Spain returned centre stage

Market analysis - 12/22/2017

Spain returned centre stage after Catalonia’s 3 separatist parties retained an overall majority in the Catalan parliament with 70 seats. But they only polled 48% of the popular vote compared to 52% for the unionists.

The regional parliament now has until February 8 to form a government and elect a president and the big question is whether the separatist parties will manage to form a coalition. Portugal, in contrast, is ending the year on a positive note. Fitch has revised its rating up to investment grade, citing the improvement in the economy with growth running above 2%, the return to a trade surplus and unemployment which is back to pre-crisis levels. 

In the US, the administration has also ended the year on the front foot by getting tax reform through Congress and getting a last-minute agreement to prevent government services shutting down after the debt ceiling was hit. This compromise will, however, have to be prolonged on January 19. On the economic front, company results and declarations have all stressed the strength in the economy as well as expectations that inflation could rise. 

But equity markets failed to move much on all this news. US tax reform had clearly already been discounted. In Spain too, equity markets only saw modest falls after the Catalan election results and were still up over the week. The energy sector rebounded by a sharp 1.5% following upbeat economic indicators, low oil inventories and the recent rise in the oil price. Bond markets cheered encouraging economic data and the US tax reform news. Yields rose first rose on US Treasuries before spreading to the German Bund and the move there was reinforced on news that Germany would be upping long-term issuance in 2018. Peripheral bonds outperformed, led by Portugal. Against this backdrop, we still prefer eurozone companies while remaining neutral on overall risk. In bonds, we remain short the Bund and long Portugal. 

  European equities

The M&A market remained active in France. After rebuffing Atos, Gemalto agreed to a bid from Thales. Combining the digital assets of Gemalto and Thales will help create the global N°1 in the rapidly expanding digital security sector while generating revenue and cost synergies. Iliad and the personal holding company NJJ of founder Xavier Niel bought a stake in Eir, Ireland’s legacy telecommunications company.

At the end of the week, H&M delivered another profit warning on particularly weak sales in the quarter ending November 30. The group cited low footfall and stock control difficulties as the main reasons.

Elsewhere, Innogy's recent profit warning precipitated the resignation of its CEO. Not only were the results disappointing but the corporate model unveiled at the company's October 2016 IPO had undergone significant changes.

Deutsche Telekom and Tele2 are to merge their Dutch businesses to become one of the country's biggest operators. €150m in synergies are expected over 3 years. The deal still requires regulatory approval and that will provide a useful pointer for other markets which are ripe for consolidation.

Airbus Group largely brushed off an internal anti-corruption probe despite the resignation of the Airbus CEO and the risk of a fine. The stock was also unaffected by Kuwait's decision to look into its purchases of Caracal helicopters.

Nokia signed a patents agreement for an undisclosed amount with China’s Huawei

  US equities

US indices rose and remained close to record highs with the S&P up 1.2% over 5 days and more than 20% year to date. The successful vote on tax reform was chiefly responsible for sending US Treasury yields from 2.35% to 2.5%. This depressed bond proxy sectors like utilities (-4.5% over 5 trading sessions) and property  (-2.7%) while sectors seen as benefiting from the new tax regime, like telecoms and financials, both gained more than 2%. Energy stocks rose 4% and materials were up 2% due to expectations of inflation returning.

In macroeconomic news, the property sector was lifted after housing starts, new builds and sales of existing homes all rose more than expected.

There was little company news apart from bid talks between Boeing and Brazil’s Embraer, only a few weeks after Airbus and Canada's Bombardier decided to join forces. 

  Japanese equities

The TOPIX gained 1.62% in another mixed market. Stocks advanced on Monday, with the index hitting its highest level in more than 20 years for the second week in a row after Wall Street gained on expectations that US tax reform would be rolled out. The market retreated on Tuesday as investors locked profits in after the surge, but rebounded the next day.

By sector, the best performers of the week were Nonferrous Metals (+5.42%), Rubber Products (+4.83%) and Insurance (+3.83%). Sumitomo Metal Mining (+8.38%) and Hitachi (+7.87%) stood out.

On the other hand, Land Transportation (-1.77%), Construction (-1.34%) and Real Estate (-0.83%) were relatively weak. Auto maker Subaru declined 4.47% after the company said that December domestic orders would fall by around 30% year-on-year due to a car recall over unauthorised staff vehicle inspections. Construction firms also declined on a bid-rigging issue.

2017 has been a good year for the Japanese equity market. Sector wise, manufacturing sectors such as Electric Appliances and Machinery were strong and lifted indices as further growth is seen in 2018. And, in general, small and mid-cap issues largely outperformed large cap names.  

