A climate of tension

Asset Management - 20/01/2017

Markets have flat-lined since the middle of December, bonds markets have calmed down and the US dollar has lost 2%. Investors have partly discounted any economic and earnings momentum from Donald Trump’s measures, notably lower corporation tax and reduced levies on capital repatriation.

At the same time, US company and consumer sentiment has improved sharply. That should lead to higher consumer spending, especially as wages have also been rising. We can also expect corporate investment to recover, regardless of the new president's tweets.

And both US and global earnings estimates could be revised up more than expected. For the time being, the focus has been on earnings upgrades for energy, materials and financial stocks. Obviously, this stimulus effect on the US economy could lead to overheating and higher inflation. But at least initially, equity markets throughout the world should benefit even if the emerging zone could be subject to political risk.  

  European equities

European equity markets remained nervous as the prospect of a hard Brexit threatened. The euro continued to lose ground against the US dollar.

This week’s bad news included Pearson which expects operating profits to fall 20% in 2017 and will be cutting its dividend. The stock lost close to 30% on the news. In contrast, Eiffage released upbeat figures. Traffic in its APRR motorway network, which represents around 70% of operating profits, was up 3.3% in the third quarter and 3.8% higher over 9 months. In retail, Casino’s fourth quarter was in line whereas Carrefour disappointed slightly with a 1.2% decline even if its supermarkets rose 3.3% and Europe as a whole is doing well. Ahold proved resilient in the US and the Netherlands but fell short in Belgium.

The mood remained upbeat in the luxury sector with Burberry reporting a better-than-expected 3% rise in sales. Rémy Cointreau’s like-for-like growth bounced by a further 9% or more than double expectations with strong performance from Rémy Martin cognac in the US.

It was a big week for French M&A with two transformational deals. Essilor and Luxottica are to merge to create a group with EUR 16bn in sales and a market cap close to EUR 45bn. The new entity will be a world leader in eyewear and lenses and in time benefit from revenue synergies. Safran launched a friendly bid on Zodiac at a 26% premium to the last quoted price creating the world’s third largest manufacturer of aerospace equipment. In other news, Accor has slightly revised up its valuation of HotelInvest from EUR 6.5bn last October to 6.6bn and has confirmed that it is in talks with possible investors 

  US equities

In a short week due to Martin Luther King Day, the S&P slipped 0.5%. There was little macroeconomic news on offer but a lot of interest in what Donald Trump might reveal in his inauguration speech. Once again this week, the President-elect took the market by surprise, this time by suggesting the US dollar was too strong. This is at odds with the higher interest rates that his reflation drive should mean or any reduction in the US trade deficit which is also likely to push the greenback higher.

Meanwhile, Janet Yellen said the US economy was close to Fed targets with almost full employment and a moderate rise in inflation. She is confident the US is on an upbeat growth trajectory which suggests that March might see another rate hike. She also warned investors that any delay in the Fed’s tightening cycle could trigger a very unpleasant surprise. And on global growth, she said that uncertainties had abated a little compared to previous years.

Railway company CSX soared more than 20% on the possibility that it might be partially taken over by the future ex-CEO of Canadian Pacific, Hunter Harrison, who is known for his strong management of the company, and activist investor Paul Hilal, a former associate of Bill Ackman, a former CP board member. Their mission would be to end poor management at CSX by applying the same remedies that worked so well as Canadian Pacific.

In the ongoing Q4 2016 earnings season, 40 out of the 54 companies to have reported have beaten estimates. Banks outperformed. Citigroup, Goldman Sachs and Morgan Stanley all beat the consensus but they fell back on profit-taking after a very strong showing in the last 6 months. 

  Japanese equities

The TOPIX slipped 0.5% on sagging global equity indices and yen appreciation. Stocks initially softened on profit-taking and uncertainties over Donald Trump's future policies prior to his inauguration on January 20. However, after Fed chair Janet Yellen’s suggested the US economy was strong and that steady interest rate hikes were ahead, the US dollar rose sharply recently and Japanese exporters benefited from tailwinds. The market enjoyed a two-day rally on growing expectations for upward earnings revisions on the weaker yen as well as upbeat conditions in the US.

The best-performing sector was Marine Transportation, up 3.8%, while Other Products shed 3%.

Fanuc Corporation jumped 6%, revisiting last-year’s high. Japan’s leading industrial robot maker serving auto and electronic goods manufacturers is expected to see domestic and foreign investor buying on hopes for earnings growth driven by the weaker yen and business expansion.

Toshiba tumbled 14.9% on worries over losses in its nuclear business which could be as high as JPY 700bn and force the company to seek additional funding 

  Emerging markets

A stable week among GEM markets. Turkey and Mexico enjoyed a slight week-on-week rise but their currencies continued to fall against the US dollar. 

In China, reforms in the banking sector continued apace. Negotiable Deposits of Certificates (NDC), a major money-market instrument issued by China’s banks, are to be reclassified with more stringent controls and limits. This will mean mid-sized bank interbank liabilities may exceed 30% of total liabilities and it will force them to reduce their asset growth, slow down loan issuance and help clean up the financial sector in the medium term.

In India, Infosys’ results were in line but the company cut its top line guidance for FY17 by 8.4/8.8% due to pricing pressures. Management is slightly more optimistic for their banking and financials verticals. Reliance’s results were also as expected but with higher-than-expected capex which will help finance growth in its telecoms business. Both IndusInd Bank and Yes Bank reported strong YoY results (+28 and +31%, respectively) with stable asset quality.

