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Low-volatility records

Market analysis - 10/13/2017

Equity market trading was thin amid fresh low-volatility records. And yet global news flow was substantial and included the threat of Spain disintegrating, more noise and fury over North Korea, Turkish troops moving into Syria and Washington’s decision to question the US agreement with Iran over nuclear developments. There was also Washington’s announcement that the US was leaving UNESCO.

Even so, markets only had eyes for two angles:

1 - so far, macroeconomic factors have suggested the economic cycle was continuing and that earnings would rise everywhere in the world. In addition, hope of US tax reform has revived.

2 - central banks are expected to move towards tightening but carefully so as not to slam the brakes on the cycle.

At the same time, oil prices and the US dollar are trading within narrow limits. 

This means the environment is still upbeat for equities, especially in Japan and in the eurozone where relative valuations strike us as cheaper than in the US. As for bonds, investors should remain highly tactical even if the environment is not expected to suddenly deteriorate sharply. 

  European equities

Trading was thin on European markets with trends dictated by news on Catalonia’s independence bid. Investors were somewhat reassured by Mariano Rajoy's firm address to the Spanish parliament in which he threatened to unleash article 155 of the constitution and gave Barcelona an ultimatum. Elsewhere, utilities gained ground after the UK’s decision to put off a decision on introducing an energy price ceiling for the coming winter. Luxury stocks advanced on LVMH’s excellent third quarter results which saw like-for-like saw sales rise 12% when analysts were expecting +9%. Banks were weak, however, due to falling bond yields and the prospects of an agreement on Basel IV. 

In M&A, Bayer is to sell its herbicide and seed businesses for €5.9bn. This will facilitate Bayer’s bid on Monsanto which is still being examined by US regulatory authorities. Accor’s bid on Australian hotel group Mantra was accepted. Campari continued with efforts to refocus on its main business by selling its soft drinks division for €80m. Lufthansa is to pay €1.5bn for 81 of Air Berlin’s 140 planes and integrate 3,000 out of its 8,000 employees. After three year of conflicts, Lufthansa also said it had reached an agreement lasting up to 2022 on pilot salaries and pensions. In 2017, the company hopes to cut cabin crew costs by 15% and pension costs by between €500m and 1bn 

  US equities

US indices edged higher to hit new all-time highs. A certain enthusiasm pervaded markets ahead of the third quarter earnings season, helped by the FOMC minutes, which were marginally dovish, and reduced political tension in Spain. Volatility remained at historically low levels with the VIX index trading below 10. The FOMC minutes contained no really new features. The base scenario still sees a rate hike in December but the big question is over the outlook for long-term inflation. The replacement of Janet Yellen will also be a big talking point in coming weeks. Donald Trump is to meet candidate John Taylor, a professor at Stanford. 

JP Morgan and Citi opened the earnings season for large caps. Their results were slightly above expectations but the banks sector still lost ground over the week. Telecoms suffered a fresh fall after AT&T tumbled 6% on an announcement from the group that its quarterly results would be hit by the loss of 90,000 video subscribers. DISH and Comcast also came under attack and lost 4-5% over the week. 

  Japanese equities

Over the week, the TOPIX gained 0.77%. The Nikkei 225 hit a twenty-year high at 20,954.72 during the week after rising steadily for eight consecutive days. Investor sentiment was lifted by news that PM Shinzo Abe’s LDP party was still polling higher than opposition parties like Tokyo Metropolitan Governor Yuriko Koike’s Party of Hope, ahead of Lower House elections on October 22. The new opposition party lost steam on news that the popular Ms Koike would not be standing in the election. Markets welcomed the news as an LDP win would provide stability to Abenomics. More importantly, however, upbeat market sentiment was fuelled by strong earnings growth.

By sector, the best performers for the week were Services (+3.11%), Construction (+2.70%) and Information & Communication (+2.25%). Softbank jumped 7.27% on speculation that the mobile operator was in talks over aggressive M&A deals. Komatsu advanced 5.30% as its US peer Caterpillar hit a record high on expectations of steady global growth.

In contrast, there was weakness in Iron & Steel (-5.61%), Insurance (-2.02%), Oil & Coal Products (-1.86%) and Mining (-1.85%). Sompo Holdings dropped 5.7% on worries over large losses from the US hurricanes. Auto maker Mazda fell 4.19% and Nippon Steel & Sumitomo Metal lost 4.05%, both affected by the data falsification scandal at Kobe Steel. 

  Emerging markets

The MSCI Emerging Market index continued to move upwards gaining another1.8%, mainly driven by India, Korea and Taiwan. Mexico was the main laggard, due to increasing concerns about the outcome of NAFTA renegotiations. According to a local newspaper, Amazon expects to launch its electronics e-commerce business in Brazil this month, expanding beyond books only. Mercado Libre, the largest incumbent, saw its share price fall on the news.

