Erratic trading

Market analysis - 29/03/2018

Equity market trading was erratic over the week. On the one hand, investors were reassured by this weekend’s start to talks between China and the US. China is moving towards significant concessions, opening up its domestic market and companies and striving to buy more US goods. But on the other, US tech stocks fell victim to profit taking. The Facebook affair could well mean tighter regulation, especially for lightly-regulated tech oligopolies.

Elsewhere, the fatal accident during an Uber driverless car test suggested that what is a growth driver for the tech sector could take longer than expected to gain traction. 

Long bond yields eased both in the US and in Europe, but economic data played no part in the move. Essentially technical Libor tensions had previously increased US dollar hedging costs for non-resident investors, reducing the appeal of US Treasuries. But incipient easing on Libor over the week made Treasuries look more attractive and sent their prices higher. In Europe, the ECB has been busy trying to reassure investors over future monetary tightening. Even the bank’s most ardent supporters of monetary orthodoxy are now arguing for caution over rate hikes, citing only very faint inflationary tensions. 

In Italy, talks on the formation of the new government have still not finished. It would appear that discussions between the Liga and the 5-star movement have made more progress than investors expected, although it is too early to say if they will result in a governing coalition. Both parties have gone easy on anti-euro rhetoric, allowing markets to brush off political risk and sending Italian bond prices higher. But we should bear in mind that versatility is not necessarily compatible with reliability and the determination of both parties to undo pension reform and put an end to austerity could jeopardise the current precarious balancing act. 

  European equities

European indices had a volatile week but ended higher. Trading was dominated by developments in Washington’s trade policy and US tech stocks. 

In company results, Sodexo’s lower-than-expected preliminary results came with a severe profit warning on the outlook for 2018. 

Several factors are to blame, including very varied performance in Europe, the North American market which has yet to see the benefits of recent management measures, and a performance lag in a small number of major contracts in other regions. 

H&M also released disappointing figures. Sales fell, operating margins declined by 400bp and inventories rose 8%, a reflection of soft trading and an increasing number of product returns from clients and stores.

In distribution, Casino is to team up with Amazon over food deliveries to Amazon Prime Now clients in Paris and its suburbs. This is part of Casino’s on-line strategy to counter Leclerc’s arrival in Paris and prevent its subsidiary Monoprix suffering margin erosion. 

It was a busy week for M&A. In the pharmaceutical sector, Japan’s Takeda admitted it was mulling a bid on the UK’s Shire. Switzerland’s Novartis said it was ending the 2015 OTC product joint venture with GSK and would pay GSK $13bn in cash. Canada’s Givaudan has acquired 40.6% of Naturex at a 42% premium and is expected to make an offer for the rest of the shares. In the Netherlands, Akzo Nobel has sold its speciality chemicals division for €10bn. 

  US equities

In a highly volatile week, the S&P edged higher. The Conference Board consumer confidence survey came in at 127.7, or below expectations, although it remained at historically high levels. Following the Trump administration’s recourse to section 301, the US and China are to examine their trade relations. Beijing’s initial response was measured and only covered $3bn in US imports. 

The Facebook affair deepened after Messenger users launched a class action and Mark Zuckerberg was asked to appear before the US Congress. Amid wide US press coverage of privacy protection, Citron Research said it had shorted Twitter, causing the stock to slump 12% on the day. Amazon suffered heavy selling after Donald Trump threatened to increase its taxes in an attempt to help traditional shops. Tesla fell sharply on worries over its autonomous car technology after a Tesla X driver died. 

In volatile trading, defensives outperformed with real estate up 3.3%, telecoms 3.1% better and non-cyclical consumption 2.83% higher. Energy lost 1,12%, IT 0,45%, materials 0.36% and cyclical consumption 0.31%. 

  Japanese equities

Due to receding concerns on overseas political issues, Tokyo rebounded ahead of a new fiscal year. The TOPIX gained 2.35% over the week. Non-residents returned to Japanese equities, encouraged by a rebound on Wall St after excessive worries over a US-China trade war. They also took heart from signs that tension in the Korean peninsula was abating after a top-level meeting between China and North Korea. 

In Japan, the Diet approved JPY 97 trillion in record fiscal budgets for FY2018. 

By sector, Chemical (+5.05%) and Rubber Products (+4.95%) outperformed the TOPIX. Quality skin-care cosmetics producer Shiseido (+10.79%) was the top performer, buoyed by expectations of strong foreign tourist demand during Japan’s cherry blossom season. Kao (+9.05%) was also strong. 

In contrast, Securities & Commodities Futures (+0.04%) and Marine Transportation (+0.21%) underperformed. Semiconductor stocks struggled to rebound due to falls in US tech stocks like Facebook and Amazon. 

Tokyo Electron lost 4.52%. Panasonic declined 5.65% over a battery fire risk in its Note PC. 

  Emerging markets

China has announced RMB 400bn in tax relief to attenuate the impact of deleveraging: VAT has been reduced by 1% for the industrial, transport, construction and telecom sectors. Press reports suggested China was already in talks over US semi-conductor imports. Brilliance China saw 2017 earnings rise 14% as operating margins improved by 1.4%. Management expects volumes to jump 20% this year. Despite, China’s limited exposure to diesel motors, the Dieselgate scandal has hit BMW’s brand image there. BYD warned that its first quarter results would plummet by 75-92% due to lower electric bus subsidies.

