Mounting concerns less than a week before the US elections

Asset Management - 04/11/2016

It was another down week on global equity markets as concerns mounted less than a week before the US presidential elections. The latest polls pointed to a sharp rebound in people intending to vote for the Republican candidate. (English version)

There was good news on industrial growth in Europe -eurozone PMI data showed Germany hitting the highest level in close to 3 years and France at a two-and-a half year high- but it had little impact on indices. After a month of strong performance, banks led declines as investors migrated to more defensive plays and took profits on a sector which had rallied by more than 25% since its July lows.

In the FOMC communique following the meeting on November 1/2, the Fed opted for the status quo 6 days ahead of the presidential elections. There was no indication of a possible rate hike in December but the tone struck a more confident note over a recovery in inflation, reflecting increased optimism that inflation could hit its 2% target. The case for a rate hike has been getting stronger and a move in December is in our view still very likely.

In this wait-and-see environment, we maintained our option hedges and our equity market positions. On bond markets, we are still cautious over US duration amid signs that inflation is rebounding in developed economies. Bond markets are becoming nervous which explains the sell-off at the end of October. 

  European equities

This week, European markets found a new reason to retreat as tightening opinion polls on the US election outcome monopolised investor concerns.

In addition, a number of company results proved disappointing. Autos were hit by poor October sales at Renault and Peugeot as new registrations for the sector as a whole fell 4%. Veolia moved lower after reporting disappointing like-for-like growth. Novo Nordisk tumbled by close to 18% over the week after cutting its medium-term objectives.

But on the plus side, investors cheered upbeat results from banks. ING's figures reflected good margins and solid growth in retail banking from higher loan volume. Société Générale also beat expectations as a surprisingly good contribution from its capital markets business helped offset lacklustre performance in retail banking within France. Elsewhere, Lafarge Holcim's results provided confirmation that prices and margins were improving. WPP's growth was fairly evenly spread across geographical zones and the company reaffirmed its guidance for 2016. Royal Dutch Shell performed well both in its upstream and downstream businesses.  

Luxury sector companies continued to do well: like-for-like third quarter growth at Hermès remained above 8% (including+16.3% for leather goods and +14% in Asia due to a recovery in Chinese spending). Richemont rebounded after beating expectations and announcing it was revamping its executive and financial teams. L'Oréal reported very strong like-for-like growth in the third quarter, notably in its luxury segment and in North America.

 

  US equities

US markets fell back with the S&P down 1.8% mainly due to disappointing quarterly figures and a US election opinion poll reversal in favour of Donald Trump. Core inflation as embodied in the PCE price index, the gauge that the Fed pays most attention to, rose 1.7% in September, in line with expectations and the year-to-date trend. Manufacturing ISM improved to 51.9 in October, up from 51.5 in the previous month. As expected, the Fed meeting was a non-event and the communique was more or less in the same vein as the previous one. This reinforced market expectations of a rate hike at the next meeting in December.

In the event, the sell-off was triggered by Donald Trump's rebound in the opinion polls. This bounce followed the FBI's decision to reopen the Hillary Clinton email case - it had been closed last July - following the discovery of allegedly "relevant" details. A Trump victory could undermine free trade agreements between the US and its trading partners and damage US exporters.

At the same time, Bernie Sanders' comments on drug prices pushed the issue back into the limelight and automatically weighed on healthcare stocks. To make matters worse, companies like Amgen, Zimmer, Gilead, Pfizer and Amgen reported disappointing third quarter results and all sounded a note of caution on the outlook for 2017.

To date, 411 companies have released third quarter figures with 312 beating estimates and 92 missing.

Over the week, utilities and consumer staples proved the most resilient, limiting losses to 0.5% while healthcare plunged more than 4% and telecoms and technology fell by more than 2%.

 

  Japanese equities

The TOPIX ended the week 1% lower as the yen appreciated to 102 amid heightened anxiety ahead of the tightly-fought US presidential election. At its policy meeting, the Bank of Japan maintained its current monetary easing stance as expected with limited impact on equities.

This week's top sector was Air Transportation (+3.6%). Financial sectors including Insurance and Securities & Commodity also posted positive returns while natural resource sectors such as Nonferrous Metals and Mining retreated by 4% and 3.8% respectively.

On Tuesday, Tokyo Electron touched a year high after jumping 8.1% on upward revisions of both its earnings forecast for the year ending March 31, 2017 and interim financial results. The improved outlook was due to increased orders for semiconductor production equipment in the US and Europe.

On a negative note, Kao Corporation tumbled 7.2% due to weaker-than-expected Jul-Sep quarterly earnings: operating profit fell compared to the same period in 2015 due to increased spending on marketing to promote the company's beauty care products in Asia.

 

  Emerging markets

Emerging markets slipped and many currencies weakened sharply in a week marked by growing uncertainty over the outcome of the US presidential election as well as US data that reinforced expectations that the Federal Reserve might raise interest rates in December.

