”

For those who can stomach the political angle, it also depends on how you want to measure Chinese performance. The HSCEI, which tracks mainland companies listed in Hong Kong, is a handy gauge of international sentiment towards China. Its also a better reason to write about China than the mainland blue-chip CSI 300 (pink line), which is lagging Europe (brown) for performance this year.

History suggests there’s more to come in the HSCEI’s rally. HSBC’s head of Asia-Pacific equity strategy, Herald van der Linde, counts 12 occasions since 2000 when the index has gained 30 per cent in less than five months — and then added another 27 per cent on average over the following four months. 

Interestingly, the HSCEI is outperforming the MSCI China, which is so often the index of choice for international investors. Since the latter is made up of Chinese listings in Hong Kong and New York as well as the mainland, its heavy with tech and internet names and views on those are mixed.

What are doing particularly well however, are Chinese banks, and that’s unusual. China’s lenders have long been seen as sluggish state-directed institutions. Despite the rally, not one of its four mega-banks is valued at 60 per cent of its year-end forecast book value (HSBC: 93 per cent, for reference).

Yet JPMorgan strategists this week ranked China Financials number two in terms of sectors enjoying increases in long-only investor allocations this year in Asia, outside Japan (Korean tech topped that ranking).

The brown line shows mainland bank stocks, which have been relatively steady gainers — particularly compared with the troubled property sector (grey) with which they’re entangled. But the standout is the Stock Connect banks index (green) — that is, Chinese bank stocks in Hong Kong that mainlanders can buy via the system that links Hong Kong with the Shanghai and Shenzhen exchanges.

Betting on Chinese banks is a bold trade when Beijing’s new measures announced last week to end a years-long property slump were met with shrugs. Geopolitics are also limiting international investor interest in the country as a whole.

“Think of it as CCP (Chinese Communist party) credit risk with a 6 per cent dividend yield,” advises one Hong Kong financier.

If mainland money is getting interested in yieldy bank stocks, that could go some way to pushing the market higher for others prepared to take the risk.

One good read

Demographic problems are more widespread, and deeper, than many think.

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