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Trade war fears fuel market nerves

Market analysis - 3/23/2018

The first press conference by the new Fed chairman, Jerome Powell, went down relatively well with markets. As expected, he raised the benchmark rate by 25bp and said the US economy was healthy enough to warrant two further rate hikes in 2018.

He also said there was nothing in current data pointing to an acceleration in inflation, a statement that pushed back the idea of tighter monetary policy. 

But traders soon focused on Donald Trump’s protectionist agenda and the risk of a trade war. At the same time, less buoyant economic news prevented markets from successfully digesting announcements of import duties on Chinese goods to the tune of $60bn across approximately 1,300 products. Commerce Secretary Wilbur Ross claimed the move marked only the beginning of talks, but China is to respond by taxing 128 US products, including pork, recycled aluminium, steel pipes, fruit and wine representing $3bn (out of total of $172bn in US imports into the country). In fact, trade war fears should have abated following Washington’s decision to exempt the European Union, Argentina, Canada, Mexico and South Korea from steel and aluminium import duties. Nevertheless, pending talks between the US and China over the issue, the levies on Chinese imports are likely to mark the return of a risk premium on global equity markets and create higher volatility. 

US tech stocks had already dragged markets lower at the beginning of the week due to the Facebook scandal, and flash PMI manufacturing data in Europe and Japan also weighed on sentiment when they edged lower, albeit from lofty levels. All equity markets retreated with the most cyclical stocks bearing the brunt. And there was the traditional switch to safe havens like 10-year German Bunds and the Yen. 

  European equities

European markets fell sharply over the week. First, Facebook was accused of not protecting subscriber data, then fears mounted over the possibility Donald Trump’s protectionist stance might trigger a trade war, and finally flash European PMI data and US weekly jobless statistics were disappointing. France’s flash data took it back to levels seen 6 months ago while the German ZEW index also faltered. 

The ensuing bond rally was strong with French yields falling to a year low and Spanish and Italian spreads widening. All this meant the agreement between London and the EU on the Brexit transition period was drowned out. Tech stocks led decliners followed by interest rate sensitive stocks like banks and insurance companies, as well as cyclicals, industrials, base materials and construction. Only the property sector managed to end the period higher.

In company news, Klépierre made a bid for the UK’s Hammerson but it was rejected. Lower US oil inventories helped the sector to curb losses. Deutsche Bank issued a fresh profits warning which sent the stock lower. Cautious forecasts from Kingfisher hit the construction sector while the agri-food sector suffered after General Mills said it was struggling to pass on higher commodity prices to consumers. 

Southwest Airlines’ warning on its unit receipts weighed on air transport and the Air France strike affected 25% of its flights. Airbus fell after another article in Handelsblatt suggested there were further corruption scandals to be unveiled. Europe's electricity producers rose due to a steep increase in carbon credit prices as well as strategic manoeuvres between Eon and RWE. Publicis’ multi-year strategy plan had a frosty welcome as poor January and February figures upstaged any strategic considerations. 

  US equities

US markets tumbled over the week with the S&P losing 3.9% and the Nasdaq ending 4.2% lower. The sell-off was mainly prompted by worries over the reach of Donald Trump’s proposed trade barriers. The Fed also raised its forecasts for growth in 2018 and inflation in 2019.

The likely consequences of a trade war on the global economy trigged rotations into defensive asset classes and stocks. The yield on 10-year Treasuries fell from 2.9% to 2.8% while the equity market lost close to 3%.

Over the week, telecoms, consumer stables and utilities were the best performers. On Thursday alone, utilities gained 0.4% while the S&P fell 2.4%.

In company news, turmoil at Facebook hit the headlines following personal data harvesting by certain companies during the US Presidential campaign. The stock plummeted by 10% over the work, wiping close to $50bn off the company’s market cap. 

  Japanese equities

Worries over escalating trade tensions between the US and China and political uncertainty in Japan sent the TOPIX 0.53% lower over the week. The market was hit by selling pressure from non-Japanese investors concerned about mounting US import restrictions on Chinese products as well as possible retaliation from China. Market sentiment was also hit after PM Shinzo Abe’s approval rate fell by approximately 10% to the low 30s, a consequence of the Moritomo Gakuen issue.

