The earnings season is in full swing

Market analysis - 1/27/2017

Donald Trump’s inauguration speech was in similar vein to his electoral campaign. His initial decrees will press for reduced regulation and higher infrastructure spending (Obamacare reform, rekindling of the USA-Canada pipeline project) but also more protectionism via the construction of a wall with Mexico and the cancellation of the Trans-Pacific Partnership.

Investors initially reacted negatively to lower interest rates and the stronger US dollar against the Yen and equities also fell on fears over the rise of protectionism. But then they chose to see the positive impact from higher growth and inflation. The Dow Jones broke through the 20,000 mark to reach fresh all-time highs. Markit’s upbeat manufacturing PMI for the US (+0.8 points to 55.1) pushed cyclicals centre stage again.

European indicators were equally encouraging, especially in France where the composite index rose from 53.1 to a 5-year high of 53.8.

But a decision by Italy’s constitutional court opened the door to early parliamentary elections and political risk in France weighed on both countries’ government bond yields. Portuguese yields also widened sharply compared to the Bund while Spanish debt benefited from strong buying. The earnings season is in full swing. The good news is that all regions are growing and most companies have beaten estimates.

We continue to focus on equities rather than bonds in our diversified portfolios. We have turned positive on the US dollar following consolidation in recent weeks. We have reduced emerging country equities and upped exposure to Japanese equities which will benefit from the stronger US dollar and Japan’s improving economic environment. Emerging markets, on the other hand, are expected to suffer from political uncertainty in the US. In bonds, we have increased curve-steepening positions in the US. 

  European equities

European markets rose amid a rash of earnings reports although the mood was ultimately dominated by actual or rumoured M&A deals.

In Italy, financials were actively traded after press reports suggested Intesa and Allianz could jointly bid for Generali.

Intesa then admitted it was looking into an industrial tie-up with Generali which reacted by immediately amassing 3% of Intesa’s voting rights in an attempt to block a hostile bid. This move will prevent Intesa gradually building up a stake in Generali but will not offer protection in the case of a bid for at least 60% of the insurance company. Investors are now wondering what a deal might mean for Mediobanca which owns 13.04% of Generali and UniCredit which is Mediobanca’s biggest shareholder with almost 9%.

Elsewhere, Deutsche Bank is said to be mulling listing part of its asset management unit.

In pharma, after a series of twists and turns, Johnson & Johnson is acquiring Switzerland’s Actelion, a specialist in pulmonary arterial hypertension. Johnson & Johnson’s first approach in early December was rebuffed and it abandoned the race, leaving Sanofi to make a counterbid which also failed. The final deal values Actelion at close to USD 30bn.

In company results, LVMH had an excellent fourth quarter with like-for like growth up 10% or more than expected. Diageo also had a good quarter but Unilever suffered a slowdown in growth at the end of 2016. 

  US equities

US indices pushed to even higher records as the Dow Jones broke through the 20,000 mark for the first time and the S&P briefly moved above 2,300. Macroeconomic news played second fiddle to Donald Trump’s comments and the ongoing quarterly earnings season. New home sales for December came in at 536,000 -well short of the 588,000 expected- and inventories rose 1%.

161 companies have now reported fourth-quarter results and 120 have done better than expected while 38 have missed consensus figures. Comcast posted upbeat figures and also increased cash amounts returned to shareholders. Google appears to have disappointed the market due to an exceptional loss on equipment but website sales rose 23% or at the top end of estimates. Microsoft pleasantly surprised the markets thanks to revenues in its cloud business Azure which soared by 95%.

The move on 10-year Treasury yields above 2.5% proved beneficial for low duration sectors. Financials and commodities led performance while bond proxies like telecoms, healthcare and utilities were the worst performers.

  Japanese equities

Japan’s stock market tracked US markets higher as the Dow Jones broke through 20,000 for the first time. The TOPIX rose 1.1% due to improving investor sentiment on a brighter outlook for global growth and sound US corporate earnings growth. The yen edged 0.8% higher against the US dollar but was flat against the euro.

The best-performing sector was Insurance (+3.8%) while the Mining and Electric Power & Gas sectors lost 3.8% and 2.9% respectively.

SMC Corporation, which sells pneumatic and electric automation equipment to various industries, jumped 10.4% after Donald Trump criticised Toyota. SMC is expected to enjoy a rise in orders from Japanese companies which are upping investment in US factories. Keyence Corporation, which specialises in factory automation products, also climbed 6.3%.

On a negative note, Kansai Electric Power lost 5.3% on a Goldman downgrade from neutral to sell which cited the testing business environment for nuclear power generation. 

  Emerging markets

Emerging markets posted solid returns this week, thanks, in part, to the weaker US dollar. Despite the approach of the long Chinese New Year holiday when markets will be closed, Chinese stocks added to gains. Brazil followed suit: inflation fell below 6%, a level not seen since March 2014, leaving ample room for the central bank to cut rates further.

Of note this week was the sharp rebound in both the Mexican peso and the country's stock market. We expect volatility in Mexico market to continue given increasingly tense relations with the US. Nevertheless, the current account deficit has stabilised due to a slowdown in imports and is making Mexico an even more attractive production hub. Value is starting to emerge on the Mexican stock market.

