A change in tone from ECB

Analisi di mercato - 30/06/2017

Equity, bond and currency markets had a turbulent week. Oil was the first to suffer with Brent crude falling below USD 45 before rallying to close above USD 47.5. Then it was the turn of US tech stocks to suffer more profit taking. (English version)

Finally, bonds suffered a correction. Eurozone bonds were particularly badly hit and German and French bonds led declines after Mario Draghi seemed to suggest the ECB was thinking about gradually ending its QE programme. As a result, the euro jumped against the US dollar. 

All these market shifts sent contradictory messages on fears the cycle was weakening and on central bank intentions to take advantage of strong economic momentum. We continue to believe in the cycle's force and are maintaining our preference for equities, notably in Europe and Japan. We remain underweight sovereign debt. The upward correction in yields should be good news for financials. 

  European equities

The trend turned decidedly negative this week across Europe because of looming changes to monetary policy and possible rate hikes. Meanwhile, somewhat upbeat manufacturing PMI data had no impact on markets. There were strong sector variations with banks and base products gaining ground while the most interest-rate-sensitive sectors like utilities fell sharply. 

At the beginning of the week, banks rose after Intesa acquired the assets of ailing Italian banks Veneto and Vicenza and they then gathered momentum due to upward pressures on bond yields. At the same time, auto stocks fell after Germany’s Schaeffler (auto parts) issued a profits warning. Tech stocks tumbled along with construction on rumours of possible cuts to infrastructure spending in France. 

Elsewhere, the food sector was buoyed after activist investor Third Point bought a 1% stake in Nestlé. Third Point wants Nestlé to sell its 23% stake in L'Oréal, increase shareholder returns and review its business portfolio. Nestlé responded with a CHF 20m share buyback programme or 8% of its capital. Philips is paying USD 1.7bn for Spectranetics (hearing aids) and is to launch a EUR 1.5bn share buyback programme over 2 years. Carrefour gave details on the July 20 IPO of its Brazilian subsidiary Atacadao. The proceeds will go on reducing the group’s debt in Brazil where interest rates are above 10%. 

  US equities

The S&P edged 0.6% lower over the five last trading sessions while the Nasdaq fell 1.5%. 

Durable goods orders came in lower than expected but the news was overshadowed by first quarter GDP being revised to +1.4% from 1.2%. Moreover, this adjustment was entirely due to consumption, i.e. final sales rather than inventories. PCE inflation, the marker the Fed prefers, came in at 2% or in line with expectations.

US markets witnessed market sector rotation over the week: financials gained close to 3% and energy finished 1% higher but technology fell 2%. The switch was trigged by a number of technical factors like over-concentration of positions but also by fundamentals like upbeat GDP data, steady inflation, and hawkish statements from Janet Yellen and Mario Draghi. The end result was that US 10-year Treasury yields to rise to 2.3% from 2.15% in the previous week. 

The CCAR bank stress test results also helped improve sentiment on financials. Most financial institutions received regulatory approval to go ahead with very significant payments to shareholders. For major banks under CCAR, this represents USD 130bn or a 100% payout. Citigroup will now be able to double its dividend, Bank of America to increase its own by more than 50% while JP Morgan might launch a share buyback representing 6% of its market cap. 

  Japanese equities

The TOPIX gained 0.8% over the week after advancing on Thursday on a US stock rebound. Financials were buoyed by a rise in US long-term interest rates due to the firm US market and bond yield rises in Europe after ECB chairman Mario Draghi’s comments on reducing stimulus. Stocks were also underpinned by the weaker yen against the US dollar.

The best performing sectors were Iron & Steel (+6.8%), Mining (+4.5%) and Banks (+3.1%). Leading steel makers such as Nippon Steel & Sumitomo Metal Corp. (+7.8%), JFE Holdings (+7.5%), and Sumitomo Metal Mining (+5.1%) made strong gains. Other major winners included mega-bank groups Mitsubishi UFJ Financial Group (4.3%), Mizuho Financial Group (+3.2%) and Sumitomo Mitsui Financial Group (+2.5%) and other financial institutions such as Sumitomo Mitsui Trust Holdings (+5%), Resona Holdings (+4%) and Dai-ichi Life Holdings (+2.8%).

In contrast, Retail Trade (-0.8%) and Services (-0.8%) were relatively weak. Toshiba plunged 10% on the news that it was suing its US chip partner, Western Digital Corp., blocking the planned sale of its flash memory unit. Other major losers were Tokyo Electron (-4.2%) and Astellas Pharma (-2.6%). 

  Emerging markets

China’s official manufacturing PMI rebounded to 51.7 in June from 51.2 in May (investors were expecting 51) and non-manufacturing PMI rose to 54.9 from 54.5, surprising on the upside. Industrial profits improved modestly by 2.7% to 16.7% YoY.

Chinese internet and gaming companies were under pressure this week as the Ministry of Culture released the names of about 30 mobile live streaming platforms which were in content violation.