China's official factory gauge rose to its highest level since July 2014, led by new orders. The data suggested the economy had continued to stabilise into the fourth quarter as robust consumption underpinned demand. Manufacturing PMI rose to 51.2 in October from 50.4 in the prior two months while non-manufacturing PMI improved from 53.7 to 54 in September. Other robust economic data in October included power production which rose 13.1% year on year.

India's government has set out the broad structure of its long-awaited goods and services (GST) tax. The committee that examined possible GST tax rates recommended a two-rate structure comprising a low rate and a standard rate, but proposed that India should strive toward a single rate structure in the medium term. As the cement sector will pay lower taxes than expected, we increased our exposure to Shree Cement.

Brazil's benchmark Bovespa stock index tumbled towards the end of the week, weighed down by a sharp decline in shares of the state-controlled oil company, Petróleo Brasileiro as traders took profits after an 11% rally in October. The Brazilian government said it would unveil its pension reform plan by the end of this month. Itaú Unibanco shares gained on better-than-expected results due to lower provisions for non-performing loans.

Mexico's stock market and currency were negatively affected by US election polls and falling oil prices. The IPC index continued to decline over the week and hit a new one-month low.

 

  Commodities

Oil prices lost a further two dollars a barrel this week, taking the decline since the mid-October high to USD 6. This took prices back to levels seen prior to the September 28 meeting in Algiers when OPEC countries reached an informal agreement to cut output. This week's drop was partly due to the subsequent inability of OPEC members to make the agreement official. Negative sentiment was reinforced by a fresh rise in their production in October as Nigerian operations returned to normal and Libya resumed exports. Russia also announced another rise in its production over the month to 11.2 million b/d.

The oil price slide was only made worse by weekly data on inventories. Crude stocks rose by 14 million barrels to a record higher as imports increased to their highest levels since September 2012. In addition, for the third week running, US production also increased.

Base metal prices continued to rise as the US dollar corrected due to a Donald Trump bounce in opinion polls and upbeat macroeconomic data in China. Better PMI data in China as well as Japan and the US is encouraging and confirmation of the recovery in manufacturing that kicked off in September, especially as China's PMI data in the steel sector hit a 5-month high. Other Chinese data on property sales, fixed capital investments, electricity production and auto sales also confirmed that the economy was performing well, all of which is good news for demand for commodities.

Following a decline in the US dollar (DXY index), gold rebounded, breaking back above the USD 1300/oz barrier, its highest level since the beginning of October. Demand for protection assets was driven by the narrowing gap between Hillary Clinton and Donald Trump in US election polls, with one poll even predicting a Trump victory. Once again, gold is proving to be the safe haven asset par excellence in times of uncertainty.

 

  Corporate debt

Credit

In a relatively uncertain climate, credit premiums widened a little over the week, hitting 76bp for investment grade and 338bp for high yield. The investment grade new issues market remained busy with a crop of relatively long-dated maturities. "12 is the new 7."

Companies refinancing debt included Abertis (Industry) with a 2027 maturity, Statoil (an integrated oil company) with a 2026 and a 2036 maturity, Capgemini (IT services) with a bond due 2021, BASF (Chemicals) with bonds due in 2020 and 2026 and RCI (autos) a 2021 maturity. In high yield, Autodis (autos), Synlab (medical laboratory) and Guala Closures (Packaging) also refinanced debt.

In company news, Air France-KLM revised down guidance for 2016 and unveiled details on its new Trust Together programme. Alstom and Bombardier look likely to win a EUR 3bn SNCF contract to build more suburban trains. Quarterly results from France's banks were overall better than expected, especially at BNP.

 

Convertibles 

On a busy new issues market, Sirius Minerals (UK) placed USD 400m of 8.5% 2023 convertibles along with a GBP 370m equity issue to fund expansion in its Yorkshire potash mine.

In Asia, Hunan Valin sold USD 369m in bonds exchangeable into Fortescue Metal Group's 2021 zero coupon bonds. Yangtze Power (the Three Gorges Power Station operator) issued two tranches of 5 year convertibles (USD 300m and 200m) exchangeable into China Construction Bank. And on Thursday night, Valeo tapped its 2021 USD convertible (125m million at 107%).

In results, Ubisoft Entertainment jumped more than 15% last Friday morning thanks to solid results: first half sales rose 36% thanks to strong player engagement on titles like The Division and Rainbow 6 and operating margins rose to roughly 15% vs. 12% last year. More importantly, the company raised its full year operating profit guidance to EUR 230-250m, up from 230m previously. Stainless steel producer Outokumpu reported better-than-expected third quarter results with EBIT at EUR 32m as restructuring and cost-cutting efforts coupled with recent price hikes started to come through. The company also reduced net debt by 6% QoQ. Inmarsat (communication satellite systems) posted strong third quarter results with Capex revised downward and a 5.8% rise in revenues.

Last Friday, the US Department of Justice was reportedly investigating suspected price collusion involving several generic drug companies that could result in charges by the end of 2016. Pending further details, the whole sector took fright: Impax tumbled 20%, Teva 10%, Allergan 4.5% and Towa 2.4%.

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