Clean-up

Marktanalyse - 09.02.2018

The volatility-free market advance in 2017 led us to neutralise risk asset exposure in December, not for fundamental reasons -the environment was robust- but for technical considerations as we felt the market had become vulnerable. (English version)

Our 2018 outlook clearly pointed out the risk of a correction amid monetary policy shifts and rising interest rates. For us, recent turmoil on equity markets shows that, after recent data on wage rise acceleration, investors are now more worried that the Fed might be “behind the curve” than concerned about simple increases in government bond yields following a change in stance from the ECB and the Bank of Japan. What we really do not need now is an inflationary surge that might upset the very gradual approach of central banks to monetary tightening.

The market correction has been exacerbated by numerous technical factors, led by significant VIX index shorts. The VIX’s jump to 50, and the sheer size of the US market’s decline in heavy trading, suggests investor capitulation and we view that as a good entry point. We have upped equity market scores, retaining our overweight in the eurozone and Japan at the expense of the US and emerging countries while trimming the bias. We have also slightly increased sensitivity via US Treasuries and European government bonds without changing the fixed income underweight in our overall asset allocation. We had used this sort of hedging before the correction and have cut money market exposure from overweight to neutral.

Even so, it would be a mistake to assume things are going to return to previous balmy conditions. The inflation revival issue will now be closely watched, especially as it could create volatility across all asset classes. The advantage of the correction is that the market has -to some extent- been cleaned up and that investors have been warned. In itself, that is a source of market stability. But volatility will return if the inflation revival is confirmed. Bear in mind that we only expect a moderate increase in US inflation and that markets which were over-concerned about deflation only a few weeks ago have now seized on a single and oft-revised monthly statistic to go overboard on worries over inflation.

  European equities

European equity markets suffered a sharp correction across sectors but cyclicals like building materials, financial services, mining and industrials and interest rate sensitive sectors like telecoms, utilities and property were particularly badly hit. The most resilient sectors were those which had already undergone corrections in 2017 such as food retail and media.

Meanwhile, annual company results over the week were generally upbeat. In France, Société Générale beat expectations in almost all its divisions. Retail banking in France declined less than before even if group cash generation remained weak. Over at BNP, and in spite of provisioning on specific problem cases like Steinhoff and Carillion, the message was relatively optimistic.
Thanks to the improving macroeconomic environment, lower tax in the US, increasing contributions from newly acquired acquisitions and the prospect of higher interest rates, management is now expecting ROE to exceed 10% in 2020. ABN AMRO, in contrast, sounded a note of caution on the potentially negative impact of Basel IV on its solvency ratio and, as a result, on the outlook for shareholder returns. Intesa Sanpaolo reported upbeat figures and released a five-year plan focused on accelerating NPL disposals and maintaining its generous dividend. There were also positive surprises from UniCredit and BPM.

In the media sector, ProSieben rebounded and investors cheered good figures from Publicis. The advertising group said clients were very interested in its integrated communication/digital transition offer amid improving prospects for the ad market.

In pharma, Sanofi missed expectations, especially in the fourth quarter. Results were hit by its US diabetes franchise and write-offs on a setback in its dengue fever vaccine. Growth prospects now look soft even allowing for recent acquisitions. Total’s results reassured investors and reflected the group’s huge efforts to cut operating expenses and investment. As a result, the group announced promising shareholder returns to come via higher dividends and share buybacks, etc. L’Oréal’s fourth quarter growth was higher than expected while margins were in line. The group sees further growth in 2018 and improving profitability. Telecom Italia continued talks over spinning off its network business into a legally separate entity.

  US equities

US markets all suffered a steep correction with the S&P ending the period 8.5% lower. After initial selling in the previous week on rising long bond yields as traders began to worry about an inflation revival, the trend accelerated throughout this week. Systematic funds were the main actors in the sell-off with 40% of volume coming from ETFs (40%) as well as significant contributions from derivatives and futures. Trading in actual stocks was relatively muted.

Comments from New-York Fed chair William Dudley fuelled fears of monetary tightening. Dudley is seen as a dove but said 3 rate hikes in 2018 looked very reasonable to him because the economy was growing above its long-term mean. More restrictive monetary policy was therefore warranted. Unsurprisingly, macroeconomic news was pushed to the side-lines. Non-manufacturing ISM came in at 59.9, its highest level since 2005 and the news only amplified concerns over inflation returning.

Financials and energy stocks led declines while utilities, consumption and property proved relatively resilient.

  Japanese equities

Following heightened volatility triggered by rising US long bond yields, worries over potential inflation in the US and further declines on Wall Street, Tokyo plunged across all sectors. Over the week, the TOPIX dropped 5.28%. Mid-and-small cap stocks also suffered from heavy risk-off pressures. However, after a sharp fall on February 6, the market temporarily stabilised as some oversold stocks rebounded thanks to upbeat earnings expectations.

By sector, Transportation Equipment (-1.79%) and Air Transportation (-2.33%) were relatively solid. Subaru (+1.97%), Mitsubishi Heavy Industry (+2.94%) bucked the trend and Toyota Motor (-0.98%), Nissan Motor (-0.81%) and Suzuki Motor (-0.68%) were also relatively resilient.

