The ECB tempers market enthusiasm

Market analysis - 12/01/2018

This new year market rally looks like the replacement for the end-of-year rally which failed to materialise. 2018 earnings growth estimations across the globe look solid thanks to a synchronised improvement in macroeconomic conditions.

And this week's data can only fuel the euphoria with eurozone industrial production up 3.2% and Germany's GDP coming in 2.2% higher. 

Meanwhile, the minutes from the ECB’s December meeting suggest monetary policy will have to change to reflect accelerating economic growth, and guidance will now be focused more on benchmark rates. Even so, the ECB wants to remain cautious so as not to jeopardise financial conditions and prevent inflation moving up to its 2% target. Elsewhere, Germany’s political horizons cleared after an agreement between the SPD and CDU parties on a government coalition. In the US, tax reform is likely to prolong the current cycle and lead to earnings upgrades for US companies. The looming results season will give us a clearer idea of revisions for 2018 and 2019. 

Bond markets appear to be endorsing this growth environment with US Treasury yields camping above the symbolic 2.5% level and German Bund yields moving above 0.5%. In Europe, 2017 saw an estimated 31% bound in financial sector earnings and an 85% surge in oil and commodity sector earnings. We continue to believe that earnings growth will now spread across all sectors and are consequently starting 2018 by once again focusing allocations on European and Japanese equities. 

  European equities

European equity gains evaporated at the end of the period after the ECB minutes suggested monetary policy would soon have to change to reflect improvements in the economic situation, and following indications that China might be less inclined to buy US Treasuries. The euro reacted by moving above 1.2 to the US dollar and bond yields continued to rise. 

As a result, interest rate sensitive sectors like utilities, telecoms and property fell while financials rallied. The oil sector also gained on oil price strength. 

In an active week for corporate transformation news, Kering said it wanted to spin-off 70% of its 86.3% Puma stake to its shareholders. The move would make Kering a pure player while Puma would have a free float of around 55%. 

Carrefour is to buy the 17% stake in on-line retailer Showroomprivé owned by Conforama, a subsidiary of South Africa’s Steinhoff. Carrefour might also lease 5 French stores so as to save on wages. Continental confirmed that it might become a holding but with some listed entities so as to be more flexible as consumers increasingly switch to electric and driverless cars. The group also released solid preliminary figures for 2017 and issued guidance that was slightly higher than expectations. 

NH Hotel rejected a bid from Grupo Barcelo but said it was still prepared to examine other strategic opportunities. Altice said it was to spin off its US and European businesses into Altice Europe and Altice USA. An exceptional $1.5bn dividend will then be paid to Altice USA shareholders. Altice Europe will use $625m of the $900m from its share in this dividend to repay part of its debt.

Sanofi said it wanted to step up acquisitions in 2018, targeting rare diseases, vaccines, diabetes and self-medication. Melrose made an unsolicited bid for GKN which was rejected by the target's board for being too low. GKN appointed a new CEO, thus opening up the possibility of a fresh bid, a new buyer or a group spin-off. 

  US equities

US equities remained upbeat as the January rally continued. There was no major economic news over the period and figures on small and medium sized company confidence and import as well as production prices held no surprises. Inflation is still the big missing ingredient and company morale remains high. Once again, Donald Trump’s unpredictable plans for NAFTA were showcased in his most recent comments. 

It was also a calm week for company news, pending JP Morgan’s launch of the quarterly earnings season on Friday January 12. But Walmart said it was going to raise the minimum wage for its US employees by 10%. 

In tech, the crisis at Intel, which, along with Samsung, is one of the world’s biggest semiconductor companies, worsened after it was revealed that CEO Brian Krzanich had sold stock worth $25m in full knowledge of the security flaw issue and the termination of the R&D partnership with Micron, but before the news for both was properly made public. Facebook unveiled a major revamp of its news threads. Content from a user’s family, friends and contacts will get preference over links, texts and videos from media outlets, companies, institutions and ONGs. 

Over the last five trading sessions, industrials, consumer discretionary and financials led advances. Property and telecom stocks suffered severe falls.  

  Japanese equities

A strong start to the New Year took Tokyo to a 26-year high last Tuesday but markets fell back as the Yen strengthened and concerns mounted that the Bank of Japan might only make a mild adjustment to monetary policy. Over the week, the TOPIX gained 0.41% but failed to stretch more as manufacturing growth stocks paused over demanding valuations, helping value plays outperform.

By sector, the best performers of the week included Real Estate (+4.30%), Mining (+3.98%), Oil & Coal (+2.94%), Pulp & Paper (+2.35%) and Marine Transportation (+2.21%). In individual stocks, two real estate giants, Sumitomo Realty & Development and Mitsui Fudosan gained 8.52% and 5.82%, respectively, and Oriental Land put on 5.54% as investors focused on what would be an undervalued sector if JGB yields were only to rise moderately. 

On the other hand, Precision (-2.28%), Foods (-1.76%), Metal Products (-1.03%) and Retail Trade (-0.99%) underperformed. Breweries Kirin Holding and Asahi declined 5.08% and 4.50%, respectively. Asahi said sales of its key Super Dry beer product fell to a 29-year low on tougher competition with less-expensive third category beers. Hoya, an optical glass producer for semiconductor manufacturers, sank 4.12%. 

  Emerging markets

Chinese macro data remained encouraging with higher-than-expected exports in December, a mild increase in consumer inflation to 1.8% and with PPI at 4.9%. The PBoC removed the countercyclical factor in calculating the renminbi’s daily reference rate, which is a strong move towards floating the currency. Moderate M2 growth, new aggregate financing and outstanding RMB loans all point to effective deleveraging. Elsewhere, Chinese airlines will be able to set their own fares on more than 300 domestic routes after the aviation regulator further freed up prices in its attempt to reform the world's fastest-growing civil aviation market. Largan’s earnings rose 2% YoY, or lower than expected, and management warned of falling revenues in January and February. 

