Investors continued to move into more defensive assets like

Asset Management - 7/8/2016

It was another week dominated by UK news and the aftermath of the referendum. In the political arena, leading Brexit advocates continued to resign.
Commodities Corporate

The UK’s new Prime Minister will be a woman, either Theresa May, currently Home Secretary, or Andrea Leadsom, Minister of State at the Department of Energy and Climate Change. In economic news, the Bank of England has already started to try to offset the Brexit impact with measures in favour of the economy and banks. But that proved insufficient: more than 7 UK property funds have suspended trading due to a wave of redemptions from investors who see property taking a dive. Sterling also came under attack, falling by more than 2% against the US dollar to a 30-year low! The first post-Brexit UK indicators show confidence has slumped as the economy slows.

In the eurozone, Italy’s banks were once again the focus of concerns. Pending the July 29 release of stress test results, the European Commission is pressing on with talks over recapitalising banks with government funding. Indicators on service sector confidence levels were pushed onto the back burner although they were upbeat in the eurozone and excellent in the US.

Investors continued to move into more defensive assets like the US dollar, the Yen and government bonds. As a result, interest rates continued lower with the yield on 20-year Japanese government bonds moving into negative territory for the first time. The US dollar and Yen moved higher while equity markets fell, especially in the eurozone as bank stocks suffered a fresh sell-off.
Against this backdrop, we are sticking with our strategy. We have continued to reshuffle equity market hedging without adding to overall risk exposure. We continue to believe, however, that European equities have rebound potential over the medium term. In fixed income, we are still sellers of US Treasuries.



  European equities

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European equity markets ended the week lower. The Brexit impact has forced some UK investment companies to suspend trading in certain property funds due to massive redemptions from investors worried about the outlook for the sector in Britain. Sterling’s hefty fall underpinned UK export stocks. Italy’s banking sector is under pressure due to worries over non-performing loans. There appear to be intense negotiations between Rome and the ECB over what shape a bank recapitalisation plan should take. The ECB recently ordered Banca Monte dei Paschi to slash its NPL exposure by 40% over 3 years. Rome has denied a news item that it was looking to inject cash directly into its banks, a move that would violate European regulations which say bank shareholders and creditors, not tax payers, have to rescue ailing banks.

Resurging risk aversion put pressure on peripheral country markets and on highly cyclical and domestically focused sectors like banks and consumer discretionary, and especially autos. But defensives bucked the trend. They were helped in part by the improving emerging country picture even if credit insurer specialist Coface this week issued a profit warning due to higher-than- expected claims in the zone.

Among a crop of M&A deals announced this week, Danone is paying USD 12.5bn for WhiteWave Foods, the biggest soy milk producer in the US. In pharma, Novartis says it plans to sell its CHF 13bn stake in its Swiss rival Roche. In Italy, Hutchison and Vimpelcom, which are moving to merge their mobile divisions, have begun exclusive talks with Iliad to sell Italian assets. This would hit Telecom Italia in several ways as it would mean stronger competition from Iliad while Iliad’s founder and CEO Xavier Niel would have to sell his Telecom Italia options representing around 15% of the equity.



  US equities

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It was a short week due to last Monday’s Independence Day. The Fed released the minutes of its pre-Brexit meeting. The mood was more accommodating than previously due to a more uncertain environment and a labour market slowdown. Yields on 10-year Treasuries hit an all-time low of 1.38%. June’s non-manufacturing ISM came in at 56.5, up from 52.9 and much higher than the 53.3 expected. The US created 287,000 non-farm jobs in June, or many more than expected, according to the Labor Department. This is confirmation that the US economy is doing well.

A good illustration of risk aversion could be seen in ongoing sector rotation. Healthcare and consumer staples advanced by more than 2% over the week while financials and energy lost ground. Financials are being hit by lower long yields and energy by falling oil prices. Pfizer says it could bid for Medivation and BioMarin. Although a drop was expected, Costco’s quarterly sales were flat on last month's performance while Walgreens’ figures were disappointing. The US has now outperformed Europe by 14% year to date and safe haven assets like utilities, consumer staples and telecoms continue to rise in price.



  Japanese equities

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Over the week, the TOPIX lost 1.6% on renewed worries over Brexit consequences. Early in the week, the index gained as the yen lost ground against the US dollar and euro, a boost for Japanese company earnings. And yet, after UK property funds froze redemptions, the market turned down and the yen advanced again. Most investors took a wait-and-see stance to gauge not only the impact of the UK’s decision but also the results of Japan’s upper-house election poll. This week’s best performing sector was Food, up 3.8%, while the property sector sagged 5.3%. Mitsui Fudosan tumbled 8.4% as it was planning a large-scale redevelopment project in London.