By sector, Mining (+4.55%) and Oil & Coal Products (+3.55%) outperformed the TOPIX led by oil developer INPEX (+4.97%) which rose after compensation on oil drilling interests was agreed with Ecuador, and energy developer JXTG Holdings (+2.96%). Astellas Pharma (+4.81%) and Ono Pharmaceutical (+2.97%) were also strong.

In contrast, Food (-2.68%) and Pulp & Paper (-1.96%) underperformed. Japan Tobacco Industry declined 6.06% and Ajinomoto lost 3.50%. There was also weakness in high-tech sectors (-1.40%) as well among growth stocks like Nitto Denko (-4.71%), Murata Manufacturing (-3.94%), and Keyence (-3.32%).

Market softness since February has taken the average P/E on 1-year forward earnings to a rather low 12.7 for the NIKKEI 225 and 14.7 for the TOPIX, or the lower end of the average P/E trading band. 

  Emerging markets

The PBoC’s new governor Yi Gang reacted cautiously to the Fed’s 25bp hike by only raising China’s rate by 5bp. The levies on Chinese imports signed by Donald Trump will have an estimated impact of -0.8% on China’s export growth and -0.1% on GDP. 

Tencent’s 2017 earnings soared 74% and sales jumped 56% but the games segment disappointed markets due to a fresh investment cycle in the fourth quarter and a delay in monetising games like Sandbox. Advertising and eFinance remained robust thanks to strong performance from Wechat/QQ

Naspers decided to cut its exposure to Tencent from 33% to 31% after 15 years of holding the position. Geely reported strong results but lack of visibility over interest in their new Lynck & Co model and capacity constraints remained major concerns. Ping An beat the consensus but the stock still fell. 

Reports in the Mexican press suggested that the US might abandon its stance on national content, signalling the possibility of a better outcome in the ALENA renegotiations. The main problem is still how to settle disputes. 

Brazil’s central bank cut its benchmark rate by 25bp to a record low of 6.5%. And by leaving the way clear for further cuts, its accommodating tone was a pleasant surprise for investors. Renner expects a 15% increase in sales as it sees consumption holding up well. PagSeguro ‘s fourth quarter results beat expectations mainly due to strong growth in loans, higher volumes and the impact of operational leverage. 

Peru’s president, Pedro Kuczynski resigned. We remain focused on the economic recovery. Argentina’s fourth quarter GDP growth came in at 3.90% or better than expected. Its current account deficit worsened sharply to 4.8% of GDP, its highest level since the 1990s. What’s more, the country is in the first economic recovery cycle. Banco Supervielle said it might be making an acquisition.

  Commodities

It was a very eventful week, what with the first press conference from the new Fed chairman, and a fresh wave of protectionist measures from Donald Trump. 

The Fed event was expected and suggested no changes were afoot over the short term. The protectionist moves raised many more questions. A global trade war is the biggest risk. It would undermine the global synchronised recovery in the US, China and Europe which has been so positive for commodity demand. 

Nevertheless, recent developments over steel and aluminium suggest there is a big difference between what Donald Trump announces and what he actually does. In the end, almost two-thirds of steel and aluminium imports were exempt. 

The exception to this rule is oil. Mike Pompeo's appointment as Secretary of State and John Bolton’s return as National Security advisor are clearly a step towards tougher relations with Iran and a possible withdrawal from the nuclear agreement. The other C5+1 members, notably France, the UK and Germany, might agree to step up Iran sanctions to keep the US in the agreement. In any case, the stage is set for increased tension on oil prices. 

As far as oil fundamentals are concerned, inventories have fallen. They are now at 2,871 million barrels so only 53 million barrels above the famous 5-year mean. However, OPEC and its allies apparently want to change the calculation method to a 7-year mean. That would mean extending the output cuts to 2019 as, on this reckoning, stocks are already 80 million barrels above that level. Saudi Arabia and Russia are still key to inventory normalisation. 