In Brazil, truck production surged 81.3% in December. For the full year, car and truck production rose 25% and 37% respectively. Brazil and China are taking strong measures to keep their debt level under control, but S&P clearly does not agree and has just downgraded Brazil from BB to BB-. 

In Argentina, inflation was at 24.8% in December, mainly due to increases in energy prices as well as a 3.1% rise in consumer prices. Even so, the central bank cut the policy rate by 75 bp to 28% but revised its inflation target upwards from 16.6% to 17.4%. In India, IndusInd Bank reported 25% YoY profit growth with stable asset quality (1.2% in gross NPLs) and 25% loan growth. Tata Consultancy saw EPS slip 1% due to sluggish demand from the Banking and Financial Services segment. Shree Cement’s results were higher than expected with EBITDA rising 16%. The company took a 92.8% stake in Union Cement Company in the UAE for $305m in enterprise value and the acquisition should be earnings enhancing.  

Commodity exporters have starred so far in 2018, especially in Russia, due to higher oil prices. Commodity and oil price fluctuations have a significant influence on current accounts and thus on currencies, so we will be closely monitoring the currencies of commodity importing countries. 

  Commodities

Given the trend in recent weeks, it was almost inevitable that Brent crude would break above $70. This duly occurred on January 11, for the first time since December 4 2014, although the price closed below that level. (Back in 2014, the price was actually moving downwards, after trading at $100 six months earlier, and was heading for a $40 low). 

Some of the factors behind recent strength, such as pipeline stoppages in Libya and in the North Sea Forties field, have now been resolved and social unrest in Iran seems to have abated, or at least no longer dominates the headlines. The big short-term uncertainty is the fate of the Joint Comprehensive Plan of Action (JPCOA) on Iran’s nuclear programme. Last October, Donald Trump failed to certify the quarterly agreement but stopped short of ending it. The next approval date is January 18 and there is a risk of fresh US sanctions.

At this stage, the impact is largely psychological, and it would be premature to start talking about any damage to Iran's oil exports. Nevertheless, the news, along with the icy spell on the east coast in the US, has resulted in traders amassing buy positions in historically high volumes. However, unless the Iranian issue worsens, the next development should be profit taking. 

In China, sales of electric cars in 2017 jumped by an impressive 53% to 777,000 (84% of which were entirely electric and the rest hybrid models). This maintains China’s position as a major player in transport electrification. Nevertheless, compared to the 27.7 million vehicles sold in China last year (a rise of 1.4%), this is still a modest performance although the electric car market share rose to 1.9%, up from 1.2% in 2016. The overall sales data explain why China became the world’s biggest oil importer in 2017, with volumes up 10% to an average of 8.43 million b/d. According to the IEA, Chinese demand for oil should only peak at the end of the 2020s.  

  Corporate debt

 

Credit

This week's rise in the German bond yield curve interrupted the strong start to the year. The IG index lost 0.1% while High Yield ended the period flat. But the new issues market revived with Italy’s Monte dei Paschi raising €750m in Tier 2 debt at 5.375%. 

Elsewhere, Exor, the Agnelli family's Italian holding company, and the biggest Fiat shareholder, raised €500m with a 2028 maturity. In high yield, and pending a return to a more dynamic new issues market, Irish packaging company Ardagh issued $350m in a very subordinated PIK bond at 8.75%. The proceeds will be used on exceptional payouts to shareholders.

Convertibles 

The primary market remained very busy with five new deals. There were two new deals in Europe. A newcomer to the convertibles market, Spanish wireless infrastructure operator, Cellnex, issued an 8Y 1.5% €600m convertible for new acquisitions. Repeat issuer, Swiss Prime Site (a REIT) came to market with a 7Y 0.325% CHF 300m convertible for refinancing. 

In the US, there were also two deals. Coupa Software, an expense management software company, issued a 5Y 0.375% $250m convertible to fund potential acquisitions. Elsewhere, Exact Sciences Corp, a molecular diagnostics company, announced a 7Y 1% $500m convertible bond for working capital purposes. And in Japan, repeat issuer, Shizuoka Bank, issued a 5Y $300m floating rate convertible at Libor-50 bp to fund US dollar loans. 

In company news, Belgian biotech company Ablynx soared 71% this week as Novo Nordisk unveiled a hostile takeover bid at €30.5 a share in cash, valuing the target at €2.6bn. 

However, Ablynx’s board rejected the bid on the grounds that it fundamentally undervalued a company with 45 proprietary and partnered programmes. Investors seemed to agree as the stock was trading at €36.3, or well above the bid. The market expects a counterbid from one of Ablynx’s partners, a list which includes Sanofi, Merck and Abbvie. 

Elsewhere, Bayer continued to sell its stake in Covestro, placing 10.4% of the capital at €86.25 for a total of €1.8bn. Ports operator, DP World, was up more than 6% during the week on confirmation by the CEO that the recovery in 2017 would be stronger than expected and that the trend should continue in 2018. 

In the US, Illumina, a leader in genetic sequencing equipment, released its 2018 forecast, beating estimates ($3.12bn in revenues versus $3.09bn expected); the stock gained as much as 6.5% on the news. Steinhoff sold its stake in Showroomprive to Carrefour for a total consideration of €79m and is considering early redemption of ZAR-denominated MTN notes at the Steinhoff Services Limited level.

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