The ECB sticks with the status quo

Market analysis - 21/07/2017

Central banks, notably the ECB, once again made their mark on market sentiment.

European equity and bond markets were relatively stable over the week but it was the euro’s rise against a basket of currencies that reflected investor nervousness over the ECB’s future monetary policy. Ever since Mario Draghi’s comments at the Sintra forum in Portugal sent bond yields higher and stoked fears over the size and duration of the bank’s asset purchasing programme, investors had been very keen to hear a clearer message from the central bank.

In fact, the ECB meeting decided unanimously not to change its accommodating bias, its QE programme and its analysis of the balance of economic risks. Mario Draghi’s cautious decision to wait for the autumn to discuss the asset buying programme is no doubt a sign of his determination to take his time over cutting back QE. He wants to avoid upsetting markets or harming an economic recovery which continues to look strong. We will now have to wait for the August 24-26 Jackson Hole symposium to see any possible shift in his attitude.

But it is clear that the euro's rise against the US dollar could make the ECB's job complicated as recent tensions on bond yields and currencies are already likely to be making monetary conditions tougher even if they are still very accommodating. At this stage, we believe this is more of a tactical adjustment from momentum investors than a real paradigm shift in the euro/USD exchange rate. After all, the euro has simply returned to levels seen a year ago.
We remain negative on eurozone sovereign debt and prefer financial bonds and high yield debt. In equities, we prefer the eurozone to the US because the former is enjoying economic momentum and stands to see better earnings growth.

 

  European equities

European markets remained geared to monetary policy decisions with last Thursday’s ECB meeting the headline event of the week. Mario Draghi clarified his intentions and said he wanted to stick with monetary stimulus in case a necessity arose. The inflation target is still far from being hit. The euro hit fresh year highs against the US dollar and banks suffered as long term euro yields fell again.

Good quarterly earnings news included ASML and the entire European tech sector rose. Publicis reported like-for-like growth of 0.8%, or better than expected, on a US upturn and a 20bp rise in its EBIT margin. Deutsche Telekom's US subsidiary T-Mobile US, beat expectations with strong sales and an increase in new subscribers. The group’s prospects were revised higher. Faurecia, Plastic Omnium and Valéo reported upbeat figures and confirmed annual guidance. Airline stocks retreated at the end of the week on easyJet’s disappointing forecasts and despite Lufthansa beating expectations. The group benefited from a rise in unit revenues rise and a drop in costs. Daimler brushed off a 3 million vehicle recall to repair a software problem. Nokia was dragged down by Ericsson which is mulling a rationalisation plan after posting its second set of quarterly losses in a row. Carrefour disappointed investors by listing its Brazilian subsidiary at the low end of the offer price spread. Mc Cormick&Co signed a definitive agreement to buy Reckitt Benckiser’s food division for $4.2bn or more than the $3bn the market was expecting. AkzoNobel’s CEO relinquished his post for health reasons and was replaced by specialties head Thierry Vanlancker.

 

  US equities

Markets had another up week with the S&P500 (+0.5%) and Nasdaq hitting new all-time highs. In macroeconomic news, housing starts rose 8% in June or more than the +6% expected and housing permits also outpaced expectations (+2%) by rising 7%. Oil prices hit their highest level in 6 weeks due to further drops in US inventories.

Investors focused on better-than-expected second quarter figures. In the S&P500, 71 out of the 85 companies which have reported so far did better than expected. Omnicom and Alcoa stood out. IBM, PPG, and CSX, however, disappointed the markets. Sears jumped 11% on news that it had signed a distribution agreement with Amazon for Kenmore’s household appliances.

The S&P tech index climbed above 2,000 to hit a fresh all-time high. The tech sector has now risen 23% year to date and has just had 10 up sessions in a row due to 10-year Treasury yields falling from 2.4% to 2.25%. Apple has enjoyed its longest up trend since August 2014 and Facebook and Microsoft are trading at their all-time highs. Google’s market cap is flirting with $700bn. The sector’s results will be released the week starting July 24.