  Emerging markets

This week’s big news came from South Africa where Cyril Ramaphosa was elected as new ANC president. The key factors to look at are the potential changes in business sentiment, potential key government posts (Treasury, Ministry of Energy), reshuffling of SOE heads and the 2018 budget where the Government needs to save ZAR 40bn (25bn in spending cuts and 15bn from tax hikes). The only tangible benefit of Ramaphosa’s election is that Moody’s will delay its sovereign rating downgrade. Over the week, the rand gained 3.6% vs. the US dollar.

India saw a number of fund raisings: HDFC Bank approved an equity capital raising of Rs 240bn ($3.8bn) in which parent company HDFC will provide up to Rs 85bn. HDFC is raising up to Rs 130bn via a share or convertible bond issue. And Tata Steel announced a $2bn equity issue (19% dilution) to go on capital expenditure.

The signal from these issues is mixed as even the cross-holding between HDFC and HDFC Bank could not be seen as a fundamental good news, but there are 2 potential benefits:

  1. The management of India’s best run bank, HDFC Bank, wants to be more prepared for an economic recovery which could occur sooner than expected.
  2. If a highly leveraged group like Tata Steel succeeds in raising equity to finance capex, investment spending may come sooner than expected and will boost the Indian economy.

The US tax bill approval raised concerns over its impact on Mexico’s fiscal competitiveness. Mexico’s finance minister has already said that the Government would take measures to counteract the effects of the tax reform bill on the country.

After a strong 2017 for emerging markets, we remain upbeat for 2018 despite the likelihood of higher volatility. China continues to progress in the value chain. India may recover more quickly than expected if we continue to see more fund raisings which will help the private sector deleverage earlier than expected. Asean countries may benefit from buoyant global trade. Brazil and Argentina are sticking to their structural reform programmes. We will probably have to be opportunistic when short term fallbacks occur due to volatile markets.   

  Commodities

Work to repair the Forties pipeline should be completed in a few days so it should be back in action at the beginning of January or a little less than a month since operations were interrupted. But the return to normal business -450,000 b/d- should not push Brent crude prices down significantly as the interruption has served to clean-up the market. This rebalancing of oil inventories could mean less volatility for prices in 2018. We expect Brent crude to trade between $55-60 and possibly push higher to $65 if demand remains strong. Everything will hinge on how OPEC and NOPEC countries manage the end of production cuts. They are all fully aware of this and have already started working on the issue. 

2017 saw the return of commodities, and especially metals which rose by an average 25%, but 2018 could be equally upbeat.

Today’s synchronised global growth is the biggest factor in demand for metals. And as major commodity players want to keep investment under control, supply could be limited. 2018 will be particularly important for metals used in electric vehicles like lithium, cobalt and, to a lesser extent, graphite and nickel. 

Gold’s propensity for resilience is now well-established. Prices have largely brushed off the recent US rate hike as well as the vote in favour of US tax reform. True, further monetary tightening by the Fed in 2018 creates a potentially negative environment for gold, but as 3 more rate hikes have already been announced, the impact may already have been discounted. Gold will continue to react to geopolitical events, but inflation will remain the most critical and most uncertain factor. If it remains at current levels, the gold ounce could trade between $1,200-1,300 but more marked inflationary trends would push it up towards $1,400. 

  Corporate debt

 

Credit

Trading was subdued on the HY market with the Crossover index moving around 230bp and ending the period slightly higher. Outflows amounted to €440m or 0.8% of total assets. Investment grade bonds dipped 0.5% over the week, mainly due to fresh interest rate volatility. After a particularly busy fortnight, the new issues market was closed ahead of the Christmas week. In company news, Moody’s upgraded ZF to Baa3 while S&P raised Fiat by one notch to BB. In M&A, Crown Holdings (packaging) acquired Signode for $3.9bn in cash and Liberty Global sold its Austrian cable company to Deutsche Telekom for €2bn, or 11 times operating profits. 

Convertibles 

Steinhoff’s board appointed former COO Daniel Maree van der Merwe as acting CEO and Alexandre Nodale, current CEO of Conforama, as deputy CEO. After December 19 meeting with creditors, Steinhoff said that €690m in credit lines had been extended but credit facilities are increasingly being withdrawn.

The company gave an update on its debt structure, but has yet to update on its cash position. It also said that it was not possible at this stage to estimate the magnitude of accounting irregularities nor when results would be released. As a result, its convertible bonds finished the week in the 47-49 area for the 2022, 40.75-42.25 for the 2023 and 56.5-59.5 for the 2021; the stock lost another 42%.

In M&A, German residential real estate giant Vonovia announced a takeover of Austrian rival Buwog for €5.2bn bn.

In US corporate earnings, Micron beat its own guidance and estimates with another set of solid results as first quarter FY2018 revenues rose 11% QoQ to €6.8bn on strength in server DRAM content and the smartphone market.

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