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All eyes on central banks

Market analysis - 12/15/2017

Markets were unsurprised by recent monetary policy meetings, but central bank takes on growth and inflation warrant some attention.

The FOMC went, as generally expected, for another 25bp hike in its benchmark rate and suggested there would be 3 more rises in 2018. But the real news was the Fed’s optimism on US growth: it revised up its GDP growth forecasts for both 2018 and 2019 to 2.5%, up from 2.4% and 2.1% respectively and also said it expects the jobless rate to fall to 3.9% over the next two years rather than 4.1%.

For core PCE inflation, the Fed has left its forecasts unchanged at +1.5% in 2017 and +1.9% in 2018, +2% in 2019 and +2% in 2020. Note that in China, the PBoC surprised markets by following the Fed and raising rates by 5bp, a move that kept the onshore and offshore renminbi stable. It was a small hike but nevertheless showed how vigilant China's central bank is over US monetary tightening amid the ongoing reduction in overcapacity in the property and industrial sectors.

The ECB left its rates unchanged and gave no further pointers on its asset purchasing programme with no details on the breakdown between corporate and sovereign bonds. As the bank had already indicated, buying will be reduced from €60bn to €30bn a month from January 1st 2018. Elsewhere, the bank revised its growth forecasts for 2018 up to 2.3% and said inflation in 2020 should be around +1.7% YoY, a modest rise which underpins the scenario of a very gradual rise in benchmark rates. The Bank of England is in a trickier position as it has to contend with a spike in inflation amid an economic slowdown. Its future decision will largely depend on the ongoing Brexit talks. All in all, central banks have confirmed that the economic situation is continuing to improve and that any rate rises will be cautious and gradual.

In our asset allocation, we tactically reduced our exposure to equity risk in November as it seemed to us that the improving economic environment had not ruled out the risk of short term volatility. We are continuing to invest in risk assets but a little more cautiously and are waiting for new opportunities to reinforce current positions. We still prefer the eurozone and Japan and remain cautious over US growth stock valuations. On bond markets, buying opportunities are becoming rare by the day and we remain underweight German and US government debt. 

  European equities

The ECB revised it growth forecasts for the eurozone up sharply, moving from 2.2% to 2.4% this year and from 1.8% to 2.3% in 2018. 

It also confirmed that it would be lowering its monthly asset purchases to €30bn from January 2018 and for a period of 9 months. Inflation is expected to remain limited to +1.4% in 2018.

Italy lost ground over the week after bond prices fell on news that parliament was to be dissolved at the end of this month. The prospect of an election is worrying as the M5S party is leading the polls.

Utilities came under attack. Innogy tumbled on a profits warning due to the group's exposure to the UK and a 25% boost to investment in 2018. This dragged down parent company RWE and spread to the entire sector, including Eon.

Airbus won a strategic, $12.7bn order for 100 A321neo planes as well as an option on another 100 planes to be delivered from 2020. The group also said its second in command Fabrice Brégier was leaving and that CEO Tom Enders would not be renewed in his post. These changes should be effective in 2018 and 2019.

Dassault Aviation is not to use Safran’s Silvercrest engine in its Falcon 5X jets and has instead initiated a new business jet project with Pratt & Whitney. Safran was also hit by Zodiac’s disappointing sales. BAE Systems won a contract (via its consortium with Airbus and Leonardo) to sell 24 Typhoon jets to Qatar.

Nexans’s mid-term outlook was viewed by investors as disappointing and the stock fell. The group’s 2022 plan is ambitious, but the market appears concerned that high capex at the beginning of the period might weigh on cash generation. Ferragamo fell on Friday after saying it could not confirm its guidance. 2018 will be another “year of transition” like 2017 as the company will need to invest in its product offer following the arrival of a new fashion designer.

In M&A, Atos launched what it called a friendly bid on Gemalto at €46 a share. Gemalto rejected the bid for being too low. Unibail made a cash and stock bid on Westfield, which is listed in Australia and owns shopping centres in the US and UK. TF1 offered to buy Axel Springer’s 78% stake in Aufeminin.com

  US equities

The S&P 500 edged higher over the last 5 trading sessions.

