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An optimistic start to 2017

Market analysis - 1/6/2017

The start to 2017 extended the upbeat trend seen in December 2016. This last week provided confirmation of an improvement in economic momentum.

PMI data across the globe surprised on the upside whether in manufacturing or services. At the same time, the reflation theme gained traction with Eurozone inflation moving back above 1%. Germany even saw prices rise by 1.7% year on year. The FOMC minutes also confirmed that the US economy was doing well while stressing the committee's concerns over the upcoming Trump team’s monetary policies.

Equity markets chose to cheer ongoing reflation and improving economic traction. US equities gained more than 1.4% in local currency with the Eurozone and emerging markets adding close to 1% and 2% respectively. Rotation into cyclicals continued, particularly in Europe. Note, however, that opportunities began to emerge in other undervalued sectors. Healthcare, for example, had a good week.

But interest rate moves varied somewhat. In line with the strong US dollar, yields on 10-year US treasuries gained 10bp while the German Bund added 6/7bp. Peripheral country yields saw wider variations, rising by 12-15bp.

Against this backdrop, we are still upbeat on the upside for equities. As far as geographical allocation is concerned, the Eurozone should continue catching up due to realistic expectations of earnings increases, attractive valuations and the fact that international investors are underweight the zone. As for international equities, we prefer a more thematic approach focusing on banks, energy/commodities, infrastructure and healthcare. On bond markets, we remain neutral on US duration, positive on inflation-linked bonds in Europe and we are still positioned midway on the European yield curve. Note that we have maintained exposure to Greek sovereign debt but have reduced positions on German 2-year bonds.

  European equities

Markets trended higher for the first week of January in light trading. Upbeat services and manufacturing PMI in the Eurozone suggested the economy was still recovering. The most cyclical and discounted sectors led gains as the pace of inflation picked up. Telecoms throughout Europe outperformed the most. Autos had a strong end to 2016 and a good start to 2017. December car registrations in France rose 5.8%, taking full-year gains to +5.1%, and the trends were similar in Europe and the US, a good point for European car manufacturers. In relative terms, however, Renault suffered from a high basis for comparison in December 2015 while Peugeot benefited from the launch of the 3008. Fiat Chrysler Automobiles (FCA) led the field in December and German car makers enjoyed double-digit growth. Bank stocks also continued to gain ground.

In a thin week for company news, Sanofi was hit after a US court banned the sale of its Praluent drug. Elsewhere, Boehringer Ingelheim and Sanofi's animal health subsidiary Merial completed the asset swap agreed in December 2015. CGG saw heavy selling on news of a hefty financial restructuring. Ryanair posted strong 20% growth in passenger traffic in December and its load factor advanced from 91% to 94%. Sales remained robust due to lower fares. Iran has picked a number of European majors like Shell, Eni and Total to take part in oil and gas projects. Nestlé appointed Ulf Schneider as its new CEO after a transition period of 4 months with the current CEO Paul Bulcke. The market is hoping for a complete revamp of the group’s product portfolio to reinvigorate growth momentum. 

  US equities

US indices started the year in style with the S&P500 up 1.3% and the Nasdaq hitting a new all-time high. The VIX volatility index revisited its 2016 lows.

Manufacturing ISM in December rose from 53.2 to 54.7, a 2-year high. The composite index came in at 57.2.

In a sign of the shifting political landscape, Ford cancelled investment projects in Mexico and relocated production units to within the US. This was probably due to Donald Trump criticising General Motors. Then on Thursday, in another tweet, the President-elect threatened Toyota with heavier import duties if the group maintained its development plans in Mexico.

Healthcare, consumer discretionary and materials led advances while consumer staples and utilities lost ground.

  Japanese equities

On January 4, Japanese equity markets started the first trading day in 2017 on the front foot. The TOPIX and Nikkei rose 2.4% and 2.5% respectively on expectations of a gradual recovery in the global economy spearheaded by the US and optimistic earnings growth estimates in Japan. Investors reacted positively to US manufacturing data in December and the expected effects from the Trump administration’s accommodating policy, including corporate tax cuts and deregulation. In addition, Japanese firms are expected to benefit from the current level of the yen against the US dollar (118).

The top gaining sector was Marine Transportation (+5.4%). Insurance and Banks also climbed 4.2% and 3.5% respectively, while Mining alone dipped -0.8%.

Toshiba rebounded by 12.3%, after a 42% loss in the previous week triggered by an accounting scandal in its US nuclear power generation business for 2015. INPEX Corporation, an oil & gas developer, shed 1.1% on worries over an oil price correction amid rising US inventories. 

  Emerging markets

Another solid weekly performance across emerging markets, with the exception of Turkey which was hit by a terrorist attack. Hong Kong, the Philippines, Brazil, Thailand and Shanghai were the best performing markets, all up 2% or more week on week.

China performed well on notable appreciation of both its local CNY and offshore CNH. The combination of a lower US dollar, thanks to a less aggressive FED, and, at the same time a less dovish stance from its central bank, the PBoC, which is no longer expected to cut rates this year, were contributing factors. In addition, with the Chinese New Year only two weeks away, the PBoC does not want to risk higher volatility in liquidity and FX at a time when mainlanders are withdrawing and spending huge amounts of cash. Strengthening the CNH and raising the cost of shorting the CNH overnight (now costing 30%) to dissuade raiders, are pre-emptive measures to ensure peaceful festivities monetary wise. This has reassured the market.

