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Fresh interest in Japan

Market analysis - 9/29/2017

Volatility remained under control despite mixed election results in Germany, the dissolution of Japan’s lower chamber, comments from Janet Yellen and Mario Draghi, persistently high geopolitical tensions and the US tax reform project. Only emerging markets were hit this week by US dollar strength and higher US rates. Angela Merkel’s election victory was less pronounced than expected and there will now be lengthy talks to create a coalition government. This uncertain climate sent the euro lower, helping European equities advance.

The movement was reinforced after Janet Yellen chose to focus her comments on the upbeat US economy and the pursuit of a gradual rise in interest rates. US yields rose on increased expectations of a December hike. Donald Trump's tax reform plan met with a cautious reaction from markets due to lack of detail on how tax cuts would be funded and the possibility of changes before the text is finally adopted. In Japan, however, equities were helped by Shinzo Abe’s decision to call early elections at the end of October and introduce a fresh stimulus package. 

This is partly why we have raised exposure to Japan. Company valuations there are cheap compared to other zones and Japan’s economy is improving amid persistently accommodating monetary policy. We are also still upbeat on eurozone equities. We remain cautious on government bonds in the US and the eurozone. 

  European equities

European equities continued to edge higher. Political visibility in German is now reduced but Janet Yellen’s determination to press on with rate hikes undoubtedly helped the up-trend. The next rate increase will be this year. Angela Merkel emerged victorious from Germany’s elections but with only 33%. Her previous coalition partner, the SPD, performed badly and decided to move into opposition. That will mean several months of haggling before the 3 remaining parties likely to form a new coalition reach an agreement. 

Company news centred on the merger between France’s Alstom and Germany’s Siemens to create a “Railbus”. Siemens will transfer its rolling stock and signalling businesses to Alstom and own 50% of the combined entity which is expected to have sales over €15bn and operating results around 1.2bn. Annual synergy gains of €470m are expected at the latest four years from now. Europe’s first railway consolidation attempt must now get the green light from Brussels. The new entity will help face up to the Chinese giant CRRC (€29bn in sales) which was the result of the 2014 merger between two state companies. 

In another big deal, ABB paid €2.6bn (1 time sales and 16 times EBITDA) for GE Industrial Solutions. This will help ABB reinforce its presence in electrification to become N° 2 in the world. Only a few days after the deal with Tata Steel, ThyssenKrupp lost no time and launched a 10% rights issue on Thursday. This will raise €1.4bn which will be used to fund organic growth in its industrial activities division- excluding steel- and to finance the restructuring of Steel Europe. 

Total was in reassuring mood at its investors’ day. Management said production would increase by 5% on average up to 2022 – it would only have risen 4% without the integration of Maersk’s assets- operating costs ex development have been almost halved and cash flow generation will allow the group to pay a wholly cash dividend from 2019 if the oil price sticks at $50. 

  US equities

In US dollars, the S&P500 edged 0.4% higher and the Nasdaq added 0.5% thanks to US Treasury yields rising to 2.3%, up from 2.2% at the beginning of the week, and a rebound in the oil price. Logically, energy and financials led gains while defensives suffered with utilities down 1% and property 0.6% lower. 

Macroeconomic data continued to point to strength in the US economy. Consumer confidence surveys remained at highs and durable goods orders came in better than expected. However, house sales fell short of estimates. 

Following Janet Yellen’s pro-growth statements, Donald Trump unveiled his "historic” tax reform plan which seeks to boost US corporate profitability and create more jobs. Corporation tax is to be reduced from 35% to 20%, tax brackets cut from 7 to 3 and the marginal income tax rate reduced from 39.6% to 35%. Investors are still unsure whether the President will be able to convince Republicans to finance these tax cuts but Gary Cohn, the White House’s economic advisor, tried to reassure them by saying growth would provide the means.