Japan's largest delivery service company, Yamato Transport, the best performer, jumped 9.9% on reports of gradual growth in small parcel deliveries. It has entered a partnership with a flea market app company.



  Emerging markets

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German mechanical engineering group Voith has decided to sell its 25.1% stake in robot maker Kuka to China’s Midea for about EUR 1.2bn. Midea, which already owned 13.5% of Kuka, has offered EUR 115 a share and said it aimed to buy at least 30% of the company.

In Taiwan, the market closed last Friday due to typhoon Nepartak.
Tata Motors reported healthy June sales for its Jaguar Land Rover (JLR) division, a year-on-year increase of 17% to 46,456 units.

Samsung announced its earnings guidance for the second quarter of 2016. The company expects Q2 2016 operating profit to come in at about USD 7bn, up a solid 17% from the same quarter last year. It will mark Samsung’s strongest profit performance in more than two years, thanks in large part to strong sales of Samsung’s new Galaxy flagship smartphones.

Brazil’s new economic team announced plans to narrow but not close its budget deficit next year, as the worst recession in decades hinders efforts to shore up fiscal accounts. The government will target a 2017 budget gap before interest payments of BRL 139bn (USD 41bn), finance minister Henrique Meirelles said.

In Venezuela, a sugar shortage has interrupted Coca Cola's production lines. This shortage is the latest chapter in Venezuela's woes over supplies of basic consumer goods. The country is experiencing the worst recession in decades due to the low oil price. Oil accounts for about 95% of foreign currency earnings.




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An oil price correction sent Brent crude close to USD 45 for the first time since the middle of May. Several news items weighed on sentiment: a Norwegian oil workers strike was only avoided when a wage agreement was reached, Russian output rose by an annualised 1.3% in June to 10.81million b/d and shows no sign of softening, and a merger agreement between Libya’s two state oil companies holds out hope that its main export ports, which had been closed since 2014, might reopen. Libya is currently turning out 400,000 b/d compared to 1.6 million before the Arab Spring.

The trend for US production is still down – onshore output dipped by 38,000 b/d last week- but petrol inventories are worrying markets as they are still high in spite of the summer, traditionally a period of strong consumption. Even so, these developments are unlikely to change the oil market’s move to rebalancing in coming quarters.

The gold ounce rose further and is now trading above USD 1,350. The driving force behind this move is prevailing risk aversion and the quest for safe haven assets; hence the slide in sovereign bond yields. 10-year yields in Germany, the UK, Switzerland and Japan have reached all time negative levels and the yield on Japan’s 20-year bonds has moved into negative territory for the first time. More than half of the eurozone’s EUR 6.4 trillion in sovereign debt now has negative yields. This means gold’s lack of a yield is no longer an issue. China’s central bank bought 15 tonnes of gold in June after staying out of the market in May for the first time since July 2015. The bank now holds 1,823 tonnes or 2.2% of its foreign exchange reserves.



  Corporate debt

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Credit markets have perked up since the UK referendum result but risk aversion remains high. There are still a number of obstacles to clear, including Italian bank recapitalisation, Italy’s referendum later on this year, not to mention the triggering of article 50 even if its timing is increasingly uncertain. The most cynical investors on the corporate debt market are, however, wondering if the situation is as important as all that as there is a “whatever it takes” buyer of last resort ready to inject massive liquidity. This week saw decompression on the market, i.e. high beta underperformed low beta, as long duration bonds benefited in full from core European yields hitting record lows.

Elsewhere, S&P revised down most UK bank ratings from stable to negative. Areva has completed the sale of Canberra to Mirion Technologies. According to El Confidencial, China’s HNA has made an offer to the Villar Mir family to buy half of Obrascon. Astaldi has renegotiated its revolving credit facility covenants.


Intraday volatility was high, a reflection of a particularly stressful environment. Europe’s new issues market was reasonably active with a number of HY deals. Zinc producer Nyrstar placed a EUR 115m 6-year 5% convertible. Tullow Oil issued a USD 300m convertible due 2021 with a 6.625% coupon and a 30% premium. Germany’s Adler Real Estate issued a EUR 150m 5-year convertible but the company’s high leverage can only be offset by revenue growth. In the UK, real estate and retail markets were once again hammered with Sainsbury losing another 5%. British Land sold Debenhams flagship store for GBP 400m. In the US, Biomarin Pharmaceutical rose 9% on the back of rumours of a takeover bid from Roche. In Asia, Japanese equities and convertible bonds remained under pressure from the continued depreciation of the yen. Exporters like Asics (-7%) led declining stocks as the Yen strengthened and approached the 100 level. In South Korea, GS Engineering & Construction Corp issued a USD 150m convertible at 4.5%.

Written on 08/07/2016

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