 

  Japanese equities

The TOPIX gained 0.5% over the week after advancing on Thursday when the BOJ decided to maintain its current monetary easing stance. Market sentiment was also supported by the US market hitting a record high. Electric Appliances and Chemicals were relatively strong on brisk earnings from overseas semiconductor related companies and strong performance from US tech stocks. In addition, mid and small cap stocks were buoyed on expectations of upbeat corporate earnings.

By sector, the best performers were Agriculture & Forestry (+4.0%) and Chemicals (+2.1%). Toshiba soared 13.5% after a three week decline on news that a prominent investor had purchased shares. Game maker Nintendo advanced 4% ahead of the upcoming release of popular game software. Kao Corporation (+5.3%), Asahi Kasei Corporation (+4.5%) and FUJITSU (+3.4%) were also strong.   

In contrast, Marine Transportation (-1.7%) and Banks (-1.4%) were relatively weak. The global apparel maker Fast Retailing dropped 3.1%. Other losers included major financial institutions such as Resona Holdings (-2.6%), Dai-ichi Life Holdings (-2.4%) and Mitsubishi UFJ Financial Group (-1.8%).

 

  Emerging markets

China’s Q2 real GDP grew more than expected, stabilising at +6.9% YoY on resilient consumption (retail sales were nearly 10% up YoY) and external demand. AAC Technologies guided for lower margins due to more pricing pressure from Apple.
Indian IT names continued to report relatively weak results: TCS reported a 5.9% drop in EPS, and Infosys only a 1.4% YoY rise. Despite destocking due to the implementation of GST, Hindustan Unilever published very decent earnings (+9% YoY) while Havells (electric equipment) was impacted by destocking. Private banks continued to publish a good set of results with IndusInd Bk up 23% and Kotak 26% higher. Reliance Industries published a 28% rise in EPS mainly due to robust refining margins.

To boost its fiscal revenues, the Finance Minister announced an 18/20% tax hike on cigarettes. In Brazil, for the same reason, the government increased tax on gasoline and diesel fuel by 41% and 21% respectively. The Senate approved the labour reform, a very important move to lower lawsuit-related labour costs.

Argentina made a U-turn and finally abandoned the implementation of a 15% capital gain tax for offshore transactions. In Mexico, airports continued to publish solid results: ASUR’s EBITDA jumped 86% like for like on strong 14.6% traffic growth. OMA’s performance was less spectacular but it still reported an upbeat 16% YoY increase in EBITDA.

We remain upbeat on emerging market prospects: China is successfully moving up the value chain and trying to keep financial leverage under control, reforms are being carried out in India and better fiscal discipline is being implemented in Brazil. Only a sharp interest rate hike in the US could end the party but this is not our base case scenario for now.

 

  Commodities

Oil prices extended last week’s rebound to end the week close to $49 for Brent crude and $47 for WTI. The rebound, however, lost some steam as concerns over Libya’s rising production mounted. This followed a statement from Libya’s national company (NOC) that it wanted to increase production from today’s 1.1 million b/d to 1.25 million by the end of 2017 and to 1.5 million by end 2018. Lack of infrastructure and investment has often been represented as an obstacle to increased Libyan output. OPEC, meanwhile, has asked Libya to share its production plan at the cartel’s informal meeting on July 22.

The DOE’s report on US inventories showed a drop in crude and oil product stocks. We are used to commenting on these data as markets scrutinise them but the week’s global inventory data (DOE, PAJ in Japan, Genscape and PJK for the ports of Antwerp, Rotterdam and Amsterdam and IE for Singapore) show crude inventories down by 10.4 million and oil products 9.8 million lower. If we lump all these figures together, total inventories are currently lower than levels seen in 2016.

Elsewhere, the EIA released its drilling productivity report which sees US shale oil output rising -for the 8th time in a row- by 112,000 b/d in August to 5.6 million b/d. This is mainly due to developments in the Permian basin. On a more positive note, the report also says productivity is down in new wells, a sign that the best wells have already been drilled.

China’s data on industrial production, housing starts and durable investments remained encouraging for base metal demand. Iron ore imports rose to 94.7m tonnes in June (up from 91.5 in May) and prices ended the week higher at $68/t thanks to:

  1. Persistently strong demand for steel (China’s production rose 5.7% while apparent demand was up 11.1%)
  2. Higher metallurgical coal prices
  3. High-quality ore shortages following downward revisions in production at Rio Tinto and BHP for 2017.