  Japanese equities

Over the week, the TOPIX gained 0.7%, bouncing back after two down sessions and hitting a year high on Wednesday. This followed Wall Street’s rise on the long-awaited release of Donald Trump’s corporation tax reduction plan, a move that helped the US dollar gain against the Yen.

Export stocks gained on the weaker Yen. Financials also gained ground due to the sharp rise in US long-term yields. However, market participants were unable to step up buying due to uncertainty over the upcoming Lower House election on October 22. Popular Tokyo Governor Yuriko Koike has launched a national “Party of Hope” and it has become a magnet for opposition party members seeking to run in the election.

By sector, the week’s best performers were Textiles & Apparels (+3.1%), Mining (+2.8%) and Glass & Ceramics Products (+2.4%). Dai-ichi Life advanced 4.9% as US interest rates rose for the second week in a row. Oil company Inpex also remained strong thanks to crude oil prices rising.

In contrast, Electric Power & Gas (-2.6%) and Marine Transportation (-1.2%) fell. Power companies like Kansai Electric Power (-5.4%) and Chubu Electric Power (-2.7%) ended the week lower.  

  Emerging markets

Emerging market currencies consolidated a little this week due to US tax reform proposals calling for tax cuts for business and individuals. The highlight was the Mexican peso and South African rand which lost 2.4% and 2% respectively.

In China, we observed some volatility in the property sector after the Government started the week by announcing some tightening measures in a number of cities. Elsewhere, Alibaba increased its stake from 47% to 51% in Cainiao, a logistics platform. Alibaba Culture & Entertainment announced the official launch of its game business and acquired Enjoy Information Technology.

In Asia, Apple’s chain fell on news that demand for iPhone 8/8+’s was weaker than expected. Nevertheless, the chain bounced back as local media reported iPhone X pre-orders looked better than expected. This came as no surprise as the iPhone X represents a big upgrade. We will have more accurate information on these pre-orders at the end of October.

In Brazil, the corruption case against President Temer will be voted in October, delaying pension fund reform to (we hope) November. Nevertheless, the economic team seems committed to continue deleveraging: BNDES is to pre-pay R$ 180bn to the National Treasury (thereby possibly reducing debt by 2.6%) and the privatisation of Congonhas airport has also been announced.

Department store Lojas Renner said third quarter same store sales should be in the low double digits, or above market expectations, due to a favourable base effect and a recovery in spending.

In Mexico, there was no interesting news from the second round of Nafta renegotiations. Mexico’s central bank kept interest rates unchanged at 7%. Sigma’s IPO was cancelled. 

In Argentina, the market continued its way up as President Macri talked about tax reduction for consumers and industrial production and GDP showed a strong figure in August (up 5%). 

  Commodities

Brent crude prices rose for the 5th week in a row. The rise was due to mounting Middle Eastern tension, this week the Iraqi Kurdistan referendum on independence, and the conclusions from the OPEC/non-OPEC meeting. Brent hit $57 or more than the start-of-year levels ($55-56) and even quoted $59 at the beginning of the week, a high since July 2015. WTI continued to lag at $51.5-52 compared to $53-54 back in January and February. 

The upward price momentum is warranted given last week’s change in sentiment which followed a clear improvement in fundamentals.

1/ The US rig count entered its 6th down week in a row. 

2/ Total US inventories of crude and products continued to fall although the data has been disrupted by hurricanes in the Gulf of Mexico and in Florida (US output is also back to normal). 

3/ Above all, tension in Iraqi Kurdistan is underpinning Brent crude prices. The region’s referendum on self-rule was opposed by Baghdad and neighbouring Turkey and Iran. The “yes” vote won easily but the region is all on its own: Iraq called for a boycott on Kurdistan oil and Tayyip Erdogan threatened to halt exports via Turkey, the transportation hub for exports to Europe. Each day, around 550,000 -600,000 barrels of Iraqi Kurdistan’s oil use a pipeline to the southern Turkish port of Ceyhan in the Mediterranean. The market is taking Erdogan’s threat very seriously. 