November inflation came in at 2.2% and 1.7% ex food and energy, both of which were more or less in line. Retail sales, however, rose 0.8% on the previous month when they were expected at only +0.3%. In an indication of the prevailing economic enthusiasm and optimism over progress on tax reform, intentions to hire by US SMEs have just hit an all-time high since records first began in 1974.

The US telecoms regulator (FCC) voted to end net neutrality. This means the government will no longer regulate access to high speed internet but there have already been vigorous protests from Democrats who want to maintain a law that came into force when Barack Obama was president, and which is defended by leading Silicon Valley players. But the decision is excellent news for telecom and cable companies which will now be able to prioritise access to certain sites and monetise connection speeds. Telecoms gained 5% over the week.

Disney and Twenty-First Century Fox have come to an agreement whereby Fox will sell its studios and international TV stations. The $52bn price tag for Disney is to be financed with Disney shares from the issue of 500m new shares. Disney’s CEO, Bob Iger, was to have left the group in 2019 but will now remain until 2021 to oversee the integration of the Fox assets.

This week’s disappointments included Oracle which plunged 7% on its quarterly figures. The culprit was the Cloud business which now expects to see sales rise by 21-25% in the next quarter or much lower than the current pace of 44%.

Commodities and financials fell over the week while healthcare and consumer discretionary led advances.  

  Japanese equities

Over the week, the TOPIX gained 0.24% in a mixed market. The week got off to a good start, hitting a 20-year high on Monday thanks to upbeat US and Asian stocks as well as strong US job growth in November. But the market succumbed to profit taking on Wednesday and lost further ground on Thursday after the Republican Party lost its Senate seat in Alabama and subsequent worries over the outlook for US tax reform. The market was also dragged down after the FOMC meeting. However, some investors suggested this negative market reaction to US government issues would not have any marked impact on Japanese market trends.

By sector, the best performers of the week were Oil & Coal Products (+6.55%), Banks (+3.52%) and Mining (+2.52%). Crude oil companies JXTG Holdings (+6.21%) and INPEX (+2.65%) advanced on higher crude oil prices. Major banking groups such as Resona Holdings (+5.51%), Sumitomo Mitsui Financial Group (+4.17%) and Mitsubishi UFJ Financial Group (+3.34%) saw buying on strong performance from their Wall Street peers. SG Holdings, the parent of major parcel delivery company Sagawa Express, made its debut on the Tokyo Stock Exchange’s first section, the largest IPO of the year. The stock closed 17% above its listing price.

On the other hand, Electric Power & Gas (-1.34%), Electric Appliances (-1.19%) and Chemicals (-1.16%) were relatively weak. Semiconductor-related company Tokyo Electron (-4.35%) lost ground on sluggish US tech stocks. 

  Emerging markets

The PBoC raised interest rates on open market operations and its reverse repo rate by 5bp. It justified the move by citing upbeat liquidity levels as well as the Fed’s rate hike. Industrial production rose 6.1% in November, which was not that bad as the negative effect from China’s air quality campaign was offset by a strong 12.3% surge in exports. October retail sales increased by 10.2%, boosted by the November 11“Singles-Day” online promotion. November CPI and PPI both softened to 1.7% and 5.8% respectively.

Tencent, its subsidiary Tencent Music Entertainment Group (TME) and Spotify jointly announced equity investments in which TME and Spotify will acquire (undisclosed) minority equity stakes in each other through new shares for cash while Tencent will invest in Spotify through secondary purchases. This will leave Spotify with a minority stake in TME, and both Tencent and TME will hold minority stakes in Spotify.

In India, exit polls for both Gujarat and Himachal Pradesh pointed to fairly easy BJP victories. This is an encouraging sign for the Narendra Modi’s administration which is rolling out the right reforms for the country like the GST and recapitalization of state banks, both of which should bear fruit over the medium term. Both boards of HDFC and HDFC Bank are meeting to consider capital raising via a qualified institutional placing (QIP) and/or a preferential issue. This suggests that cross-holdings should increase between the 2 entities.

Bank Indonesia kept its interest rates at 4.25%, a sign that it is confident inflation can be kept within its 2.5/4.5% target.

Mexico’s central bank increased interest rates by 0.25bps to 7.25%. Despite the accompanying hawkish statement, this was lower than expected. Inflation has been a tricky issue due to a double digit rise in the minimum wage, the tight labour market, the weaker currency and low CDS spreads. Nevertheless, according to the Monetary Policy Committee, NAFTA renegotiation is still the main risk to the domestic market.