3SBio, China’s leading biopharma play, reported a better-than-expected 31.3% increase in results for 2017. Shenzhou International’s earnings rose 27.7% in 2017 thanks to higher operating margins in Vietnam. Kweichow Moutai, China’s biggest producer of Maotai liquor, saw earnings soar 62% in 2017. 

The Reserve Bank of India fined ICICI Bank Rs 589m (€7m) for failing to comply with regulations on the sale of assets which had fallen due. The Federal government’s YoY fiscal deficit for February was 3.8%, or in line with expectations. Overall loan growth remained relatively subdued at 9.8% but retail banking loans grew 20%. Thailand's central bank left its benchmark rate unchanged at 1.5% for the rest of the year. Brazil's central bank confirmed that interest rates should continue to fall. Argentina saw strong annualised GDP growth of 4% but the soya harvest was lower than expected and persistently high inflation remains a concern. South Africa’s central bank cut its benchmark rate by 25bp to 6.5%. The rand’s appreciation has reduced inflation expectations to 4.6%. 

Despite volatility due to fears of a China-US trade war, we remain upbeat on emerging markets over the medium term. 

  Commodities

Equity market fragility spread to commodities. Oil prices had been disconnected from equities since the middle of March with Brent crude rising by close to 9% to $70 while international equity markets fell by 4% in US dollars. But 3 weeks of non-stop gains ended as Brent lost a dollar to end a short week around $68.5 while WTI fell by $1.5 to around $64.4. 

According to the Department of Energy, US inventories rose due to higher imports but overall stocks, including crude, petrol and distillates, fell sharply. As the end of the refinery maintenance period approached, utilisation rates returned to normal but at high levels so crude inventories should be under pressure.

The market chose to ignore this good news. China, the world’s largest oil importer, launched its first oil futures contract in Shanghai, the first ever renminbi-denominated oil listing. But the really important news this week came from Saudi Arabia which is in talks with Russia over a long-term pact to better control global oil production. The renewable OPEC/non-OPEC agreement is currently in force until the end of 2018. The Riyadh-Moscow pact would be for 10 or 20 years according to Crown Prince Mohammad Bin Salman. The details still need to be finalised, but a sustained output control strategy would seriously shake up the oil market and avoid the sort of rapid plunges seen between the end of 2015 and beginning of 2016 when Brent sank below $30. Other cartel members say they might be interested in joining the pact. Iraq’s oil minister said OPEC producers had an appetite for an agreement that would extend production controls beyond 2018. 

Elsewhere, the gold ounce, which had risen on risk aversion following Donald Trump's appointing of Mike Pompeo and John Bolton, returned to around $1,320 after Kim Jong-un’s conciliatory comments during his visit to Beijing raised hopes that the Korean peninsula might be denuclearised. 

  Corporate debt

 

Credit

In spite of a rebound on European markets, the high yield segment saw only a modest tightening of spreads at the beginning of the week and eventually ended the period lower. Investors remained on their guard and a number of idiosyncratic risks on companies like Rallye, Casino and CMA CGM continued to weigh on sentiment. 

Amazon and Monoprix (Casino group: Ba1/BB+) signed an agreement to distribute Monoprix’s food products to Amazon Prime Now customers in Paris. This should help the group win back market share in Paris and relieve pressure on the company. 

It was a quiet week on the new issues market. Spain’s Ibercaja (Ba3/BB+) raised €350m with a CoCo issue at 7%. Coty (Ba3/BB), which makes beauty products, issued three senior 5- and 8-year bond tranches, two in euros at 4% and 4.75% for €800m and one in US dollars at 6.5% for $550m. 

Nordex SE (B3/B, wind turbines) reported disappointing 2017 results with sales down 9.3% and EBITDA 15.2% lower due to pricing pressure and reduced orders. The company sees both sales and EBITDA falling further in 2018 for the same reasons and said cost cutting will not offset the fall. Neopost (BB+), a digital communication and postal specialist, saw 2017 results narrowly miss expectations. Sales fell 4.1% on declining business in its Enterprise Digital Solutions (EDS) division but free cash flow was higher, enabling debt and leverage to fall. Alain Afflelou (B3/B, eyewear) posted satisfactory second quarter results after restating for calendar effects and the end of December’s opportunistic purchases. Own brand sales rose 2%, free cash flow improved and net leverage was stable.  

Convertibles 

During another volatile week on the markets, we saw one new deal from US online educational platform Chegg Inc., a $300m 5Y 0.25% coupon to finance potential acquisitions. 

This week’s focus was on Tesla as the company was downgraded one notch by Moody’s to B3 as it continued to burn cash and failed to meet production expectations. Elsewhere, the NTSB is investigating the fatal Model X crash in California. If the Autopilot feature were to be responsible, Tesla’s positioning in autonomous driving would be undermined. Tesla shares slumped 15% this week. 

NXPI experienced its largest one-day decline for two-years, falling over 4% on Thursday on mounting speculation that China’s Mofcom could further delay, and even block, the takeover of the company by Qualcomm

In Japan, Lixil announced revisions to its FY guidance, lowering sales slightly by JPY 13bn to 1,680bn and business profits to JPY 77bn, down from 93bn on lower domestic housing starts and higher input costs. 

Real estate company China Overseas Land & Investments said gross margins had risen to 32.9% in 2017 as the company achieved higher average selling prices. Management reiterated its 2020 sales target of HKD 400bn but the dividend payout was a disappointing 28%. 

In Europe, Sanofi announced that its offer to acquire Ablynx would start on April 4 at 393.7% per outstanding convertible bond.

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