In company news, various leaders released encouraging figures. Alibaba’s fiscal third quarter for FY 2017 (the fourth quarter of 2016) saw revenues rise 54% to USD 77bn, or more than expected while net income jumped 36% to USD 3.3bn. The company has revised up its revenue growth guidance for fiscal 2017 from +48% to +53%.

Elsewhere in China, TAL Education, a leader in the highly fragmented after-school tutorial services segment, both offline in classes and online across China, reported a 83% surge in its fiscal 2017 third quarter revenue to USD 260m. Student enrolment jumped 75% YoY and net income came to USD 31.1m. The group added 52 new learning centres during the quarter.

In India, HDFC Bank reported another clean set of results with stable NIM and asset quality while earnings rose on further cost-cutting efforts. This is further evidence that demonetisation and credit rate cuts by banks have had no major negative effect on business conditions. 

  Commodities

Donald Trump's first actions as US president will effectively mean more protectionism and that should lead to a stronger US dollar. His Border Tax Adjustments will increase WTI crude prices compared to the international Brent crude standard. Pro-oil industry measures include an executive decree to rekindle two emblematic pipeline projects which had been put on hold. Keystone XL (which will only be operational after 2020) will facilitate the transport of Canada’s heavy crude oil to Texan refineries while the Dakota Access Pipeline, which is 90% complete, will link the Bakken basin in North Dakota to the same refineries.

OPEC countries will be closely watching to see if any measures affect their oil exports. In the meantime, they have made encouraging production cuts and have attained 80% of the targeted cuts. Some like Saudi Arabia, Algeria and Kuwait have even gone beyond scheduled cuts (although Iraq is running late). This is good news as Libyan production is now back and has reached 715,000 b/d, a level not seen since 2014, although it is still a long way off potential output of 1.2 million b/d.

Meanwhile, BP’s annual report of energy mix trends has confirmed the rise of gas and renewable energies, primarily at the expense of coal. The report goes on to say that by 2035 oil demand should be rising by 0.7% a year, gas by 0.6% and renewable energy sources by 7.1%. Coal is expected to be declining by 0.2% a year. There are currently 1.2 million electrical vehicles but by 2035 this should rise to 100 million. The impact on oil demand is expected to be limited as combustion-powered vehicles are seen doubling to 1.8 billion units. The biggest impact on oil demand could come from users making shorter trips and much greater reliance on car sharing and pooling.

2016 was calm on copper markets: 3 new mines came on stream and there were few production stoppages. 2017 could be exactly the reverse: not much new capacity is planned but we could be in for some serious strikes due to a flurry of wage renegotiations, notably at Escondida, the largest mine in the world (1 million tonnes and 5% of global output).  

  Corporate debt

Credit

January ended on the front foot both for new corporate debt and financial bond issues. The Itraxx Main and Itraxx Over were once again relatively flat with the latter widening by just 4bp over the week. German yields increased sharply as the Bund and the Bobl rose by 9 and 8bp respectively to reach 0.47% and minus 0.36%.

In new corporate bond issues, CGG sold a tap on its USD-denominated 2021 maturity in exchange for reduced commitments on future rentals on 3 ships. B&M (BB-/Ba3) sold a GBP 250m 5-year NC2 bond. Portugal’s Energias (Baa3/BB+) raised EUR 600m with a 2023 maturity at 1.875%. The issue was much in demand and the order book ended at EUR 2.5bn. Kernel (B/B+) raised USD 500m with a 2022 maturity at 8.75%.

In financials, Crédit Suisse issued a Perpetual NC5.5 USD1bn 7% transitional CET1 trigger equity conversion and Banco Santander a EUR 1.5bn Tier 3 bond at 1.375% due 2022.

In M&A, the Canada’s PSP and Switzerland’s Partner Group are reportedly paying EUR 1.8bn for PAI Partners’ stake in Cerba Healthcare. UK retail giant Tesco said it had reached an agreement to buy wholesaler Booker in a deal which values the target at EUR 4.4bn. The resulting entity will be an essential player in the retail and wholesale businesses. 

Convertibles 

Earnings were in focus this week as full-year 2016 reporting kicked off in earnest. Highlights among our convertible bond issuers included ST Microelectronics, which announced unexpectedly strong revenue growth and gross margins supported by strong demand from Apple and automakers. LVMH also put in a very strong showing across all of its divisions which points to a revival across the broader luxury sector.

In Asia, Nanya Technologies reported stronger-than-expected fourth quarter sales on improved DRAM memory product pricing, allowing it to comfortably absorb costs from its transition to next-generation production technology.

In the US, cloud software provider, ServiceNow, beat 2016 expectations and raised guidance on 2017 revenues and billings. However, on a less positive note, infrastructure software provider, Citrix Systems, sold off sharply as strong 2016 performance was offset by cautious 2017 guidance.

In other news, shares of Charter Communications surged on speculation that it could be the subject of a takeover bid from Verizon which would create the number one internet access and number three TV provider in the US. Meanwhile, rival operator, Dish Networks, which some thought Verizon was eyeing, fell sharply.

With the market focused on earnings, primary activity was muted with just three deals including one from US business development company, Ares Capital, which issued a USD 350m, IG-rated, 5-year bond with 3.75% coupon and at a 15% premium. Nevertheless, with two trading days of the month still to go, new issuance has already reached USD 6.2bn so far in January 2017 compared with USD 3.2bn for the entire month of January 2016.

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