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The monetary fog is lifting

Market analysis - 9/8/2017

This week’s economic data provided confirmation that the synchronised global recovery was doing well but it was the ECB’s monetary committee meeting that dominated news. The press conference held no big surprises but delivered more detail.

The bank has slightly revised up its economic outlook and revised down inflation. Even so, Mario Draghi was quite clear that tapering might be announced at the next meeting unless some exceptional event occurred. This is in spite of the bank’s increased scrutiny of the euro's volatility and its new forecast of inflation at 1.5% in 2019, or lower than its target. The news was more or less what investors were expecting but the euro still continued to strengthen while long bond yields eased further, highlighting the contradictory nature of the market’s initial reaction. At any rate, the ECB meeting left the recent trend of euro strength and falling bond yields intact, a pattern which has now moved beyond simple fundamentals. 

In the US, the resignation of Fed vice-chair Stanley Fischer left investors still unclear over future monetary policy. They are now factoring in less than one rate rise by the end of 2018, an assumption that strikes us as unusually low. Tepid inflation is still a source of concern but it is largely temporary and the US recovery is still on track. And comments from various Fed members show the committee is divided with William Dudley and Loretta Mester in favour of a hike and others like Lael Brainard against a move while Robert Kaplan is still undecided. True, the bank’s outlook is clouded by the looming board reshuffle as Janet Yellen’s mandate runs out in 5 months. 

In the current situation, we are sticking with our asset allocation decision to be reasonably overweight equities with a focus on the eurozone and, to a lesser extent, on Japan. Recent long bond and US dollar movements look overdone to us but we have not yet changed our asset allocation breakdown apart from some tactical shifts in certain portfolios. 

  European equities

European markets overall trod water ahead of last Thursday’s ECB meeting but ended the period slightly lower due to persistent tension between North Korea and the US.

Mario Draghi pushed any decision on tapering back to next month’s meeting but took care to distinguish tapering from rate rises, insisting that there would be a prolonged transition period. The bank revised down its inflation forecasts for 2018 and 2019 and the euro rallied against the US dollar, even breaking through 1.20 again and fuelling a sharp fall in long bond yields.

Inevitably, financials were hit, and banks in particular. Autos, however, stood out after LMC Automotives said August car sales had risen 4.9% over 12 months in the eurozone thanks to strong demand in France, Spain and Italy. The figures were better than expected and augur well for the future. Renault, which is to unveil a new concept car as part of a new range at the Frankfurt show, also rose on rumours that the French government was thinking of selling its stake. That would allow management to restructure the group without any government meddling. The rumours followed the government's decision to sell 4.15% of Engie.

In M&A news, Schneider Electric’s third attempt to acquire IT company Aveva was successful and the price tag is £3bn. Schneider’s software division (20% of sales) is expected to be merged with Aveva, creating a new company listed in London which will be 60% owned by Schneider and consolidated as part of its Industry division. Elsewhere, Altran is reportedly close to buying Global Edge, a product engineering company active in India and the US. Altran also released robust results with an improvement in its operating margin which makes its 2020 objectives credible. 

  US equities

It was a week of contrasted data. Non-farm payrolls came in at 156,000 or well below the 180,000 expected while manufacturing ISM pleasantly surprised everyone by hitting 58.8; its highest level since 2011. The S&P edged 0.5% lower over the period due to geopolitical tensions. Stanley Fischer’s resignation from the Fed’s board had little impact. Nor did the agreement with Democrats to put off the debt ceiling problem for a further 3 months.

Elsewhere, the euro added another 1.6% to its inexorable rise against the US dollar. The dollar is beset by geopolitical concerns, the potential impact of hurricanes and also the resignation of Stanley Fischer, one of the Fed’s most orthodox members. This all caused risk aversion to return and demand for 10-year Treasury bonds sent the yield down to 2.02%, its lowest level since November 2016. This triggered sector rotation out of financials and telecoms and into sectors like technology and consumer staples which are seen as offering long duration.

Comcast plunged 6% on management comments and the entire sector came under pressure. The cable giant said that it could lose as many as 150,000 subscribers this quarter due to intense competition from traditional players like AT&T and Verizon as well as from alternative video platforms like Hulu. Earlier in the week, news emerged that Facebook had tried to acquire TV rights for $600m, a sign that it was really keen to move seriously into content broadcasting. As a result, last Thursday alone, the media sector lost more than $25bn in market cap.

Over the last 5 trading sessions, energy and healthcare chalked up the biggest gains. Telecoms and financials both lost more than 3%. 

  Japanese equities

The TOPIX declined 1.3% over the week. The market was initially relatively weak but gained ground after Wall Street rebounded on Wednesday and the yen weakened against the US dollar. Nevertheless, upside was capped by lingering concerns over geopolitical tensions in North Korea, ahead of its national Day of the Foundation of the Republic. Export oriented stocks were buoyant thanks to the weaker yen.