In China, there was news on BMW’s possible joint venture with Great Wall to produce the Mini. On the macro side, exports accelerated in September, but were below expectations (8% versus consensus of 10% and August’s 6%) and imports were up 19% higher than the 15% expected.

In India, Bharti Airtel announced the acquisition of Tata’s mobile business. The stock reacted positively as Bharti continued to benefit from the consolidation trend in the sector. Both TCS and IndusInd Bank published results in line with expectations. For TCS, top line growth remained modest (+8.3% YoY) but margins were slightly above expectation (25.1% EBIT margin vs. 24.7% expected). IndusInd Bank reported 25% earnings growth with lower credit costs.

TSMC’s stock hit an all-time high, after Taiwan’s exports rose 28% in September, up from +12% in August. TSMC is also expected to gain market share in 7nm from the second half of FY18/2019 earnings.

In Korea, Samsung Electronics reported preliminary results in line with expectations. Stronger earnings on memory more than offset the weakness in the display business (which is expected to improve with the iPhoneX launch).

In Russia, X5 reported encouraging results (24% revenue growth, or higher than expected). This was expected and driven by bigger sales drives so the EBITDA margin should fall but this is already expected.  

  Commodities

Oil prices ended the week higher as Brent crude moved back above $57 and WTI above $50. Monthly reports from OPEC, the IEA and the US Energy Information Administration made the headline news. They were generally little changed on the previous month and remained upbeat on global demand for 2017 and 2018. This followed OPEC’s decision to once again revise its 2017 expectations higher to 1.4 million b/d and the same for 2018. The IEA is more optimistic for 2016 (1.6 million b/d) but has the same forecast for 2018. Agencies are still generally optimistic for demand in 2018 amid strong global GDP growth. All three reports said global inventories were genuinely falling.

In the US, DoE data said crude inventories were down and oil products slightly higher. China's crude oil imports rose 13% in September compared to August and remained at the sort of high levels consistent with strong demand. Mohammad Barkindo, OPEC’s secretary general, also stuck a reassuring note on the cartel’s actions and the possible extension of cuts beyond March 2018. He said oil producers were succeeding in rebalancing a surplus even if they would probably have to take further extraordinary measures to underpin oil prices in 2018.

Iron ore fell by close to 3% over the period to $60/tonne, taking the drop over a month to around 20%. The decline was due to (i) China’s decision to cut production temporarily this winter for environmental reasons and (ii) the slowdown in China's property market. The Chinese Communist Party’s 19th Congress is to be held shortly and should provide more light on developments. We remain upbeat on Chinese growth and on infrastructure spending. And in our view, the property market does not seem to be overheating. The iron ore price looks close to a floor. 

  Corporate debt

 

Credit

Xover spreads tightened by 4bp between last Monday and Thursday. The rise was driven by fears over Catalonia, the ECB's reassuring tone on banks and QE and the IMF's upbeat outlook on global growth. The FOMC minutes had little impact on markets as investors had already discounted a dose of US monetary tightening and switched their focus to third quarter results. 

In a relatively busy week on the primary market, Vallourec (B), global n°1 in premium tubular solutions, issued a 5-year senior bond for €400m. Switzerland’s Dufry (Ba2/BB), which runs duty free shops, raised €800m with a senior bond due 2024. Spain’s Empark (Ba3, car parks) issued a two-tranche senior bond (floating and fixed) with 7 and 6 year maturities for €475m. In financials, ASR (BBB+) issued Restricted Tier 1 (RT1) debt, the first of its kind in euros. It raised €300m at 4.625%. 

Levi Strauss & Co (Ba1/BB+) unveiled satisfactory third quarter results. Sales rose 7% and the gross margin increased by 11%. Sales were particularly strong in Europe where they rose 23%. The group subsequently raised its guidance on sales for this year to +5/6%.

AccorHotels (BBB-) confirmed that it had paid €900m for Mantra, one of Australia’s largest hotel groups. This puts pre-synergy EV/EBITDA at 12.4 times and less than 10 times if synergies are taken into account. Cinven sold Ceramtec (B2/B), a German artificial hip maker, for €2.6bn or 13 times EBITDA. 

Convertibles 

We had 3 deals this week, 2 mid-cap companies in France and one in Asia.

In the Aeronautics industry, sub-contractor and family owned Figeac-Aero raised €100m over 5 years at 3.5% and a 30% premium. The proceeds will be used to fund capex over coming years as well as external growth. French biotech company, Genfit (cardiovascular / metabolic and specialised in “NASH”, or nonalcoholic steatohepatitis, a liver disease) successfully raised €180m over 5 years at premium terms for investors, a 30% premium and a 3.5% coupon. The proceeds are to complete the phase 3 clinical development programme for its Elifibranor product (NASH), prepare for its possible marketing and reinforce the company’s pipeline.

In Asia, China’s Zhongsheng Group (auto retailer with $ 5.1bn in market cap), hit the market with a HKD 2.35bn 1-year maturity zero coupon to be used on working capital and possibly to repay its offshore debt.

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