Weighing up fundamentals and geopolitical concerns, the current situation suggests Brent crude should be trading at $65-70 over the short term. 

The other beneficiary of today's flight to quality based on the assumption that more protectionism means higher inflation is, of course, gold. The ounce is now at $1,345 and flirting with last January’s high of $1,366. 

  Corporate debt

 

Credit

This week saw the CDS index roll into Series 29 and several earnings reports and news items on companies. As well as the roll effect, the Main widened by 4bp and the Xover by 16bp. 

CMA CGM reported excellent 2017 figures with EBITDA coming in above €2bn, but the company sounded a more cautious note for 2018 as it expects freight to decline and costs to rise. CBR Fashion (B2/B) said its sale to Alteri Investors had been finalised. 

In the ongoing conflict over Telecom Italia between the activist Elliott fund and Vivendi, a majority of the Italian company's board resigned. The new board is expected to be announced on May 4. 

Switzerland’s Salt (mobile phones), which is owned by Xavier Niel’s NJJ fund, made a dramatic entry into the fixed line market by launching a new generation Box providing TV, internet and content to future subscribers. Germany’s ZFF was upgraded to investment grade. In new issuance, TUI (tourism) pulled its bond issue after failing to secure a yield below 1%. 

Team Systems (B), which offers payroll, HR and finance solutions to Italian SMEs, raised €750m in 5 and 7-year FRN bonds at E+400bp. LKQ, a US auto supplies company, raised €1bn with 8 and 10-year maturities at 3.625% and 4.125%. The proceeds will be used on an acquisition. 

Convertibles 

The fast pace of issuance continued this week with 8 deals for approximately $2.4bn. Most of the activity took place in the US with 5 deals in total. Apptio, which offers cloud-based IT management, planning and optimisation solutions, priced a $125m, 5Y bond with a 0.875% coupon and 30% premium for general corporate purposes that may include working capital, capex and potential M&A. Repeat issuer, Herbalife, the nutrition company once described by Bill Ackman as a pyramid scheme, issued a $500m, 2024 convertible bond with 2.625% coupon and 30% premium. The proceeds will be used to repurchase a portion of the outstanding 2% 2019 convertible. REIT company, Blackstone Mortgage Trust, came back to the CB market with a $220m, 5Y maturity with 4.75% coupon and 15% premium to originate and buy additional commercial mortgage loans and other target assets and investments. In-vitro diagnostics company, Accelerate Diagnostics, brought a 5-year deal with a indicative coupon of 2-2.5% and premium of 27.5-32.5%. Final pricing is yet to be confirmed but the amount raised will be used to market existing products and for general corporate purposes. And fuel cell system developer, Plug Power, issued a $100m 5Y convertible to finance share buybacks, working capital, capex and potential M&A.

Europe saw 2 non-dilutive deals. The Anglo-Swiss Commodity Trading and Mining Company, Glencore raised $500m with a 7-year convertible. Although the issue has no coupon, the premium redemption structure means Yield to Maturity is 1% per annum and the proceeds will be used for general corporate purposes and to purchase cash-settled call options. Europe’s largest food retailer, Carrefour cited the same use of proceeds when it too came to the market with a second $500n non-dilutive convertible with 6Y maturity, 20% premium and 0.55% yield to maturity.

In Asia, Australian REIT and repeat issuer, Cromwell Property Group issued a €230m 7Y convertible with a 2.5% coupon and 7.5% premium. The company intends to extend its debt maturity and buy back its existing €150m 2020 convertible.

In the news this week, Ubisoft announced the successful placing of 13.4m shares at €66 in connection with Vivendi’s sale of its 27% stake and Tencent’s acquisition of 5% in the French video game developer. Despite the reduced probability of a takeover by Vivendi, the shares rallied over 3% on the day, closing over 6% above the placing price as investors focused on the company’s ability to accelerate the reach of its franchises in China.

Elsewhere, leading Japanese airline, ANA Holdings, announced the merger of its two budget carriers, Peach and Vanilla, to support its push into South-east Asia, as well as signing a codeshare with Alitalia, to help expand its European services.

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