By sector, the best performers for the week were Machinery (+0.5%) and Mining (+0.4%). Komatsu advanced 4.9% due to expectations of strong reconstruction demand in refineries hit by the hurricane in the US. Auto makers such as Suzuki (+3.6%) and Toyota (+0.9%) were relatively strong on the weaker currency.

In contrast, Securities & Commodity Futures (-3.9%) and Marine Transportation (-3.8%) both lost ground. Nomura, the largest brokerage house, fell to a year low (-5.5%), followed by other financial institutions such as Tokyo Marine (-3.4%) and Resona Holdings (-3.1%). 

  Emerging markets

Apart from the geopolitical scene, it was a quiet week in Asia. 3SBIO’s acquisition of Therapure’s contract development and manufacturing business at an estimated maximum price of $297.9m (implied FY16 EV/EBITDA of 16 times) is a perfect example of Chinese efforts to move up in the value chain quickly. The acquired business currently serves over 20 clients with thirty ongoing projects and backlog contracts of over CA$400m up to 2020. It will strengthen 3SBIO’s R&D capability.

By the end of 2017, the South Korean government will announce revised regulations on lower interest rates on overdue payments and will tighten regulation on mortgages in mid-September. Korean banks were under pressure this week. Geopolitical tensions between China and Korea are hitting Korean cosmetic companies where there is a lower limit on purchasing cosmetic brands in duty free shops.

In Latin America, we continue to see encouraging signs of economic improvements. In Brazil : with inflation at an all-time low (2.46% in August), the central bank cut its Selic rate further by 100bp to 8.25%. Lower inflation is significantly improving purchasing power for Brazilian consumers. The IBOV is near its all-time highs in local currency terms.

Similarly, in Mexico, consumption of national goods and services rose 3.2% YoY as inflation is under control and boosting real wages. However, gross fixed investment fell 1% YoY in the second quarter.

With China going up in the value chain, lower inflation giving back purchasing power to the Brazilian and Mexican consumers and structural reforms in India and Brazil, we remain upbeat on emerging market equities. 

  Commodities

The gold ounce broke above $1,350 at the end of the week, its highest level since August 2016. It has gained 12% since July 10 due to (i) North Korea’s H-bomb test last weekend, (ii) the accelerating fall of the US dollar (now back to January 2015 lows against the euro and on the DXY index) and (iii) declining US Treasury yields. Concerns over low inflation could make the Fed put off the next rate hike and that would provide further support for gold. Gold last broke through $1,400/oz in 2013 but that was on the way down. It is now around 3% off this psychological barrier.

Over the short term, gold looks a bit overbought, mainly due to the non-stop rise in Comex traders’ long positions in the last 7 weeks, but a significant correction looks unlikely unless geopolitical tensions suddenly evaporate. 

As expected, Hurricane Harvey seriously disrupted oil fields when it hit Texas. However, oil rigs in the Gulf of Mexico and onshore sites have restarted production fast than refineries where 8% of US capacity is still out of action. Refinery utilisation rates in PADD 3 districts (i.e. those bordering the Gulf of Mexico) were only 63%, down from 96% in the previous week. This has disrupted weekly inventory data, especially as import/export figures have been hit by reduced activity in certain ports. DoE data showed crude oil inventories rising by 4.6m barrels, the first rise since June and only the second since the end of March. Petrol and distillate inventories fell by 3.2m and 1.4m barrels respectively. 

  Corporate debt

 

Credit

The week saw the new issues market reopen for business and Mario Draghi's press conference after the ECB’s monetary committee meeting. 

In the high yield segment, Kronos (chemical products, B2) raised €400m at 3.75% over 8 years NC3 to refinance a syndicated loan. Equinix (data centres and global infrastructure hosting) raised €1bn over 8 years NC3 at 2.875% (BB). Spain’s Cortefiel (retail) raised €600m (split between a fixed rate 7 NC2 bond and a FRN 7 years NC1 bond) at 5% to refinance a senior loan. 

In financial debt, Julius Baer sold a US dollar-denominated Tier 1 bond and Nationwide issued sterling denominated Core Capital Deferred Shares (CCDS). 

Convertibles 

We had busy first week of September in new convertible issuance. Serial issuer Qiagen (molecular diagnostics, next generation sequencing and life sciences), raised $400m at 0.5% with a 2023 convertible, simultaneously hedging the transaction with a call spread. Another deal in the region came from Capital Stage, a solar and wind farms operator, that raised €100m at 5.25% with a perpetual subordinated convertible (callable 2023) to finance capex. In the US, NextEra Energy, a renewable energy company, issued a $300m1.5% 2020 convertible. In Japan, electric parts manufacturer Hosiden issued a Y10bn zero coupon 2024 convertible to fund capex. 

In earnings news, Finisar reported quarterly results in line with expectations but its second quarter revenue guidance of $322-342m was weaker than expected. This was due to softness in Telco end markets, especially in China, and a delay in the ramp up of 3-D sensor production.

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