Defensive sectors also outperformed, notably Pharmaceuticals like Ono Pharmaceutical (+5.87%), Daiichi Sankyo (+1.50%) and Astellas Pharma (+0.47%).

In contrast, economic-sensitive sectors such as Non-ferrous Metals (-9.55%), Metals (-8.54%) Glass & Ceramics (-8.08%) and Securities & Commodity Futures (-7.81%) were badly hit. SMC dived 13.53% and Kyocera succumbed to mounting profit taking despite favorable third quarter earnings. Fast Retailing (-11.42%) and Japan Tobacco (-10.34%) were also weak due to slowing sales.

The JPY/USD rate was relatively stable at around 109 with “safe currency” buying offset by upward pressure on the dollar due to the rising interest rate gap between the US and Japan.

  Emerging markets

There was a steep correction on emerging markets this week, led by China. Higher US bond yields drove emerging market currencies down.

China’s January CPI softened to +1.5% YoY, or in line with expectations, while PPI dipped to 4.3% on lower commodity price growth. The trade surplus was $20.3bn, or less than half of market forecast as imports increased 36.9% YoY, up from +4,5% YoY in December, mainly due to the shift in the Chinese New Year date. Exports rose 11% vs. consensus of +10.7%. The renminbi fell from a 2-year high after the trade data and finished the week flat against the US dollar.

CBRC re-emphasised its deleveraging ambitions during its annual meeting for 2018: it intends to reduce its debt, rein in the rise of household leverage, bring down interbank investment, contain property bubbles, and cooperate proactively with local government in dealing with their implicit debts, etc. Although this may lead to short-term tightening, we continue to believe that deleveraging is positive for China’s economy in the mid/long term.

Netease’s fourth quarter 2017 top line was up 20% YoY, but diversification from gaming to e-commerce proved to be a painful process: a spike in sales & marketing expense (16.4% of total revenue versus 10.4% in 4Q16) due to seasonal heavy promotional drives cut earnings by 10% YoY.

India’s central bank voted by 5-1 to keep rates on hold and maintained its neutral stance, in line with market expectations. It also raised inflation projections and lowered its growth estimates for FY18. It expects inflation and growth to pick up in FY19 as the union budget announced that the government will provide a minimum support price (MSP) of 1.5x cost to farmers in the upcoming sowing seasons.

Eicher Motors reported steady 3QFY18 figures: net sales rose 23% and net earnings were 24.5% higher. Royal Enfield’s EBITDA was in line, order backlogs have been piling up due to new variants and the company remains bullish on export opportunities. The latest results from Tata Motors also reflected strong domestic performance, driven by commercial vehicles. Domestic operations turned around this quarter as total sales growth reached 29% thanks to a higher contribution from CV.

Brazil’s central bank cut interest rates by another 25bp to 6.75% with a neutral outlook. Inflation in January was lower than expected due to lower services inflation. Itau reported solid results, in line with consensus. Management was upbeat for 2018, as the credit cycle continues to improve, with higher loan growth and lower provisions. In contrast, Lojas Renner’s results disappointed due to higher expenses because of new store openings in Uruguay. SSS was a reassuring 8.7%. We continue to be positive on emerging markets. 

  Commodities

Commodity markets were down across the board. Brent crude shed more than 5%, falling under $65 while WTI tumbled more than 7% to $61. The main reasons for the correction were sharp US dollar appreciation and the indirect impact of the equity market sell-off. Worries over oil stemmed from higher US inventories. The DoE said crude stocks had risen by 1.9m barrels in the previous week but investors were mainly unnerved by the rise in petrol and distillate products. The statistics were skewed by strong refinery utilisation rates. Coming weeks will be affected by the refinery maintenance period which should logically mean higher crude inventories and a dip in products, or quite enough to fuel further price volatility.

In its Short-Term Energy Outlook, the Energy Information Agency raised its 2018 output forecasts by 290,000 b/d to 10.6 million b/d while cutting OPEC production forecasts.  

Iran’s oil vice minister said the country wanted to increase output to 4.7 million b/d in the next 3-4 years. That would mean an increase of around 700,000 b/d and perhaps even 1 million b/d if foreign companies agree.

On a more positive note, China’s oil imports hit a record 9.57 million b/d in January (up from 8.4m on average in 2017). This is only natural ahead of preparations for the Chinese New Year.

Base metals also suffered from the US dollar rally and fell 2.5% on the LME. In the end, gold proved the most resilient by only shedding a little more than 1% to $ 1,315/oz. The price was naturally under pressure from higher long bond yields but increasing volatility promoted its defensive characteristics and acted as a cushion. In any case, the rise in US wages that helped trigger higher bond yields should also drive inflationary pressures and that is good news for gold. 

  Corporate debt

 

Credit market volatility surged as the VIX took off, US and European government bond yields rose, and the Bank of England turned slightly more hawkish. High yield and investment grade spreads both widened. The Xover widened by 20bp and the Main by 9bp.

Financials underperformed as Deutsche Bank returned centre stage with lower-than-expected results. On the high yield market, France’s Elis (industrial laundry, BB+) issued €1bn in dual-tranche bullet bonds with the 2023 maturity yielding 2% and the 2026 at 2.875%. Algeco (modular construction, B) refinanced existing debt by raising €1.1bn in senior and subordinated bonds at 6% and 10% due 2023.

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