Despite demonetisation, Havells, India’s Schneider, surprised positively with 12% YoY top line growth, another indication that the impact from demonetisation is not as worrying as expected.

In Russia, there were rumours that the government might abandon its plan to introduce a uniform 50% dividend payout ratio for state-held companies and bring it down to 25%.

In Brazil, inflation continued to fall at a faster than expected 5.3% YoY. According to Valor, Heineken is to acquire Brasil Kirin for around USD 2bn, a 50% discount to the USD 3.96bn Kirin paid for Schincariol back in 2011. In Mexico, the Peso continued to depreciate amid protectionist rhetoric from Donald Trump.

In sector news, we began to see significant new semiconductor capacity announcements: Tsinghua Group announced a huge investment of USD 70bn to build the world’s largest 3D NAND flash factory. This compares with last December’s news of a USD 2.6bn investment by SK Hynix, one of the existing leaders. But logic foundry companies like TSMC are cautious about 2017. It is expecting 5/10% sales growth in 2017 or less than the 9.4% consensus. Some logic capacity may return to memory chip making 

  Commodities

Brent crude prices fell to USD 53-54 following reports from the IEA, the EIA and OPEC. Traders' speculative positions are at 5-year highs, another source of market nerves.

The good news was the IEA’s upward revision in global demand by 1.5 million b/d in 2016 and 1.3 million in 2017. Global supply fell by 0.6 million b/d in December and Saudi output and stoppages in Nigeria took OPEC production down by 320,000 b/d to 33.1 million b/d. The agency expects a 0.7 million b/d reduction in inventories in the first half of 2017, thereby rebalancing the market -the EIA and OPEC expect that to happen in the third quarter.

This means all eyes will be on January’s output data as they will reveal if the various players are complying with the agreement reached at the end of 2016.

The EIA’s drilling productivity report sees shale oil rising by 41,000 b/d in February, primarily in the Permian basin as other areas are expected to see further falls. Of note was further M&A activity in the Permian basin with announcements from Exxon Mobil and Noble Energy.

Elsewhere, Donald Trump’s comments on the US dollar being too high failed to help metal prices. The gold ounce ended the week below USD 1,200 which is where it started it. China said it wanted to shut down low-grade electric steel works (100-120m tonnes in capacity) to help shift production to blast furnaces producing liquid iron. If successful, this could trigger a deficit on the iron ore market and push prices much higher.

  Corporate debt

 

Credit

The strong momentum seen on the high yield market at the beginning of January continued. The Itraxx Main and Itraxx Over indices were more or less unchanged, widening by no more than 3bp. S&P downgraded Areva by one notch from B+ to B, arguing that the European Commission had conditioned approval for capital increases at Areva SA and Newco on positive results on the ASN tests of the Flamanville EPR vessel. S&P added that if the capital increases go ahead, it could upgrade NewCo to BB or even BB+.

In M&A news, Safran is bidding EUR 29.4 a share for Zodiac Aerospace. This represents a 25% premium on the previous closing price. The acquisition will be funded out of cash followed by a bridging loan.  The new Safran-Zodiac group will be valued at EUR 21.2bn and expects to make EUR 2.7bn in operating profits. Investors reacted positively to the news, sending Zodiac 22% higher at the start of trading while Safran rose 2.04%.

Elsewhere, Loxam sweetened its bid on Lavendon to 270p a share, a 3.4% increase on the latest counterbid from TVH.

There were four big new issues. First, Jaguar Land Rover’s tap, GBP 300m in its 2021 NCL bond at 3%. Ardagh sold a USD 1bn senior unsecured 6% note due 2025 to repay its 2019 maturities. Smurfit Kappa also refinanced its debt, raising EUR 500m with a senior unsecured issue at 2.375% due 2024. Hapag-Lloyd AG raised EUR 250m with a 2022 maturity at 6.75%.

Convertibles 

The primary convertible market was in full swing with deals across all regions. In Europe, a repeat issuer, Fresenius, came to market with EUR 500m in zero coupon non-dilutive convertible bonds to finance the acquisition of Quironsalud Hospitals in Spain. In the US, another CB aficionado, Liberty Media Corp, issued USD 350m in convertibles to finance its USD 8bn acquisition of Formula 1 Group. In Asia, semiconductor company Nanya Technologies Corp issued USD 500m in zero coupon, premium redemption convertibles to finance its capex for 20nm technology conversion.

In M&A news, France’s Safran unveiled a EUR 8.55bn bid for Zodiac Aerospace, potentially creating the world’s second largest aircraft equipment player. In Thailand, convenience store chain CP All was rumoured to be competing to buy Polish retailer Zabka in a deal valued at around EUR 1.5bn.

The fourth quarter earnings season has started. Jazz Pharmaceuticals was up 11% as the FDA granted the company’s Citizen Petition requesting refusal of approval of any generic of Xyrem (Jazz’s sleeping and neurological disorders drug) that disregards portions of the Xyrem package insert, thus eliminating the risk that an approved generic will be able to launch without infringing Jazz’s patent. Eyewear producer Safilo, which has licensing agreements with many high fashion brands, fell 15% this week -the 2019 convertible shed 4 points- on rumours that LVMH was in talks to acquire a stake in rival Italian eyewear producer, Marcolin.

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