Earnings season kicks off, will there be another market shift between China and the United States?

For the past week, there are two major issues that the market is most concerned about: a. What is China's fiscal policy like? b. When will the US Treasury bonds stop falling? Let's take a look at them separately here.

I. Is the US Inflation "Indian Summer" Coming?

As of the economic data released in September in the United States, not only did the PMI and employment data greatly exceed market expectations, but the market is very concerned that the combination of a US rate cut and Chinese stimulus may lead to a secondary global inflation. Last week, the September inflation data released by the United States seemed to show signs of an "Indian Summer".

Although the overall CPI only increased by 0.18% month-on-month, which is basically in line with the previous month, the core CPI exceeded the caution line of 0.25% month-on-month, reaching 0.31%. Such core inflation indicates that the US's story of resisting inflation has basically turned a new page, which is quite embarrassing.

If we look closely at the factors causing core inflation, it is not the previous housing crisis, but the medical services and transportation services within the core services. Prices of doctors and medical insurance services in the medical services sector have increased significantly; and within the entire transportation services sector, prices of car rentals, car repairs, car insurance, car registration, and parking fees have all surged, while air tickets, which were already rising in August, continue to rise. It is very strange that prices in the transportation services sector are soaring while fuel costs are continuously declining.

This scenario is very similar to the one at the beginning of the year, where a similar pattern emerged: CPI stagnated, then prices of cars and medical insurance soared, and CPI quickly rebounded. However, this time, there are signs of price increases driven by some labor shortages in the supply chain, such as in medical services.

This is probably the main factor leading to the rapid rise of the 10-year US Treasury yield to above 4%. However, an interesting point here is that during this inflationary process, the growth in borrowing behavior of residents and businesses is not significant, and is even slowing down further. This means that the current 50 basis point rate cut has not stimulated residents to leverage up, and the rate cut has not led to increased borrowing by residents and businesses.

Therefore, although this upward trend in CPI seems to be supported by employment and wage data, Dolphin Jun is skeptical about how far the government bond yields can rise this time

II. Chinese Assets: Third Quarter Performance Faster than Policy Implementation

For domestic assets, the market's expectations exceed monetary policy. Whether the policy can shift from the supply side to the demand side, the extent of policy measures to reverse deflation expectations, and how strong the market hopes to see answers.

However, from the results, the attitude is very positive, but the specific quantity for 2025 is still unclear. It will have to wait for subsequent National People's Congress meetings and the annual Central Economic Work Conference. Although the shift in 2025 is not very clear yet, it is clear that in the weak economic performance of the second and third quarters, efforts will be made in the fourth quarter to maintain the annual 5% growth target. At least the fourth quarter is unlikely to be worse than the third quarter.

Therefore, the short-term contradictions in Chinese asset investment are very clear:

a. The third-quarter financial reports of Chinese assets are imminent. Currently, the forward-looking statements given by major companies for the third quarter are generally flat. Due to the weak macroeconomic performance in the third quarter, individual stocks may not outperform their performance alpha, which is normal. Currently, major companies do not have a very clear outlook for the fourth quarter. This means that there may be very few companies that can surprise in terms of overall performance in the third quarter, especially given the current situation of already restored valuations.

b. With individual stocks unwilling to provide guidance on fourth-quarter performance and policies intending to make efforts in the fourth quarter to maintain the 5% economic growth target for the year, the subsequent rebound of overseas Chinese assets still depends on whether macroeconomic data can improve. Key observations include PPI, credit and social financing, household deleveraging, and price trends.

However, overall, with the third-quarter performance about to be released and valuations already restored, Dolphin believes that the short-term opportunities for Chinese concept stocks are not significant. Therefore, as the earnings season approaches, positions were significantly reduced last week (for details, please refer to 《Returning to Basics, Can Chinese Concepts Escape the Bottom Curse?》), and close attention is being paid to the improvement of subsequent economic data and year-end fiscal policies.

III. Portfolio Returns

Since the start of testing the portfolio (March 25, 2022) until last weekend, the absolute return of the portfolio is 72%, with an excess return compared to MSCI China of 6%. From the perspective of asset net worth, Dolphin initially had a virtual asset of USD 100 million, which exceeded USD 170 million by last weekend.

IV. Portfolio Asset Returns

In the week of October 12th, the Alpha Dolphin virtual portfolio's returns declined by 2.3%, underperforming the S&P 500 index but outperforming the CSI 300 (-3.3%), Hang Seng Tech Index (-9.4%), and MSCI China (-7%). This was mainly due to Dolphin Jun reducing the allocation of Chinese assets, leading to a relative increase in US stock weight, offsetting the impact of the decline in Chinese concept stocks.

Since the start of the portfolio testing on March 25, 2022, until last weekend, the portfolio has achieved an absolute return of 68%, with a 72% return relative to MSCI China. From a net asset perspective, Dolphin Jun's initial virtual assets of $100 million have now grown to $170 million.

V. Individual Stock Profit and Loss Contribution

Last week, Dolphin Jun's holdings fluctuated, mainly driven by a significant pullback in Chinese concept assets and the relative strength of US stock AI assets, with the decline in Chinese concept stocks being the main factor. The specific reasons for the rise and fall of the holdings and observation positions are as follows:

Swzdwcx

VI. Asset Allocation

The Alpha Dolphin virtual portfolio holds a total of 14 individual stocks and equity ETFs, with 3 core holdings and 8 equity assets underweighted. The rest are distributed in gold, US bonds, and US dollar cash. As of last weekend, the asset allocation and equity asset holding weights of Alpha Dolphin are as follows:

VII. Key Events This Week

This week marks the official start of the third-quarter earnings season for US stocks, with semiconductor giants ASML and TSMC leading the way. Their reports may provide insights into the recent semiconductor rally. Additionally, Netflix's prolonged upward cycle raises questions about intensified content competition in the second half of the year. Moreover, as a major player in the recent ChiNext rally, CATL's performance in the third quarter will be closely watched to see if it can support such a significant increase.