Is turbulence back?

Market analysis - 11/10/2017

After a much more turbulent week and following an impressive series of rises, equity markets fell sharply last Thursday.

One of the first reasons to be put forward was a comment from the ECB’s Benoît Cœuré that the current cycle would one day come to an end and that the temptation to take on ever more debt should be resisted in favour of structural reforms. This resulted in slight tensions on bond markets and equity indices then turned lower. 

The other main features over the week were the US dollar's strength and higher oil prices. The rise in oil was driven by stronger global demand but also by the ongoing purge in Saudi Arabia and mounting tension between Riyadh and Teheran. Markets also kept an eye on the progress of US fiscal reform in Congress. 

We continue to prefer European and Japanese equities to government bonds but have turned tactically more cautious over the short term due to an acceleration in global growth and the likely impact that might have on monetary policy in 2018. 

  European equities

Markets ended the week lower with third quarter earnings dictating price shifts. With the market trading near its highs, any earnings misses led to heavy profit taking, particularly after the ECB’s Benoît Cœuré said quantitative easing would not be around forever as a solution. Like-for-like sales growth nevertheless flirted with the 5% level as cyclical sector sales built on the first quarter recovery and a sharper increase in momentum in the third.

The oil sector performed well as Brent crude approached $64. Distribution was in demand after Ahold released excellent quarterly figures and unveiled another share buyback programme scheduled for 2018. Building materials also performed well as both HeidelbergCement and Vicat ended up having a good quarter. Heidelberg maintained its target of a 5-10% increase in EBITDA in 2017. Utilities like Veolia and Engie also released upbeat results.

Banks, however, fell due to poor figures and falling long bond yields. Autos succumbed to profit taking due to : (i) the European Commission deciding on a 30% cut in carbon emission for new vehicles, (ii) disappointing figures from BMW and (iii) difficulties at Peugeot-owned Opel.

This week’s headline plunge was Altice which now has debt totalling €51bn. The stock has lost 50% since June. Founder Patrick Drahi has taken over in the driving seat following CEO Michel Combes’ resignation.

Elsewhere, ADP rose on news of progress on the group's privatisation. Fortum made an official bid for 100% of Uniper and EON has until January 2018 to sell its 46.65% stake. Innogy is reportedly in talks with SSE over merging their UK subsidiaries to create an independent, listed energy distribution company. The T-Mobile/Sprint merger has been abandoned. 

  US equities

US equity indices were almost unchanged over the last 5 trading sessions but a few jitters resurfaced. With no major economic data to chew on, investors concentrated on the political front and a declaration from some Republican senators that tax reform might only be introduced in 2019. 

Oil prices returned to highs not seen for over 2 years. Demand for oil continued to surprise on the upside at close to 2 million b/d compared to traditional growth of 1 million in 2016 and OPEC seems inclined to extend cuts next year. In addition, shale gas output in the US has not surged as much as it was expected to do. Quarterly figures from US exploration and production companies show production only increasing by 1%. 

With the earnings season almost over, 37 companies out of 457 have beaten expectations and 109 have missed them. Aggregate EPS is $33.36 or 7% higher than in the same quarter in 2016 and 4% more than consensus expectations of $32. 

Defensive sectors like property, utilities and consumer staples as well as energy led gains over the week while financials were the worst hit by some flattening in the yield curve. Fears that tax reform might be pushed back hit long bond yields and a December rate hike has already been broadly discounted by investors. 

  Japanese equities

The Japanese stock market hit a 25-year high with the Topix up 1.1% but ended the week on a down day. The recent bull run has clawed back half of the decline from the peak in 1989 to the 2009 trough, encouraging some experts to be upbeat on the outlook. Large caps outperformed small and mid-caps on hopes for good global economic growth and solid earnings projections for FY 2017. Trading firms, viewed as economically sensitive, surged, with Mitsubishi up by 8.6% and Sumitomo by 6.7%. Among large caps, Keyence jumped 8.3% and chemicals group Asahi-Kasei 7%.

