Trump and Brazil spoil the party

Market analysis - 5/19/2017

After a month of strong performance from global equities, the MSCI World in local currency had its worst down week since Donald Trump’s election.
Investors took fright after reports indicated that back in February, Donald Trump had asked James Comey, who he sacked as FBI chief last week, to stop an inquiry into the Russian contacts of Michael Flynn, the ex-national security advisor. Global markets eventually lost a little more than 1% over the week, but it was all in all a rather measured reaction compared to the 13% gained since Donald Trump’s election. 

Despite a rebound in market volatility, both current economic and political forces are still particularly upbeat. First, expectations of global growth continue to be revised higher while inflation appears to be stabilising at much higher levels than 12 months ago when serious worries about deflation were gathering strength. Take Japan, for example. The country is highly sensitive to the global cycle and saw the fastest rise in first quarter growth in the last year, a sign that reinforces chances of a robust recovery. GDP grew by an annualised 2.2%, the fifth up quarter in a row and higher than analysts' expectations of +1.7%. Second, falling political risk in Europe is clearly being reflected in tightening sovereign debt spreads in France, Italy and Spain vs. Germany. 

As a result, we believe that today’s surge in volatility due to US domestic events in no way undermines our decision to overweight developed country equities, particularly in Europe and, to a lesser extent in Japan. 

  European equities

The downward trend in Europe worsened with each successive day. Bets on Donald Trump being impeached were followed by accusations of corruption against Michel Temer, president of Brazil. On Thursday, stocks with links to Brazil like Vallourec, Casino, CNP and Danone all fell. 

As we near the end of the first quarter results season, Europe has scored well with company earnings up 23% overall, one of the best results in the last 7 years. 

This was achieved thanks to top-line sales rising more than 10%. Energy and commodity stocks led the field. 

This week, RWE’s results came in slightly better than expected and the company maintained its guidance for 2017 as a whole. Bouygues Telecom's sales and EBITDA came in better than consensus expectations and the company continued to gain high number of new mobile customers. Iliad’s quarterly sales rose 7% or in line with expectations. 

Saint-Gobain used its investors' day to discuss its acquisitions programme. It expects to spend EUR 2bn over 4 years to accelerate growth. Danone was cautious on like-for-like growth over the medium term and said it expects the second quarter to be weak. It now sees like-for-like sales growth of 4-5% by 2020, down from more than 5%. 

Accor said its board had approved the spin-off of HotelInvest (960 hotels under management) into a subsidiary which will in time be sold. 

  US equities

Risk assets all lost ground with the S&P down 1% and the Nasdaq 1.1% lower. At the same time, volatility returned and the Vix jumped to 14 vs. 10 the previous week. The sell-off was triggered by new political risk. 

In economic data, both housing starts and building permits fell in April (down 2.6% and 2.5% respectively) which was much worse than expected. Industrial production, however, continued to rise, adding 1% compared to +0.5% last month and raising capacity utilisation rates to 76.7%. 

After a good start to 2017 with improving macroeconomic and excellent microeconomic figures, geopolitical risk returned to haunt markets. Donald Trump’s supposed links with Russia, Moscow’s possible intervention in the US presidential campaign, allegations that the president passed on top secret information and suspicions that he has tried to obstruct FBI action could all lead to impeachment. Worse, they could slow down the reform programme.

Reduced confidence in the ability of the Trump administration to deliver on its big legislative agenda triggered sector rotation into defensives. Utilities and consumer staples led gains over the last five trading sessions while financials, industrials and consumer discretionary were the biggest victims, all losing more than 1.5%. 

  Japanese equities

Over the week, the TOPIX dropped 0.3%. After remaining firm up to Wednesday, heavy selling pressure emerged on Thursday after US equities plunged on mounting concerns over the Trump administration’s ‘Russia-gate’ issue which took the US dollar lower against the yen. Export stocks declined as the US dollar briefly retreated below 111 against the yen on Thursday, while domestic related defensive stocks were relatively firm on institutional buying.

The good news was the stronger-than-expected 2.2% rise in Japan’s GDP for January-March with solid growth in exports and a recovery in consumption.

By sector, the best performers were Food (+3.0%) and Agriculture & Forestry (+2.4%).Defensive stocks were also buoyant. Shiseido Company, the leading domestic cosmetics play, jumped 7.9% and Kao Corporation, Japan’s top toiletry products maker, rose 2.3%. Elsewhere, there were gains from the largest domestic food company, Ajinomoto (+5.1%) and Japan’s largest tobacco company JT (+4.9%).

In contrast, economic sensitive sectors such as Mining and Oil & Coal Products lost ground due to a decline in crude oil futures. Insurance and Banks were also weak, notably Dai-ichi Life Holdings (-9.8%), Resona Holdings (-8.8%) and Mizuho Financial Group (-7.5%). 

  Emerging markets

Brazil's political crisis managed to offset what was otherwise a good week for emerging markets. 

India’s inflation slowed to an all-time low of 3% or lower than the central bank's medium term target of 4%. We expect the bank to stick with its accommodating stance in coming quarters. In Argentina and Brazil, job creations in the first quarter and in April were surprisingly good, mainly in services but also in Brazil’s industrial sector and Argentine construction. 

Elsewhere, Chinese internet giants like Weibo (the national Twitter), Netease, Tencent and Alibaba all beat expectations. They are increasingly monetising their services, still winning over high numbers of new users and launching new services which will provide further avenues of growth. The sector is one of our top-conviction picks.  

