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Equity markets push higher

Market analysis - 3/17/2017

Equity markets rose for the second week in a row with Europe and some emerging markets leading the trend.

The headline events were the Dutch parliamentary elections and the Fed's decision to raise rates by 25bp. Holland’s election results reassured investors over any spread of populist sentiment in the wake of the Brexit vote and Donald Trump's election. The Fed also scored a communications victory by raising rates without worrying markets about the possibility of faster monetary normalisation. This left markets basking in a favourable interest rate environment, allowing them to benefit from upbeat economic data and rising expectations of corporate earnings.

The Michigan consumer confidence index and the Conference board’s advanced indicators will tell us whether the US economy is still on a healthy trajectory. Markets still face political risk in France as well as in the US where the new administration’s budget intends to cut spending across the board with the exception of defense. Rolling out this programme will trigger fierce debates, especially over healthcare and research.

  European equities

European indices rose while mining stocks made spectacular gains on the Fed’s rate hike and a commodity price rebound. Anglo American led sector gains after an activist investor bought a stake.  Telecoms also trended higher after Telefonica and Vodafone reached an agreement on the fibre market.
More than 90% of companies have now reported results. 66% of MSCI Europe stocks beat sales expectations, a sign that confirmed top-line growth in a good many sectors, while 56% beat earnings consensus estimates.

In this week’s results, Innogy’s figures were in line but debt levels and the dividend payout were both much better than expected. Lufthansa’s fourth quarter 20116 was encouraging with a beat from EBIT and positive 2017 guidance. Zodiac, however, issued an umpteenth profit warning (its 10th?) on like for like second quarter figures which fell 2.5% due to the seating division’s problems with UK production since the end of 2016.

Elsewhere, Amundi launched a EUR 1.4bn rights issue to fund its acquisition of Pioneer. Crédit Agricole (which holds 75% of Amundi) will take up most of its rights to end up with 70% subsequently.

  US equities

The S&P edged higher this week to above 2,300. Last week’s strong 227,000 increase in private sector jobs, and this week’s news that CPI was running at 2.7% YoY, underpinned the Fed's recent indications to the market. Benchmark rates were upped by 25bp to 1%, the highest level since December 2008.

In Donald Trump’s first budget, spending on defense will, as expected, rise by USD 54bn.  In contrast, the money allocated to the Federal medical research programme via the National Institutes of Health will fall by close to 20% (USD 5.8bn) to 26bn. Unsurprisingly, the new president is targeting a sharp fall in spending on diplomacy (down 28% for the Department of State) as well as in international aid and climate change programmes.

This week’s best performing sectors were property and consumer staples which were buoyed by a decline in long bond yields. Financials, however, suffered a correction.

 Japanese equities

The TOPIX ended the week 1.2% higher. Sentiment was slightly affected by the US rate hike and the BoJ’s Monetary Policy Committee but prices moved within a narrow range as both events were expected. The BOJ left its current monetary easing stance unchanged as inflation has stabilised and is still far from its 2% target and the bank thinks the economy is still on a moderate recovery trajectory. The yen rebounded to 113 against the US dollar on Friday after the Fed’s rate hike.

The best performing sector was Air Transportation (+3.5%), led by ANA Holdings. Japan’s biggest airline gained 5% on expectations of cost reductions from lower fuel prices due to the declining oil price.

Mitsubishi Heavy Industries jumped 11.1% after the International Chamber of Commerce set lower-than-expected compensation for the shutdown of a US nuclear plant.

On a negative note, the Iron & Steel sector lost 3%. Nippon Steel & Sumitomo Metal Corporation and JFE Holdings dropped just over 3% on weaker-than-expected machine orders in January.

  Emerging markets

Equities on GEM markets posted strong performance. HK listed China, Argentina, Poland and Chile all gained more than 3% over the past 5 days, a trend reinforced by local currency strength against the US dollar and several significant local developments. 

Brazil added a net 35,000 jobs in February, the first rise in almost 2 years. This still represents the green shoots of recovery on the labour market but with today’s 12.5% unemployment it marks another positive turnaround signal. Moreover, Moody’s raised its country outlook from negative to stable citing an improvement in the policy framework. On a negative note, the government’s legal case on corporate tax calculation was rejected by the Supreme Court. The resulting shortfall in tax revenue is expected to be USD 6.5bn. The government will appeal, but will probably lose again, so it may have to increase tax on certain sectors to offset the liability.

Korea’s market reacted positively to the impeachment of President Park. There will be new elections within the next 60 days. The favourite is the opposition leader Moon Jae-In who is in favour of a closer relationship with China and wants to reform the so-called Chaebol conglomerates which are often criticised for acting like a “State within the State”. Listed Korean companies with significant business in China rose on the news this week.

In India, Prime Minister Modi’s BJP party triumphed in the Uttar Pradesh State election, winning 312 seats in the 403-member assembly, up from 47 in the previous election in 2012. The result is seen as strong approval of Modi’s policy which includes opening up the country to more foreign investment and seeking to introduce a goods and services tax. The market rose by more than 2% and the rupee ended the period 2% higher.

Asian insurer AIA had to let the group’s valuable CEO, Mark Tucker, go. He is joining HSBC as chairman. The stock fell on the news but should recover as Ng Keng Hooi was quickly confirmed as a replacement. Mr Ng has been working with Tucker for more than 20 years and was effectively the number two in charge of key markets like China, Thailand and Indonesia and also supervised the agency channels.