As far as sectors were concerned, mining (+6.3%), marine transportation (+4.6%) and wholesale trading (+3.3%) were on form while fishery & agriculture         (-3.3%), rubber products (-2.6%) and non-ferrous metal (-1.3%) all fell. Banks also declined by 1.9%, with Mizuho down by 0.9%, Sumitomo Mitsui Financial Group by 1.4% and Mitsubishi UFJ Financial Group by 2.2% lower. Investors think bank stocks look undervalued, but are not yet convinced about their business strategies after plans to downsize branches. 

  Emerging markets

Emerging markets performed well, especially China where the MSCI China index gained 2.4%. Results were generally upbeat, again, mainly in China. Another important driver was better-than-expected demand for the iPhone X. And its dual camera function and new 3D sensing boosted key Chinese OEM suppliers such as Sunny Optical, AAC and Q-Technology. On the macro side, Chinese export and import data was in line, even if the pace had slowed compared to September due in part to distortion from mid-autumn festivals.

In India, Goods and Services Tax on a host of products was lowered. Chocolate, chewing gum, aftershave, beauty products, powder, detergent, health drinks, and marble saw their rates lowered to 18% from the highest 28% bracket. In results, the industrial sector had a mixed week. Results at Voltas rose 19% despite modest top line growth of 7% due to excellent cost controls. In power equipment, Bharat Heavy was loss making at the EBIDTA level due to delays in the execution of projects. In the auto equipment space, while Motherson Sumi published results slightly below expectations (+22%), Bharat Forge announced a very strong 52% surge due to a rebound in the US truck business. Indraprastha Gas published a solid 17% increase in results due to anti-pollution measures forcing buses and private cars to switch to CNG.

In Brazil, results were also better than expected, driven by better top line and operating margins (lower costs). Ecorodovias (toll roads) reported revenues, EBITDA and net profits up 11%, 21% and 85%. Iochpe (industry, autoparts) also beat EPS expectations by 15%, driven by strong top line growth of 21%. October’s auto production jumped 65% and demand rose 25% YoY.

In Argentina, banks reported another quarter of good results, driven by strong loan growth. The central bank increased interest rates by another 100bp to curb inflation and announced the end of the subsidy for small companies so that they could obtain loans below benchmark levels, a positive move in our view.

We remain upbeat on emerging markets which should rise on upward earnings revisions and lower inflation. 

  Commodities

Strong momentum continued on oil markets thanks to mounting political risks and the realisation that fundamentals were really improving. Brent crude rose for the fifth week in a row and flirted with $64, a level not seen since June 2015.

Falling global inventories have helped geopolitical risk to be rerated. Prices were underpinned by several factors: (i) increased tension between the US and Iran – Donald Trump has refused to sign the nuclear agreement and a missile was fired into Saudi Arabia from Yemen, (ii) tensions between the Lebanon and Saudi Arabia after the Lebanese prime minister resigned after accusing the Hezbollah and Iran of effectively controlling the country and (iii) the risk of default in Venezuela (1.94 million b/d in September output according to the IEA). The Saudi crown prince Mohammad bin Salman also consolidated his power with last weekend’s purge of prominent political and business personalities. To an extent, this move reinforces the country’s credibility as the leading force behind OPEC’s policy of production cuts. A spokesman for Saudi’s energy ministry said that the kingdom intended to cut exports to all countries in December by 120,000 b/d.

In weekly data, the US rig count fell by 8 to 728. US crude inventories rose by 2.2 million barrels over the week amid the peak refinery maintenance period. Total inventories (crude plus oil products) fell by 4.4 million barrels. Demand is still rising.

As a result, we have raised the bottom of our spread estimates from $50 to 55 so the spread is now $55-65. We also believe the rise could be capped over the short term. The recent surge in oil price could make OPEC push back any decision to extend cuts beyond the initial March 2018 end date. OPEC's next meeting is on November 30. The oil price has risen 14% in euros, but we believe the energy sector still has room to catch up. 

