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Equity markets advance

Market analysis - 4/13/2018

Equity markets generally trended higher over the period. Moves were influenced more by sentiment on US-China talks on freeing up markets and protectionist worries than by interest rate or economic cycle considerations.

In coming days, more light should be shed on the economy when the earnings season kicks off. Another important development was the increased tension in Syria which pushed Brent crude prices above $72. We have maintained our equity overweight with a focus on Japan and the eurozone.

We are still cautious over core eurozone government debt which means taking a very tactical approach to managing fixed income products. 

  European equities

Equity markets traded in line with news on geopolitical tension, whether the US-China trade dispute, a possible military intervention in Syria or US sanctions against Russia. 

Higher oil prices were particularly good news for oil services companies like TechnipFMC, Saipem, and Tenaris. The luxury sector also benefited from LVMH’s excellent quarterly results which saw like-for-like growth of 13%. The share jumped and dragged up Kering too. L’Oréal gained on upbeat first quarter sales in its luxury and cosmetics divisions. Autos were in vogue after China’s president Xi Jinping promised to slash import duties on foreign cars. But stocks with Russian exposure were hit. 

In M&A, IAG bought 4.6% of Norwegian Air and has not ruled out bidding for the entire company.  The move has reinforced pressure for more sector consolidation in Europe. Rumours of a tie-up between T-Mobile and Sprint in the US returned in force.  

Softbank could agree to Deutsche Telekom owning a majority stake in the new entity. Volkswagen has appointed Herbert Diess as new CEO. At the same time, the supervisory board has been heavily reshuffled and brands reorganised depending on positioning (mass market, premium, truck, etc.). The group is also preparing an IPO for its Volkswagen Trucks & Bus division, which might also be part of a strategic alliance with Japan’s Hino (Toyota). The Private Equity fund, Francisco Partner has offered to buy VeriFone, at a 54% premium. The news sent the Ingenico share higher. The activist Elliott fund confirmed that it had raised its stake in Telecom Italia to around 9%, ahead of the April 24 shareholder meeting. 

  US equities

It was an excellent week on Wall St with the S&P up 2.3% and the Nasdaq 3.3% better. Investors interpreted the latest statements from the Trump administration on import tariffs as more accommodating. The mood was also fuelled by investors wanting to take positions ahead of the results season which is expected to reflect a cyclical acceleration since the year began and also the impact of tax reform. Consensus first quarter estimates are for sales to rise 10% and earnings by 17%, or the strongest pace of growth since 2011. CPI inflation rose by an annualised 2.4% or in line with expectations. 

The latest FOMC minutes held no real surprises. The tone was balanced and the message largely mirrored Jerome Powell’s inaugural press conference statements. Economic prospects and financial conditions are improving but not to the extent that a change of monetary policy is warranted. ‘Gradual’ is the watch word on monetary tightening. However, the minutes showed the voting members thought a trade war would hit US growth. 

The market advance favoured the highest beta sectors, led by technology (which was also lifted by Facebook’s reaction following Mark Zuckerberg’s appearance before Congress), energy and financials. Defensives not only fell relatively but also in absolute terms with utilities down 2%, property 1.7% lower and telecoms 0.4% weaker. 

  Japanese equities

Japanese stock prices were practically flat with the TOPIX edging 0.05% lower. 

Despite previously weak indications, Japan’s February Machinery orders survey data, a leading indicator of private equipment investment, was stronger than expected, hitting a ten year high in the manufacturing segment due to robust capex demand. However, upside was limited by the risk of the US-China trade dispute reducing demand. Many investors stuck to a wait-and-see attitude. 

In sectors, Mining (+3.68%), Marine Transportation (+1.75%), Iron & Steel (+1.75%) and Oil & Coal Products (+1.45%) outperformed the TOPIX. Insurance (+2.15%) and Banks (+1.20%) were firm. 

On a negative note, there was relative weakness in Pharmaceuticals (-2.45%). Services (-2.02%) and Retail Trade (-2.02%). Ono Pharmaceutical dived 14.74% and online trade service provider Rakuten tumbled 6.92%. Recent outperforming cosmetics producers like Kao (-5.21%), Shiseido (-4.73%) and Unicharm (-4.59%) fell back on profit-taking.

  Emerging markets

It was a turbulent week on emerging markets. Trading in Rusal’s bonds was suspended- the portfolio has no exposure to them- while the possibility of reinforced sanctions against Russia triggered massive capital outflows. The Rouble plunged 8% in a single week despite a rebound in oil prices that should logically boost Russian exports. In the ongoing US-China tussle, Beijing made a move towards calming down the situation by mooting reduced import levies on autos and fewer restrictions on holdings by non-Chinese partners in joint ventures. A 10-15% cut in levies would make certain top-end Chinese models less competitive than imported cars in the same category. 

At the Boao Forum for Asia, China’s equivalent of Davos, the PboC’s governor gave numerous indications that China was opening up its financial markets: the Hong Kong Connect quota will be quadrupled from May 1st, and non-domestic companies will be able to control up to 51% of broking, asset management and insurance joint ventures. The governor also promised not to devalue the renminbi if trade disputes were to intensify. 

Elsewhere, South Korea’s central bank left benchmark rates unchanged at 1.5%. In India, Amazon and Walmart are battling each other in an attempt to penetrate the budding mass distribution market. Both have bid for a minority stake in Flipkart, India’s largest e-commerce company. But the country's infrastructure projects remain just as feeble and will fall 52% in fiscal 2018. In Mexico, March inflation was 5.04% or lower than expected. Industrial production rose 0.7% in February, which was below expectations of 1.2%. Brazil's inflation continued to fall, coming in at +2.68% in March, down from +2.84% in the previous month. 

