China spoils the party

Market analysis - 11/24/2017

Economic data remained upbeat on both sides of the Atlantic. In Europe, preliminary PMI surveys for November improved further to new highs, reflecting an economy which is continuing to gather speed. In the US, October’s durable goods orders pointed to a recovery in corporate investment, an indication which suggests the economy is continuing to recover.

However, this positive backdrop could not mask fresh uncertainties over China where equity and government debt markets have seen volatility return. The PBoC’s tougher funding conditions are expected to weigh on the property market and slow the pace of economic growth. We should keep a close eye on these latest developments, but they are not surprising insofar as Beijing has never made a secret of its intention to focus more on the quality of growth. Government forecasts are still banking on growth levels staying high but a little less so than before.

The latest FOMC minutes showed that a rate hike is expected to be announced at the next meeting on December 13. However, committee members, and Janet Yellen in particular, are now more cautious about inflation: its persistent weakness is less and less excusable. Even so, these doubts have not undermined the Fed’s analytical framework: as US growth is running above its potential, inflation should end up rising and the pursuit of very gradual monetary tightening would therefore be justified. 

  European equities

Markets kicked off with a technical rebound following 2 down weeks but were then hit by doubts over the formation of a ruling coalition in Germany. It was a quiet week, anyway, because of Thanksgiving in the US, and Europe managed a small rally as European PMI data hit record highs. Further euro strength against the US dollar limited the move, however. Cyclicals led gains.

EDF was particularly strong on expectations that production which is essentially nuclear, would be spun off from the rest (renewable energy, networks and distribution), a move that would reduce each division’s implicit discount.

Similarly, Telecom Italia rose sharply on hopes that its fixed network would be spun off. The group intends to hire advisers for its project. Altice lost further ground initially but the prospects of asset disposals like its phone network in the Dominican Republic helped it eventually stage a slight rebound.  

Carrefour said it could open around 30 of its hypermarkets on Sundays to boost sales, imitating rival outlets in highly competitive zones which are already open. In a move that will heighten pressure in the distribution sector, Alibaba bought a stake in Sun Art, which is co-controlled by Auchan in China.

NH Hotel rose sharply after Barcelo said it was interested in merging to create a big European player. Axalta ended up walking away from a deal with AkzoNobel following a more interesting offer from Nippon Paint.

Bayer is ready to sell $7bn in agrochemical assets to BASF but could go even further so as to get the green light for its merger with Monsanto. Uniper rejected Fortum’s bid for being too low whereas its shareholder E.ON had already agreed to sell its stake at that price. 

  US equities

In a short Thanksgiving week with markets closed all day last Thursday and only open on Friday morning, the S&P gained 0.7% to hit new highs.

Michigan University's consumer confidence index came in at 98.5 or slightly below October's 100.7. November's durable goods order fell 1.2% but existing home sales rose 2%.

The FOMC minutes confirmed that a rate hike was in the offing for December despite soft inflation. Fed committee members were overall still upbeat on the jobs market and the economy as a whole.

Chances of US tax reform getting through Congress this year improved after Republican senator Lisa Murkowski came on board. She had previously been a dissident.

Over the week telecoms and tech rose 2% and 1.2% respectively while more defensive sectors like consumer staples, utilities and property were unchanged. 

  Japanese equities

The TOPIX gained 0.76% over the week. Stocks edged up as all three major US stock indices hit record highs on stronger-than-expected existing home sales and hopes for brisk Christmas sales. Tokyo was also boosted by the risk-on sentiment prevailing in global markets during the period. Export stocks such as electronics and auto makers gained thanks to buoyant US and Asian markets.

By sector, the best performers of the week were Oil & Coal Products (+5.59%), Mining (+2.97%) and Nonferrous Metals (+2.72%). Oil companies JXTG Holdings (+5.58%) and INPEX Corporation (+2.82%) rebounded from the last week’s decline as crude oil prices rose.

The worst performers were Insurance (-1.29%) and Pharmaceuticals (-1.27%).

Pharma companies Shionogi & Co. (-3.43%) and Astellas Pharma (-2.98%) both lost ground. In insurance, Sompo Holdings and Tokio Marine Holdings were dragged down after MS&AD plunged 6.72% on a profit warning for FY 2017. Ajinomoto (food and chemicals) also fell 2.84% after a brokerage house slashed its target price. Investors are being very selective in this rising market. 

  Emerging markets

Emerging markets had another good week, ending 1.4% higher.

In China, the PBoC announced that it was discussing new legislation over online micro-lenders.  The idea is to cap the lending rate and suspend some licenses. We welcome this regulation change as it could prevent the segment expanding in a disorganised fashion. Bond yields continued to rise on the news as there are investor concerns that tighter regulation could push them higher but we consider this move on micro-lenders as positive in the medium term. As usual, monetary policy will be data dependent and we see no risk of over-tightening in the next 12 months.

In Asia, third quarter earnings beat expectations, mainly driven by top line growth. EBITDA was under pressure due to higher costs, especially in the Apple supply chain, and higher material prices.