The gold ounce rose over the week to $1,250 after Mario Draghi struck a more dovish tone than expected, especially as regards worries over today’s inflation levels.

 

  Corporate debt

Credit

Credit markets started the week quietly but woke up on Wednesday on expectations that Mario Draghi would adopt a dovish tone at the ECB meeting the day after. The Xover tightened and government bond yields fell, triggering strong flows into long duration bonds. All credit market segments performed well with high yield bonds rising by 0.36%, outperforming IG (+0.22%).

It was a busy week on the new issuance market. Eurofins Scientific (not rated), a global player in testing and support services, raised €650m with a senior 7-year maturity. Thermo Fisher (Baa2/BBB), which supplies laboratories with materials, issued senior debt in 4 tranches of 2, 8.5, 12 and 20 years, raising a total of €260m. DS Smith (BBB-), a UK paper and packaging company, issued a senior bond in two tranches, 7 and 12 years, for €1bn. In the B2B media sector, Infopro Digital (B2/B) issued a 5-year senior bond in 2 tranches, fixed and floating, for a total of €500m.

In financials, Nationwide Building Society (Aa3/A/A+) raised EUR 1bn with a subordinated Tier 2, 12-year, non call 7 bond at 2%.

Most of this week’s numerous results were encouraging apart from poor figures from Ericsson (Ba1/BBB-). Sales fell 8% and adjusted EBIT collapsed 93%, both below consensus expectations. Insufficient investment and poor sales were in part responsible for this situation. In stark contrast, airlines like Lufthansa (Ba1 pos/ BBB-) and easyJet (Baa1/BBB+) reported buoyant sales due to a recovery in passenger traffic in Europe. Beni Stabili was also on form with gross rents up 3% and occupancy rates at 94.8%. The company was rated BBB- by S&P. Rémy Cointreau (Baa3/BB+) reported sales up 9.9% or better than expected, mainly thanks to excellent results from Maison Rémy Martin.

In M&A news, French payment terminals specialist Ingenico (not rated), signed an MoU to buy Bambora (online payment services) from Nordic Capital for €1.5bn. As the deal will be funded in cash and bank loans, Ingenico’s leverage will remain below 3 times EBITDA.

 

Convertibles 

Primary activity was muted amid the summer holidays and the start of the Q2 reporting season. Nonetheless, there was a $1.5bn mandatory convertible from US telecoms infrastructure player, Crown Castle, partially to finance its acquisition of Lightower. Also entering the market was the first of a number of China A-share companies expected to issue convertibles this year. Guotai Junan Securities launched a RMB 7bn, 6-year convertible at a 25% premium and with a 0.5% coupon stepping up each year to 2% in year 6.

In company news, French gaming developer, Ubisoft, reported a 45% YoY jump in sales driven by 55% growth in digital revenues. The results were ahead of expectations even with no significant game launches and management signalled its “increasing confidence” in its targets for the next two years, which will see the launch of a new Assassin’s Creed and the next Far Cry; the stock jumped more than 10%. Dutch biopharmaceutical company, Ablynx, unveiled a research and licensing agreement with Sanofi regarding various immune-mediated inflammatory diseases. The news sent the stock up over 8%. French electronic payments player, Ingenico, reported solid second quarter sales together with the €1.5bn acquisition of Bambora, a growing payment services company in Nordic countries. Following Severstal’s solid production numbers last week, the Russian steel company reported in-line revenues, strengthening free cash flow generation, and also the acquisition of the Yakovlesvsky mine for RUB 12bn, thereby securing its long-term vertical integration into iron ore. In Asia, Taiwanese DRAM manufacturer, Nanya Technology, reported second quarter results in line with expectations, together with a huge capital gain on its disposal of Micron shares. It also gave a more favourable outlook for the second half and the stock rallied over 10%. Finally, after several delays, Sony confirmed it would complete the transfer of its battery business to Murata Manufacturing by September 1st 2017.