Despite strong volatility from the risk of protectionism, rising interest rates and mounting geopolitical tensions, emerging markets have continued to outperform the developed zone since the beginning of 2018. China in particular has made serious efforts to rein in debt and stimulate innovation, two drivers which have been robust enough to help it make a positive contribution (+0.65% in EUR) in spite of trade war rumors.

For the moment at least, investors are keeping a cool head.  

  Commodities

Oil prices surged with Brent crude up 8% and QTI 6% higher. Brent topped $73 for the first time since November 2014 when it was on its way down from $100 in June 2014 to $45 in January 2015. The recent euphoria is down to mounting geopolitical tensions and improving fundamentals. Increased tension in Syria may have only had a limited impact on oil output there (15,000 b/d compared to 400,000 before 2011) but there is a risk of indirect conflict between the US (plus France, the UK and Israel) and Russia (including the Hezbollah and Iran). The indirect struggle between Saudi Arabia and Iran in Yemen is not such a big headline at the moment but carries more risk to oil exports as 5 million b/d transit through the Gulf of Aden. 

All these conflicts could well mean the US quitting the agreement on Iran's nuclear capacity when it comes up for renewal on May 12. However, given the Trump method and his frequent about-turns, diplomats can still hold out hope. The current oil risk premium can be estimated at around $5 a barrel.

Meanwhile, monthly reports from the EIA in the US, OPEC and the IEA, show the fundamentals are continuing to improve: (i) upwards revisions for US output have slowed compared to the last 6 months, mainly because of pipeline bottle necks (ii) OPEC production fell by 200,000 b/d in March compared to February and output in Venezuela and Angola continued downwards, and (iii) demand has remained unchanged despite higher prices. All this has led to OECD crude inventories falling to 2,84lm, or 26 million barrels above the 5-year mean. The IEA expects this mean to be hit in May. Bear in mind that OPEC and Russia are considering shifting to a 7-year mean, a move that would extend efforts to cut output.

The gold ounce has only benefited a little from current geopolitical tensions but is still trading around a high $1,330-1,360 spread. Since the beginning of 2018, gold ETFs have seen inflows rise by 1.7m ounces to a total of 73.3 million ounces. 

  Corporate debt

 

Credit

Markets rose after China said it would be cutting import duties on certain products and Donald Trump’s rhetoric turned more conciliatory. But some Russian issuers were particularly hard hit by US sanctions against Russia. Due to its exposure to Russia, Raiffeisen’s CoCo bonds came under selling pressure at the start of the week. 

The primary market was very busy, Fives (B3/B+, engineering), raised €600m with two 7-year maturities, one at 5% and the other floating. Vallourec (Ba1/BB, steel tubular solutions) raised EUR 400m over 5.5 years with a 6.375% coupon. Deutsche Pfandbriefbank (A-) raised €300m with its first AT1 issue at 5.75%. 

Tenneco (Ba2/BB) is to pay Icahn Enterprises $5.4bn for Federal Mogul (car part supplier). The deal will be part-funded by debt and Tenneco expects this will take Net debt/EBITDA to around 3 times. The company expects to reduce this to 2.5 times by end 2019.

Burger King France (B3/B-) had an excellent 2017 with sales up 13% and EBITDA 63.5% higher. This was due to new restaurant openings. Cerba (B2/B+, biomedical labs), released satisfactory 2017 figures. Sales rose 5.9% and EBITDA 3.9% but cash flow was negative to the tune of €15m due to high taxes and deteriorating working capital requirements. Atalian (B1/ B+, leader of integrated corporate services), is upbeat about 2018 after sales rose 13.3% and EBITDA 15.1% in 2017 despite the non-renewal of a contract with Temco in the US. 

Convertibles 

There were three new deals on the primary convertible market. In Europe, Germany’s Shop Apotheke Europe, an online pharmacy, raised €75m with a 5Y 4.5% coupon convertible to fund acquisitions. In Korea, LG Chem issued a double tranche 0 coupon 3Y convertible for €315m and $220m to go on overseas investments. In Japan, Sapporo Holdings, a beer and spirits company, issued a JPN 20bn zero coupon 3Y convertible bond for refinancing purposes. 

In earnings news, Pierre et Vacances posted a better-then-expected 7.5% rise in second quarter sales thanks to strong winter and Easter weekend bookings. The shares rose 7% on the news. 

In M&A, IHH Healthcare is reportedly offering $1.3bn to acquire India’s Fortis Healthcare, topping a TPG-backed consortium bid. The CEO of French biotech company Genfit said that the company was open to a takeover or an alliance with the right partner to market Elafibranor, currently in phase III trials, which could treat patients suffering from non-alcoholic steatohepatitis or NASH. IAG bought a 4.61% stake in Norwegian Air and is considering a bid for this low-cost rival on the profitable North Atlantic market. Aperam announced the acquisition of the special stainless-steel company VDM Metals for €438m; its credit rating was subsequently put at BBB- by S&P. Russian Polyus offered to repurchase up to 50 million of its outstanding convertible bonds as market volatility after US sanctions had created an opportunity for balance sheet management. In an attempt to strengthen its balance sheet after the accounting scandal, Steinhoff sold a 6% stake in Steinhoff Africa Retail, raising around €250m.

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