The State Bank of India’s decision to cut benchmark lending rates steeply has prompted other state-owned lenders to follow suit. A least four other large and mid-sized public sector banks and one private lender announced rate cuts at the beginning of the week. Flush with low-cost deposits, the central bank cut its marginal cost of lending rate, or MCLR, by 90bp, across all maturities. Bank shares reacted negatively at first but are now recovering on expectations of higher loan volume to offset lower spreads.

Brazil performed well despite rather weak industrial production data in November. But the market focused more on the positive aspects with capital goods production expanding 2.5% month on month.

Mexico was impacted by Ford’s cancellation of a planned new auto facility after a tweet from Donald Trump. As a result, the Peso lost 2% despite central bank intervention. Elsewhere, business confidence and PMI manufacturing both fell in December.

In company news, Samsung Electronics released strong 4Q prelim profits, at KRW 9.2 trillion,  a massive beat compared to the 8 to 8.2 trillion expected. Details are still pending but we suspect the memory division was very strong. It is likely that the smartphone division also made more than the KRW 1.2 trillion which was based on the galaxy Note 7 disaster. We presume Samsung managed to fill the gap with higher sales of its Galaxy S7 Edge which offers a similar design. The weak KRW also helped. Management will discuss 2017 guidance on January 24th. 

  Commodities

Brent crude traded between USD 56 and 58, managing to move above USD 58 intraday for the first time since July 2015. Prices reacted favourably to the first indications that producers were complying with the output cuts agreed on November 30. OPEC-member Kuwait, for example, reduced production by 130,000b/d to 2.75 million on January 1st. Iraq also cut exports by 210,000 b/d on the same day while Oman (non-OPEC) told its clients that deliveries would be reduced by 5% in March. Russian production came to 11.2 million b/d in December, +3.8% over a year but stable compared to November. Libya, which is not party to the agreement due to its recent problems, is moving back into play and currently producing 700,000 b/d compared to 685,000 in December and 600,000 in November. The government was hoping to hit 900,000 b/d by the end of 2016 but resumption of production proved more complicated than expected.

Elsewhere, manufacturing picked up in December according to PMI data. The aggregate 16-country indicator showed that global manufacturing had improved 0.5 points to 52.6 since August 2014. This augurs well for future demand for metals. Note, however, that December’s improvement was driven by developed countries like the US and the Eurozone while emerging countries slipped back a little. Metals like copper and nickel are benefiting from this lift in demand as well as US dollar weakness following indications in the FOMC minutes that the Fed is likely to be cautious over the pace of interest rate rises. This also sent the gold ounce higher to close to USD 1,180, an increase of 4% on its December 2016 lows. 

  Corporate debt

Credit

The new issues market reopened on fine form with a number of deals in financials and investment grade bonds. French banks issued senior non-preferred debt, essentially in US dollars, following the passing of the so-called Sapin 2 act in December. In Italy, Intesa SanPaolo reopened the Additional Tier 1market by raising EUR 1.25bn at 7.75%.

In investment grade, Berkshire Hathaway raised EUR 1.1 bn over 4 and 6 years at 25bp and 62.5bp respectively. In Europe, PSA Peugeot issued a 3-year maturity at 50bp. Spreads stabilised at rather low levels in Europe with the Xover at 289 and the Main at 69.

In company news, CGG announced the appointment of an ad hoc director to work on cutting debt levels. Vodafone and Liberty Global completed their Dutch joint venture project at the beginning of January. In regulatory news, the Basel committee postponed its meeting of the Group of Central Bank Governors and Heads of Supervision (GHOS) which was scheduled for January 8 and meant to discuss revising Basel 3. No alternative date has yet been fixed. 

Convertibles 

Newsflow was a little light in this holiday-shortened week. Nonetheless, Convertible Bonds primary activity has already burst into life with two repeat issuers tapping the market. In Europe, the first deal of 2017 came from French tyre manufacturer, Michelin.  The company, which recently had a previous CB issue redeemed, issued USD 500m in dollar-denominated, non-dilutive convertibles with a 0% coupon and at a 28% premium. The proceeds are expected to be converted into euros and used for general corporate purposes. Elsewhere, US Real Estate Investment Trusts, Colony Starwood Homes priced a USD 345m maturity at 3.5%, using the proceeds to pay down existing facilities and for “opportunistic” acquisitions.

In convertible universe news this week, Dassault Aviation released its order intake, deliveries and backlog data as of the end of 2016. Unsurprisingly, the business jet market is suffering with 21 net new orders for the company’s Falcon jet compared with 25 in 2015.  However, the outlook is more positive in defence where the Rafale business took the lead with 36 new orders thanks to the Indian government contract.  In the US, Tesla announced Q4 deliveries that came in below estimates at 22,400 vehicles owing to what management characterised as “short-term production difficulties”; this is the third successive year that Tesla has missed FY delivery targets.  Nonetheless, the market was cheered by the news that the company had also begun battery cell production at its Gigafactory in Nevada.

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