  Corporate debt

 

Credit

Strong selling resulted in the Xover index widening by 19bp. Long-dated bonds and peripheral debt led underperformers as rates rose. 

The new issues market was very busy. Titan (building materials, BB+) raised €250m with a 7-year senior bond. Rexel (multi-channel energy distribution, Ba2 /BB s/BB), raised €500m with a 7.5-year maturity. CMC di Ravenna (leading construction company, B2/B), issued a 5.25-year bond for €325m. French biotech Eurofins Scientific sold an 8-year perpetual bond, non-call 8Y for €400m. Ferrovial (infrastructure, BBB/BBB), raised €500m with a 5.5-year perpetual hybrid bond, non-call 5.5 years. In financials, BNP Paribas (Aa3/A) and BBVA (Baa1/BBB) sold non-call 10-year CoCos, raising $750m and 1bn respectively. 

In quarterly results, New Look (apparel, Caa1/CCC+), released FY 2017/18 results which were down again. Sales fell 4.5% largely because of a 6.4% drop in the UK retail network. Gross margins fell 11% due to an increase in sales drives. The group said, however, that it was confident it could redress performance although it admitted the second half would be challenging. Italy’s mobile operator Wind Tre (B1/BB-) released disappointing third quarter figures. Sales fell 6% (down 2.1% for the first 9 months after +0.2% in the first half) and EBITDA was down 5% (+2% and +7.9%) Most of the fall came from a 3.8% decline in third quarter mobile sales, fiercer competition and changes to roaming regulations in Europe. Wienerberger (terracotta bricks, Ba2), saw third quarter sales rise 4% thanks to stronger construction in North America. Car rental group Europcar (B1/B+) reiterated full year targets after a 12.3% rise in quarterly sales driven by strong performance in southern European countries. 

Altice (B1/B+) announced the resignation of CEO Michel Combes ahead of a group reorganisation. Founder Patrick Drahi has now taken charge of operations. This followed disappointing third quarter results with France losing subscribers and strongly underperforming. Pro forma sales fell 1.8% to €5.75bn. The group’s shares and debt underperformed sharply. 

Convertibles 

It was a busy week with volatility returning to markets and strong primary issuance.

In Europe, French construction and concessions company Vinci tapped its 2022 non-dilutive convertible bond issued in February for $150m. In China, Qingdao Haier issued a HKD 8bn zero coupon bond exchangeable into HK-listed consumer electronics company Haier Electronics so as to repay debt. In Singapore, Suntec REIT came to market with a SGD 300m 1.75% 7Y convertible for debt repayment purposes. In the US, insulin infusion devices producer Insulet issued a $350m 7Y 1.375% convertible for refinancing. Another deal also came from biotech company Sarepta (RNA-based therapeutics) which issued a $475m 1.5% 7Y convertible to strengthen its balance sheet. The third deal in the US came from Arbor Realty Trust, a specialised real estate finance company, which issued a $125m 5.375% 3Y convertible, with the proceeds earmarked for business investments.

In company news, shares in Italian construction company Astaldi tumbled 44% and its credit spread widened by 1,200bp after the company said it was mulling a €200m rights issue and might also refinance its €750m 2020 bond. The news broke after the group postponed the release of its quarterly results.

On the earnings front, French video games publisher Ubisoft posted a strong 85.8% YoY increase in second quarter sales to €264.2m, beating both its own targets and broker estimates. The figures revealed upbeat performance from Mario + Rabbits and Rainbow Six Siege. The digitalisation process is still underway and now accounts for 73% of total sales. In the US, Pacira Pharmaceuticals reported revenues of $67.3m better than feared, the company noted a strong acceleration in Exparel sales despite the impact of Hurricane Irma. The shares jumped 17% during the session. In Japan, Teijin beat estimates with a strong JPY 37.5bn in half-year results as its materials business performed strongly.

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