Markets retreated, led by Japan and eurozone countries

Market analysis - 6/3/2016

The Japanese government’s postponement of a scheduled VAT hike failed to offset traders’ frustrations over the delayed introduction of reforms. Central bank uncertainty sent the yen higher. European markets took profits after last week’s energetic bounce.

​The much-awaited ECB and OPEC meetings had little immediate effect on indices. This means that US monetary policy trends and expected corporate earnings growth should guide market movements.

Accordingly, we have maintained a slightly positive bias on eurozone equities which we feel have more upside than elsewhere. Risks from Brexit over the short term and, looking further out, China's economy will continue to fuel market volatility, warranting a certain degree of tactical caution even if equities still look appealing, especially compared to fixed income. We have, however, slightly trimmed our negative bias on US Treasuries as the market has begun to factor in the risk of a rate hike in coming months.

EUROPEAN EQUITIES

Markets fell back despite upbeat indications like the ECB's slight upgrading of its growth expectations. It was a very busy week for M&A as Chinese companies appeared eager to continue buying. Air France confirmed that it was in exclusive talks to sell 49.9% of Servair to HNA along with operational control. (HNA only recently acquired Gategroupe, Servair's Swiss rival). Then Jin Jiang, which already owns 15% of Accor, said it wanted to increase this to 29%, flirting with the 30% threshold which would force it make an official bid. Press reports suggest the French government has stepped in to maintain French control and limit Jin Jang's representation on Accor's board.

Elsewhere, Bayer said it had widened its banking pool to help it with its bid on Monsanto. Is a sweetened offer being prepared? Valeo has acquired Germany's FTE (drivetrains and brake systems) for EUR 820m, a highly complementary marriage that will reinforce Valeo's global standing in the drivetrain business. The resulting synergies are expected to be earnings enhancing as early as next year.

Bolloré in contrast said there was no need to make another significant acquisition as he had enough assets at his disposal to pursue his strategy concerning Vivendi. Elsewhere, press reports suggested the French state could sell the 14% it holds in Peugeot.

New registrations in France remained buoyant, rising 22.3%. Renault continued to lead the field (+34%) ahead of Peugeot (+25.6%). The French market has risen 10.5% year to date. Volkswagen's first quarter sales were overall in line thanks, it would appear, to strong performance at Porsche. Audi's contribution slipped and VW brand sales in China remained sluggish. Commenting on its Asian business, which represents 10% of group sales and EBIT, Pernod-Ricard confirmed that trends in India and China were complicated. Vinci (and partners) unveiled their first Danish contract, notably the construction of a tunnel connection to Germany. Vinci's share represents EUR 1bn.

US EQUITIES

In a short week due to last Monday's holiday, the S&P500 edged higher to within 1% of its record high. Manufacturing ISM came in better than expected at 51.3 due to lower inventories and improving external demand. Its price component hit 63.5, the highest level since 2011. Earlier in the week, PCE data for April showed prices had risen by an annualised 1.6% or at the same pace as in previous months. The US created 38,000 jobs in May or much less than expected by analysts. The figures could undermine the case for a US rate hike in the near future.

In company news, apparel retailers Michael Kors and Limited Brands (Victoria Secrets) advanced on better than expected figures and dragged other sector stocks higher, a contrast with very poor performance in May. In pharma, Allergan jumped 8% when the FDA approved Teflaro for children and on news that activist investor Carl Icahn had bought a stake. Note for the record that Allergan is about to sell its generic drugs division to Teva Pharmaceutical for USD 40bn; the proceeds will be used to pay down debt, buy back shares and make sundry acquisitions.

Healthcare gained 2.3% over the last 5 trading sessions while energy and commodities were, in relative terms, this week's losers.

JAPANESE EQUITIES

The TOPIX advanced over three days in a row, but ended the week 0.8% lower. Indices initially rose when the yen weakened on growing expectations of a US rate hike in coming months following Fed Chair Janet Yellen's hawkish comments. But they then retreated on the yen's rebound and uncertainty over Japan's growth strategy as PM Shinzo Abe did not refer explicitly to any economic-stimulus measures after announcing he was postponing a planned VAT hike.

The electric appliances sector gained 1% thanks to Toshiba soaring 15.2% on expectations that it might be removed from the "Securities on Alert" list in September after its internal control system was thoroughly reviewed. Other sector stocks like Murata Manufacturing and Fujitsu were also in demand and gained more than 4%. On a negative note, the Air Transportation sector sagged 5% on worries that rising oil prices might hit sales. Japan Airlines and Ana Holdings lost 6.1% and 3.7% respectively with WTI hovering around USD 50.

EMERGING MARKET

China's official manufacturing purchasing managers index stood at 50.1 in May, matching April's number and suggesting the world's second-largest economy was stabilising.

Former Brazilian planning minister Romero Juca (PMDB party) resigned because of leaked taped conversations in which he appeared to be discussing how to use Dilma Rousseff's impeachment to derail a corruption investigation. The scandal threatens interim government leader Michel Temer only 11 days after taking over from Rousseff, who was suspended as President by the Senate on May 12 on charges of breaking government accounting rules. Juca, who is Temer's right-hand man, was supposed to be leading the team asking Congress to approve urgent measures to pull Brazil out of recession. Elsewhere, local Brazilian newspapers said that education provider Kroton had hired investment banking advisers to make a friendly bid for competitor Estacio. A merger would create a huge player in the educational sector, with 1.6 million students, BRL 21bn in market cap and BRL 3bn in EBITDA.