In India, we attended the CLSA India Forum. The general feedback is that the economy is recovering, led by consumption.

Private investment will take longer to return due to excess capacity. The recapitalisation of state banks has helped to solve the issue over asset quality. This should make the economy more dynamic. Moreover, the Government has amended the bankruptcy code to ensure that existing promoters cannot re-acquire their assets. This is perceived as a negative news in the short term as it could slow down resolution between bankrupt companies and banks but the move is healthier for the medium term. We returned optimistic about India in the long run. 

In Brazil, this week’s third quarter results came in above expectations, mainly driven by strong EBITDA and EPS growth on lower costs and financial expenses.

In Russia, Yandex received FAS approval for the Uber deal.

We expect further earnings revision for emerging markets when the earnings season has ended. The zone continues to look attractive compared to developed markets.

  Commodities

Brent crude ended the week higher but remained below its recent $64.7 high. The more significant move came from WTI which ended at $58, a level not seen since July 2015. This reduced the Brent-WTI gap over the last month from $7 to 5. OECD crude inventories in Asia and Europe have returned to normal in recent months so the current surplus compared to the 5-year mean is essentially due to the Americas zone. 

However, US inventories have been steadily declining which helps explain in part why WTI has been faring better. The closure of the Keystone pipeline (590,000 b/d of heavy crude from Alberta in Canada to US refineries) due to a leak, has also helped.

Next week will see the crucial November 30 summit of OPEC/non-OPEC countries which agreed to cut production. Markets are expecting the cut to be extended beyond March 2018, so they will be disappointed if the decision is put back. Middle Eastern tension, particularly between Saudi Arabia and Iran, should not hold too much sway over the talks as the summit will focus more on economics than politics. But current supply and demand projections indicate that an extension is required if crude inventories are to return to normal.

LME metals, and especially copper and nickel, clawed back some of the previous week’s losses thanks to the weaker US dollar. The gold ounce was relatively unchanged over the week. The FOMC minutes reflected serious concerns over persistently soft inflation and suggested the number of rate hikes planned for 2018 might be reduced. 

  Corporate debt

 

Credit

Trading was relatively calm compared to the previous, highly volatile week. The market edged higher as spreads tightened and buyers returned for low-risk companies. Political tensions in Germany and the ongoing US tax reform saga had little impact.

Bombardier (B3/B-), world N° 1 in planes and trains, raised $900m with a new 7-year senior bond. Tikehau (NR, investment management) raised €300m with a 6-year senior bond. In financials, BNP Paribas Cardif (A-) sold a Tier 3 7-year maturity for €750m and Nordea (Aa3/AA-) issued an AT1 at 3.5%  for the same amount.

In a batch of quarterly results, Verallia (B1/B), global leader in glass containers, had a good third quarter with sales up 4.7% and EBITDA 6.8% higher over a year thanks to increased volumes and a better product mix in Europe. Burger King France (B3/B-) also had an excellent quarter with sales up 21% and EBITDA jumping 44.3% over a year thanks to having 104 more Burger King restaurants compared to September 2016. Its Quick restaurants, however, saw sales fall 21% due to restaurant closures. SNF Floerger (Ba2/BB+, chemicals) reported satisfactory figures thanks to the US oil & gas market but EBITDA tumbled 16%, hit by more expensive commodities after Hurricane Harvey. Loxam (BB-, building material rentals), had a satisfactory quarter with sales up by a sharp 45.3% and EBITDA 46.3% higher on a rebound in the French construction market and the integration of Lavendon and Hune.

Trading in the shares and bonds of Altice (B1/B+) was once again highly volatile. Management ruled out a rights issue and said that it intended to reduce debt through asset disposals. 

Convertibles 

Europe saw two deals from German small/mid cap real estate companies. Property developer, Consus Real Estate, issued a €200m 4% 5Y convertible for business expansion and acquisitions in commercial real estate. Real estate investment company, Corestate Capital Holdings, came to market with a €200m 1.375% 5Y convertible for refinancing purposes.

In Japan, regional power producer, Chugoku Electric, issued dual-tranche 2.2Y and 4.2Y convertibles totalling Y100bn to buy back its existing 2018 convertible and finance capex for a thermal power plant in Malaysia. Meanwhile, news reports suggested that Chugoku’s fellow power producer, Kyushu Electric, was set to postpone the highly anticipated restart of its Genkai number 3 nuclear reactor. 

Elsewhere in Asia, Chinese software developer, Kingsoft, reported a strong third quarter with total revenue up 16.5% YoY to RMB 1.3bn thanks to upbeat results in the Cloud and Office software divisions; the stock jumped 11% on the day. Moreover, management said a number of new games were to be released in partnership with Tencent

In the US, Tesla continued to monopolize the headlines following the unveiling of its electric truck and new roadster in the previous week. The company claimed it was ready to start testing the giant battery it had built in the Australian outback. 

Finally, in Europe, recent convertible issuer, Figeac-Aero (an aeronautics subcontractor), disappointed investors by announcing that like-for-like growth had slowed to +5.6% in the second quarter due to delays. The stock plunged 13%.

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