4/ Although the outcome of the OPEC/non-OPEC summit was as expected, there were some positive results: the cartel is still optimistic on a market rebalancing and reaffirmed that all options were still on the table to ensure this happened, for the "good of all". Russia said it would decide in January whether to extend production cuts beyond March 2018. The UAE, hitherto the naughty boy as far as quota compliance is concerned, said that it was in 100% agreement with last November’s agreement. The next meeting will be held in November in Vienna. 

  Corporate debt

 

Credit

Spreads widened slightly at the beginning of the week on more North Korean uncertainty and a surge in the support for the extreme right in Germany’s elections. Angela Merkel’s re-election was a mixed success. But spreads then stabilised despite rising government bond yields and yield curve steepening in the wake of the US tax project and the Fed’s hawkish tone.

In results, 4th quarter results at But (B2/B+) were in line. Sales advanced 5.3%, EBITDA rose and there were also cost savings after talks with suppliers. Mediaset’s first half results were satisfying: sales were flat compared to the first half but operating costs fell 4.7% and the company made a profit of €75m vs. a €28m loss last year. However, net debt increased 7% compared to December 31 2016. Neopost (BB+) posted first half 2017/18 results in line and stuck with its medium term guidance. Sales edged 0.4% higher, EBITDA was slightly higher and net debt fell. No surprise from Hema (B3/B-) which continued to recover and reported a 3.3% rise in sales. The group also confirmed that Lion Capital was considering selling its stake. 

In new issues, transport company Brambles (Baa1/BBB+) sold a euro-denominated 10 year senior bond. In financials, Banco Santander and ABN Amro issued euro-denominated AT1s, non call 6 and 10 years, with coupons of 5.25% and 4.75%.

Elsewhere, Air Berlin’s supervisory board said talks on selling the group's assets were still going on with Lufthansa (Baa3/BBB) and EasyJet (Baa1/BBB+) and expected to last until October 12. 

The US wants to inflict antidumping levies of 220% on Bombardier (B2/B-) for its CSeries planes. This follows Boeing’s claim that Delta Airlines had bought 75 CSeries planes at below cost price. The US decision is only preliminary and will be confirmed by December. Bombardier said it totally disagreed with the move and that Boeing had suffered no damage as it was not party to the Delta tender. 

Convertibles 

We had a very active primary market this week with six new deals.

In Europe, AMS, which is headquartered in Austria and supplies 3D sensing components to Apple, issued a $350m 5Y convertible bond with 0.875% coupon to finance the expansion of its manufacturing capabilities. Vallourec, a French manufacturer of specialty tubing for the energy industry, came to market with a €250m 5Y 4.125% convertible bond for refinancing purposes.

We also saw two deals in the real estate sector: Deutsche Wohnen issued a €800m 8.25Y 0.6% convertible, simultaneously repurchasing the outstanding in-the-money 2021 convertible; and Austrian developer, CA Immobilien, issued a €200m 8Y 0.75% convertible to optimise its financing structure.

In the US, Air Transport Services Group, a commercial aircraft leasing company, issued a $225m 7Y 1.125% convertible for refinancing. A second deal came from InterActiveCorp; the parent company of the renowned dating app, Tinder, which came to market with a $450m 5Y 0.875% convertible to refund its existing 2018 straight bond.

On the earnings side, Micron reported a very strong quarter, beating estimates owing to further improvements in DRAM/NAND prices which resulted in a 14% jump in QoQ sales. The share rallied 8%.

Rocket Internet sold a 13% stake in Delivery Hero to Naspers and announced a further €100m buyback of its outstanding convertible bonds. Bayer sold another 6.9% stake in Covestro, relinquishing control over its subsidiary.

On a slightly less positive note, Chinese property stocks came under pressure after a number of mainland cities unexpectedly tightened rules on reselling homes. And in Japan, power companies fell sharply when Yuriko Koike, the Governor of Tokyo and head of the new political movement “Party of Hope”, said she wanted the country to abandon nuclear power by 2030.

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