India's GDP grew 7.9 % in the fourth quarter of 2015-16, taking overall growth for the entire year to 7.6%. Shares of Tata Motors surged over 10% on Tuesday after the company posted a three-fold rise in consolidated net profit for the fourth quarter. Profits were mainly driven by strong sales in its Jaguar-Land Rover unit, unusually good earnings in India and a strong showing in China.

Russia's manufacturing activity declined at a slower pace in May as production growth led to job creation for the first time in nearly three years. Demand, however, remained weak. Manufacturing PMI index rose to a four-month high of 49.6, up from 48.1 in April.

COMMODITIES

As expected, OPEC's 169th summit failed to agree on any concrete action. It is true that since April's exceptional Doha meeting, oil prices have moved from USD 45 to 50 on improving fundamentals. Lower US inventories are partly due to production stoppages in Canada (forest fires) and Nigeria (fresh militant action in the Gulf of Guinea) but also due to a sharper drop in US onshore production (40,000 b/d less last week) and persistently strong demand.

But the OPEC gathering did at least replace the tension seen at previous meetings with a more united and conciliatory mood. Saudi Arabia's new oil minister said attendees had been very cooperative whilst his Iranian counterpart welcomed a good spirit of unity. The meeting even broached the subject of returning to global production ceilings or country quotas. Any mention of the 30 million b/d ceiling was abandoned in December 2015 but that figure had not been revised since January 2012. The cartel was producing 32.8 million b/d in April 2016 according the IEA.

Gold settled around USD 1,201/oz after falling 6% or USD 80 from its recent April 29 peak amid US dollar strength. This has purged the market as the latest, May 24 report on Comex traders' positions pointed to a 21% drop (6.9 million ounces), the steepest fall in absolute terms since April 2004. This was mostly due to expectations of a US rate hike over the summer.

Zinc jumped 8% in USD over the week, returning to July 2015 highs and taking YTD gains to 24%. The shutdown of the Century mine at the end of 2015 is starting to have an impact and the mining production deficit has widened. Prices could, however, encourage Glencore and Nyrstar to resume production that had been paused.

CORPORATE DEBT    

Credit

The week's big event was the ECB's detailed presentation of the Corporate Sector Purchase Programme (CSPP) which is being launched on June 8. The ECB said it was very optimistic over the efficiency of its policy and its role in helping lending to recover. It revised eurozone growth estimates up from 1.4% to 1.7% and inflation from 0.1% to 0.2% due to strong domestic demand and higher oil prices.

Credit markets pushed even higher. The investment grade sector rose 0.23% while high yield added 0.26%.  AAA and CCC rated bonds outperformed while equity markets slipped 1%. The Xover widened by 12bp to 309bp compared to 3bp for the Main. The IG new issues market was particularly active. The Banque Postale raised EUR 500m with a Tier 2 bond due 2028 and a yield of 3%. Thales sold a EUR 600m bond due 2023 at 0.75% and AIG issued a EUR 750m bond due 2023 at 1.5%.

In company news, IKKS posted a sharp drop in first quarter results: like-for-like sales fell 0.8% to EUR 92.6m while EBITDA tumbled 33.1% which suggests margins slumped by 6.3 points to 12.4%. The 6¾ 07/15/21 bond fell 3.5 points and is now trading at 96%.

Convertibles

New convertible issues across the globe took centre stage this week. In Europe, Glanbia Co-op issued a EUR 100m 5y 1.375% exchangeable into Glanbia PLC (GLB ID). As the largest shareholder of the dairy and protein company, it is trying to raise funds (collateralised by its stake) to help farmers hit by low dairy prices. However, in an industry hit by oversupply and deflationary prices (at least in the short term) and which is exposed to Brexit, the deal is particularly unattractive.

Rocket Internet (-14.5%) reported mixed Q1 results, with particularly poor performance from its ecommerce portfolio (Home24, Westwing, GFG, Linio, and Jumia) and the convertible lost four points.

In the US, Weatherford International, an oil services firm which was downgraded to even lower junk status by the 3 largest rating agencies last month, came back to the CB market with a USD 1bn 5y 5.875 exchangeable to refinance debt. The proceeds from the exchangeable will be used on a  tender offer for four bonds maturing between 2017 and 2020. On the back of this upsized deal, this new '21 was very actively traded. Ciena reported very strong Q2 results, sending the stock higher 12% on Thursday and taking gains since the beginning of the week to 19%. Revenue came in at USD 640m and EBITDA stood at USD 82m (compared to estimates of USD 73.7m), helped by strong Asia-Pacific region growth and improvement in Europe. Otherwise, pharma and biotech shares outperformed on additional M&A hopes following Jazz's bid for CPXX: Impax Laboratories was up 6.2% by Friday.

Japan saw three new issues, which is interesting as the country had seen no recent issuance. Softbank issued a mega mandatory exchangeable into Alibaba. The 3 year USD 5.5bn deal was priced at the low end of the range (a 5.75% coupon and a 17.5% premium) along with a USD 2bn share placement for Alibaba and sovereign wealth funds. The bond was priced on BABA's close (USD 76.69) while the stock placement price was USD 74.00. 

Kansai Paint (paints and related products for autos, construction and ships) raised a total of JPY 100bN (EUR 823m) through two zero coupon convertibles, one for JPY 60bn over 6 years and the other for 40bn over 3 years. Star Micronics, issued a JPY 8bn (EUR 65m) 5y zero coupon convertible; JPY 5bn of the proceeds was used to buy back 10.63% of the company's shares.

Written on 03/06/2016

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