The Reserve Bank of India is to tighten provisions for 12 cases (representing USD 39.2bn in loans) which are under the Bankruptcy Code by asking banks to set aside 50% of all secured loans and 100% of unsecured loans. Implementation of the GST will kick in next week. After a strong first half, foreign institutional investor flows were more moderate in June, slowing to USD 2.3bn (up to June 26), the lowest figure so far in 2017.

The Brazilian Senate special committee voted in favour of labour reform, reversing the Government’s defeat last week when the social committee voted against. The final vote is expected to take place next week. May’s current account continued to improve due to a higher trade surplus as a result of better terms of trade and a stronger harvest.

In Argentina, Cristina Fernandez confirmed that she would lead a new alliance into the midterm legislative elections in October. The election will be a key indication of President Mauricio Macri’s reform implementation.

Better than expected economic activity in China, GST reforms in India and ongoing fiscal reforms polluted by political noise augur well for the medium-term outlook for emerging markets. 

  Commodities

Oil bounced by close to 5% over the week or +7% since its June 21 low. Brent crude moved back above USD 47 and WTI above USD 45, partly due to the weak US dollar. Fundamentals are no different than before the drop but the market’s negative sentiment has abated. Libya is the main market concern. Output there has moved above 900,000b/d even if the pace of the increase has slowed. Unsurprisingly, OPEC has no short term plans to cut production further. As we have already pointed out, summer is traditionally a period when exports fall and that will help inventories decline. Tanker movements over the last month show a significant drop of about 560,000 b/d in OPEC oil. US weekly data also showed domestic output declining by 100,000 b/d. We should, however, be cautious over these figures as they are only a statistic model and were influenced by Cindy the tropical storm. 

Iron ore prices also rebounded to flirt with USD 65/tonne, a rise of more than 20% since the mid-June low. China’s PMI rose to 513.7 in June up from 51.2, an indication that manufacturing is still on the up and that tighter property lending in major cities has been more than offset by infrastructure spending and a persistently strong property market in smaller cities. This more positive view of the economic environment also helped copper which hit at 3-month high at close to USD 6,000/tonne. 

Gold stabilised at USD 1240-60/oz due to the lower US dollar. But its rise was limited by higher bond yields and signs that ultra-accommodating monetary policy might be about to end. 

  Corporate debt

 

Credit

The High Yield retreated and the Xover widened by more than 10bp to 245 by Friday. Single-B bonds were particularly hard hit, losing 0.2 points on Wednesday and Thursday. Long dated Utility and TMT bonds fell when Bund yields widened by close to 20bp over the week.

But new issuance momentum was undimmed. Although a little effortful, Manutencoop (B2/B) issued a EUR 5-year NC2 bond at 9.5% to refinance its debt and buy in minorities (33% of the capital). French media company Banijay (B+/B1/BB) raised EUR 350m with a senior secured 5NC2 bond at 4% to reimburse its existing debt and fund costs arising from its acquisition of Castaway. Worldwide Flight Services sold a EUR 50m tap on its Senior Secured 2022 bond and MotherSon (BB+) raised EUR 300m with a 7-year bullet at mid swap +140bp. 

Company results: Burger King France (B3/B-) posted first quarter sales of EUR 145m (+5%) and a strong 40% rise in EBITDA to EUR 16m. Margins expanded by 2.8 points as the group presses on with converting Quick restaurants into Burger King. Leverage was unchanged at 6.1x. eDreams Odigeo (B2/B) also released upbeat figures for FY 2016/17. Sales rose 5% to EUR 486.6m and adjusted EBITDA was up 12% to EUR 107.3m. Leverage was down 0.6x to 2.7%. 

In contrast, Schaeffler (Ba3/BB+) revised its EBIT 2017 down from 12-13% to around 11%. S. The free cash flow forecast was also cut to EUR 500m from 600m. Management said the profit warning was due to increased pricing pressure from auto makers as well as rising R&D costs. 

Convertibles 

Despite some choppiness in the underlying equity and credit markets, convertible issuance continued with three deals. In Europe, French retirement homes operator, Korian, issued a EUR 240m perpetual 2.5% convertible (callable in 2022) to strengthen its balance sheet (this is a hybrid bond which will count as equity). UK oil & gas exploration company, Hurricane Energy, came to market with a USD 220m 7.5% 2022 convertible while simultaneously raising USD300m in new equity; the proceeds will be used to get its Lancaster field, west of the Shetland Isles in Scotland, into production. In the US, EZCORP (payday loans), issued a USD 125m 2.875% 2024 convertible for refinancing.

On the earnings side, Micron reported a very solid quarter with sales up 20% to USD5.57bn while the gross margin increased by more than 9 points QoQ on higher DRAM prices. In Europe, German specialty chemical manufacturer, Covestro, held a capital markets day which highlighted its intention to make bolt-on acquisitions or to return cash to shareholders if the company undertakes significant M&A in the next couple of years. In Asia, shares of Taiwanese silicon foundry, UMC, rallied 15% this week on the back of analyst upgrades on management and strategy changes. Zhejiang Expressway listed its securities affiliate on the Shanghai Stock Exchange this week and the shares doubled. 

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