In Brazil, the government put back the vote on pension reform from December to February. Qualicorp sold off on the potential of regulatory changes to the healthcare sector.

Chile’s central bank kept rates unchanged at 2.5%.

In Argentina, pension reform was also delayed, but the government said that it could approve the reform by decree. Unemployment continued to decline, although job creation decelerated.

We saw a good deal of indiscriminate profit taking, regardless of YTD performance. Higher valuations still mean less tolerance of lower-than-expected profits. This ‘reality check’ is healthy and necessary if a bubble is to be avoided. However, the difficulty is deciding which companies are trading at high multiples but with lower than expected growth and which still offer high-growth prospects.

Looking ahead in China, we expect a gradual slowdown in growth due to the ongoing clean air campaign (December up to the first quarter of 2018), a reduction in local government debt levels and reduced excess capacity. Although, we remain confident on China for 2018, it is doubtful that we will see the same level of performance in the next 12 months.

In South Africa, we need to closely monitor the outcome of the ANC election which could be a game changer for the country’s prospects. 

  Commodities

Oil prices were relatively unchanged over the week though trading was still volatile. Brent crude surged to a high of $66 after a shutdown in the Forties site in the North Sea. Cracks were discovered in a pipeline which carries 450,000 b/d as well as 800Mcfd in gas. This is a large amount in the current environment, but the incident was also important as the site, along with Brent, Oseberg and Ekofisk, participates in Brent crude price formation. The shutdown is temporary but operator Ineos is unable for now to say when production might resume and is talking about weeks rather than days. The immediate effect is that it will help reduce crude oil inventories.

The recent IEA report said the surplus had been reduced in October by 40m barrels to “only” 111m (down from a high of 350m barrels). In their monthly reports, all three agencies- the IEA, the EIA and OPEC- revised expectations for NOPEC output higher by around 900,000 b/d, a situation that would make an extension of the cuts announced in November even more necessary. Compliance with cuts varies between OPEC and NOPEC but is still high and running above 100% on balance (121% for OPEC and 92% for NOPEC).

Barclay’s half-yearly survey on upstream investment intentions shows an 8% increase for 2018, up from 4% this year. This is still, however, rather modest given the size of cuts in previous years and cycles and it suggests that companies are still cautious.

Elsewhere, LME metal prices rebounded after Chinese data on imports, PMI, industrial production, housing starts, and infrastructure spending showed the economy had recovered in November after a lull in October due to the Communist Party Congress.

The gold ounce was under pressure in the days leading up to the 5th US rate hike since the cycle began but doubts over the vote on US tax reform helped the price rebound.  

  Corporate debt

 

Credit

Trading was dominated by news from the Fed and the ECB as well as individual stock stories.

The ECB confirmed that it was to gradually reduce its bond buying although an extension of the period remained a possibility. It also announced a change in eligibility criteria for senior unsecured bonds issued by credit institutions. I

In company news, TEVA said it was to lay off 25% of its workforce to reduce operating costs by $3bn and was also to pass on its dividend.

Swissport’s investors are worried about the difficult financial situation of its parent company HNA and the fact that an intercompany loan has been extended when it should have been repaid before the end of 2017.

On the new issues market, Inter Milan football club raised €300m at 4.875% over 5 years to refinance the debt housed in the club’s subsidiary which manages sports rights and sponsoring contracts. 

Convertibles 

The convertible bond primary market was very quiet ahead of the festive season with only one new issue, a 6-year, $125m convertible from US provider of oil and gas-related transportation services, Bristow Group.

Steinhoff continued to dominate the headlines. Following last week’s events, the company announced that its 2016 financial statements would also need to be restated owing to accounting irregularities. In addition, chairman and interim CEO, Christophe Wiese, resigned from the supervisory board to address concerns regarding a potential conflict of interest.

Steinhoff’s convertible bonds traded in the 40-43 area ahead of talks with the company’s lending banks which are scheduled for December 19.

Japan’s SBI Holdings had a stellar run, jumping 18% as the Ripple cryptocurrency, in which it owns an 11% stake, surged 213%.

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