Hong Kong listed Samsonite (American Tourister & Lipault brands) saw revenues increase by a strong 15.5% YoY (17.3% YoY on constant currency basis excluding the recently acquired high-end Tumi brand) and its net profits jumped 29.4% YoY. There were clear signs of sales picking up speed in the second half of in 2016, especially in Europe and Latin America. Management is optimistic about FY 2017 which will see the integration of Tumi, a brand which should contribute 30% of the company’s total profits by FY 2018.

  Commodities

Has volatility returned to oil markets or are we seeing a new price level emerging? At any rate, prices remained under pressure with Brent crude around USD 52 (down from the 56 level seen so far this year) and WTI at 49 (down from 53). OPEC output data were responsible for this fall back. Saudi Arabia said February’s production was 10.01 million b/d, which is higher than January’s 9.75 million but lower than its 10.06 million quota. Even so, markets read the news as a weakening of quota compliance.

However, the only reliable figure is that published by so-called secondary or independent sources. And they say Saudi Arabia produced 9.80 million b/d last month compared to 9.86 million in January.

There are 2 conclusions:

  1. we should be careful about judging the issue as we do not know what the precise figures are and
  2. Saudi Arabia might be sending a message to other producers that it does not want to shoulder the burden of cutting production on its own. Meanwhile, markets would like OPEC to commit to extending the cuts beyond the June 30 deadline decided in December 2016. It is, however, still too early to assess the impact on reduced output on crude oil inventories? Current OPEC production (32 million b/d) will help reduce stocks over 2017 but only if countries like Iran and Iraq do not up production and US shale output does not rebound too quickly.

As for the commodity demand picture, combining January and February data so as to smoothen the impact of China's New Year break, throws up some very positive indications for the Chinese economy. The 6.3% rise in industrial production, a 32% leap in infrastructure investments, better electricity generation (+6.3%) and an 11.5% improvement in housing starts all point to a healthy economy.

Elsewhere, the gold ounce reacted well to the FOMC’s decision on rates by rebounding back above USD 1,200. The 25bp rate hike was fully discounted but the good news was that the pace of tightening would not increase.

  Corporate debt

Crédit

High yield bonds lost ground at the beginning of the period on persistent ETF profit taking, especially in the US, and ongoing political worries over France's presidential election campaign. But prices recovered after the Fed raised interest rates by 25bp and the results of the Dutch parliamentary elections. The Xover index widened by as much as 291bp before settling at 285.
In a busy new issues market, Spie (Ba3/BB) raised EUR 600m with an unsecured 2024 maturity at 3.125% to fund its acquisition of SAG while Paprec sold a EUR 225m tap to pay for its purchase of Coved. Play Topco (B2/B+), issued EUR 500m in senior notes due 2022NC1 at 5.375% to help it pay out a dividend to shareholders. Companies continued to take advantage of low rates to refinance. First Quantum (B-/B) issued USD 1.6bn and Progroup (BB-/Ba2) raised EUR 150m. In financials, Credit Suisse raised CHF 200m in perpetual AT1 debt.

Selecta is to buy its Dutch rival Pelican Rouge, the leading coffee vending company. This will double Selecta’s sales to EUR 1.3bn with EBITDA expected to hit EUR 200m.

In France, Renault is suspected by the economic fraud watchdog to have misled customers on actual pollution emissions in its diesel engine cars. The company’s risk premium widened by 6-10bp over the week depending on maturities. BNP issued EUR 1bn in senior non-preferred bonds. Crédit Agricole said it would not be calling its Legacy 6.637% Tier 1 but in the second half of this year intended to buy it in as well as a Euro-denominated legacy CMS-indexed T1 bond and 4 legacy step-up T1 bonds.

Convertibles 

The Japanese market reawakened this week with two jumbo deals. The industrial chemicals conglomerate, Mitsubishi Chemical, issued Y150 billion in dual tranche CBs (2022 and 2024, zero coupon) for the repayment of debt, general corporate purposes and a share repurchase program.
Similarly Japanese power producer, Kyushu Electric, issued Y150 billion in 2020 and 2022 zero coupon CBs: the proceeds will be used for the construction of the Matsuura Power Station Unit, a geothermal power project in Sarulla, Indonesia and short-term debt repayment.

It was also a busy week in the US with around $3.7 billion of new primary including some well-known issuers to the market. For example, ON Semiconductor issued a $500 million 6.5-year maturity CB with 1.625% coupon; the voice recognition software company, Nuance, issued $350 million of 8Y, 1.25% CB; and, electric carmaker Tesla brought a new $750M 5Y CB along with $250M in equity issuance. The proceeds will be used to ease the near-term capital pressure for 2017 and help finance the ramp in the Model 3 coming later this year. Nonetheless, we believe the company will have to come back to the market again for more capital, probably in 2018.
Also of interest was the £2 billion mandatory exchangeable bond into Anglo American issed by Volcan Holding.  Volcan is owned by the Agarwal family who are majority owners of Vedanta, and would own 13% of Anglo’s stock making it the second largest shareholder.  There has been speculation historically that Agarwal wants to take over Anglo American. Elsewhere in Europe, SNAM, the top player in Italian gas distribution issued €400M of 5Y zero coupon CBs. In other CB-related news, Tullow Oil announced a $750 million rights issue in order to help reduce its net debt/EBITDAX to 2.5x and to increase its financial flexibility for pursuing future growth opportunities.

On the earnings side, the UK retailer, J Sainsbury, reported disappointing Q4 like-for-like food retail sales down -0.5% QoQ, but its recently acquired general retail business, Argos, showed strong results with sales up +4.3% QoQ. In China, software developer, Kingdee, reported a +23% YoY jump in revenue, aided by the strong growth in ERP and cloud sales.