In Brazil, President Michel Temer appears to have been taped discussing payments to silence the jailed former Speaker Eduardo Cunha. The news emerged during talks over reducing the sentence of Joesley Batista who owns the JPS Group. Batista, who is opposed to Temer, has often been in trouble with the law. 

Brazil’s market index tumbled when the news emerged on Thursday even if it is unclear if the claims can be proved. The biggest risk for the economy and markets is not so much whether Temer remains president- he is not essential to the ongoing reform programme- but possible ripple effects like: 

1) a delay in the vote on retirement schemes which was to take place in the next two weeks and now looks unlikely 2) the resignation of the current administration which has been highly efficient so far at pushing through sensible reforms and 3) outflows that might weaken the Brazilian Real and force the central bank to postpone its expected strong cut in interest rates. 

Temer has refuted the allegations and is refusing to resign even if that would be a positive way out of the current crisis. There are still a number of uncertainties. If there is sufficient proof, Temer’s position would soon be untenable and an impeachment likely. That would seriously slow down ongoing economic improvements although the investment case still holds providing a solution is found quickly and decisive action is taken. The current account is improving, real interest rates are attractive and the currency is not expensive. 

  Commodities

A strong oil price rebound took Brent crude back above USD 53 and WTI higher than USD 50 for the first time in a month. This move was primarily due to: 1/ a joint Saudi-Arabia/Russia declaration in favour of extending production cuts by 9 rather than 6 months. The proposition will have to be confirmed at the May 25 OPEC summit by all stakeholders. It would be an extremely positive development as it would provide the visibility that has been missing since the beginning of the year. Saudi Arabia’s version of Mario Draghi’s “Whatever it takes” is a powerful signal. 2/ speculative trader positions which have been cleaned up leaving them room to take long positions. 3/ lower inventories with US stocks down for the 3rd week in a row according to DOE data. The IEA confirmed that OECD inventories had fallen by 32.9 million barrels in March. High inventories are the biggest brake on investors returning to the sector. 

The IEA report is rather upbeat. It has maintained forecasts of 2017 demand growing by 1.3 million b/d despite a small downward revision in the first half. Non-OPEC production has been revised higher by 600,000 b/d (up from 485,000) mainly due to US shale oil. The agency said the market had been balancing out again in the first quarter and that it expected to see this trend accelerate.

Elsewhere, US petrol consumption in April hit an all-time high for that period of the year due to economic growth and relatively low prices in service stations. 

Fresh geopolitical risk helped the gold price advance to around USD 1,250/oz thanks to possible moves to impeach Donald Trump, the subsequent fall in the US dollar and allegations of corruption against Brazil's president. 

  Corporate debt

 

Credit

High yield investors were relatively enthusiastic about Edouard Philippe being appointed French prime minister. Elsewhere, rumours that Donald Trump might be impeached were fanned by suspicions that his team had been in close contact with Moscow during the election campaign. And yet, the market was impacted more by news that Brazilian president Michel Temer was facing corruption allegations. The Xover widened to 259bp on Thursday when the story broke. 

New issues: Rallye raised EUR 350m with a Senior Unsecured 2023 maturity to refinance its 2018 bond. The issue was massively oversubscribed with EUR 3bn in bids. Groupe Bruxelles Lambert (unrated) raised EUR 500m with a Senior Unsecured 2024 maturity and Iron Mountain (Ba3/BB-) EUR 300m with Senior Unsecured Notes due 2025 NC3. 

This week’s first quarter releases were generally upbeat. Synlab (B2/B+) reported satisfactory results with top-line sales driven essentially by acquisitions. Sales were EUR 446m, up 3.2% like-for-like. Verallia (B1/B) reported better results with sales up 8.3% to EUR 593m thanks to an overall lift to volumes and higher South American prices. 

S&P downgraded CGG to D due to non-payment of interest on its 2020 bonds. The company is currently restructuring so as to reduce its debt from USD 2.7bn to 1.05bn but stakeholders have not for the moment come to an agreement. 

Douglas (B2/B), which is continuing to expand in Italy, is buying Limoni and La Gardenia Beauty, two perfume shop chains which have 500 outlets between them. 

Convertibles 

The primary market remained active with two new deals in the US and one in Asia.

RealPage, a US developer of software and services for rental businesses, issued a USD 300m 2022 1.5% coupon convertible to finance future acquisitions. This coincided the same day with a deal from airfreight operator, Atlas Air Worldwide. The company, which recently signed a strategic agreement with Amazon, came to market with a USD 260m 2024 1.875% coupon convertible to help refinance existing expensive credit facilities.

In Asia, holding company China Mengniu Dairy refinanced existing debt by issuing a USD 200m 2022 zero coupon premium redemption bond exchangeable into China Modern Dairy shares.

The earnings season is almost at an end. In Europe, Ubisoft reported its end-March 2017 financial year with solid numbers in a competitive environment: FCF is back in positive territory: sales grew +5% and management announced a high-quality AAA games line-up for next year. In the US, Salesforce.com (the world’s number 1 CRM provider) provided healthy Q1 results, beating revenue estimates, with growth across all regions and also strong margins and cash flow.

In Asia, Bangkok Dusit (a healthcare facilities provider based in Thailand) posted disappointing Q1 2017 results with earnings falling 18% YoY amid higher-than-expected medical treatment costs but also a reduction in the number of outpatients amid a decline in influenza and dengue fever cases.

S&P upgraded European stainless steel producer, Aperam, to investment grade (BBB-/Stable from BB+). The company is already rated IG (Baa3/Stable) by Moody’s.

Elément complémentaire