Mounting concerns over US dollar weakness

Market analysis - 1/26/2018

Risk assets generally moved higher amid strong visibility on economic prospects and no dissenting messages from the week’s statistics.

The IMF revised up its economic outlook for this year and next. Even so, the prevailing market calm was ruffled by further US dollar weakness. Its recent decline has prompted various ECB members to express concerns about the euro’s strength and Mario Draghi reiterated this sentiment at last Thursday’s ECB monetary committee. But the reminder that currencies could trigger an ECB reaction failed to reverse the trend, probably because there was no clear indication of what steps might be taken to halt the euro's appreciation and also because the dollar is slipping against a host of currencies, and not just the euro. 

The Trump administration’s attitude to the dollar’s weakness is ambiguous. Given the persistently large US trade deficit, it wants to earn more from global trade so as to restore its external accounts. Hence the introduction of protectionist measures like import duty on solar panels and washing machines. But the government might well try to push the dollar lower. Speaking in Davos, Treasury secretary Steven Mnuchin said currency shifts had improved the US situation over the short term. However, Donald Trump, also in Davos, failed to follow though and spoke instead about making the dollar strong. 

  European equities

Export stocks were hit by the strong euro with the aerospace and tech sectors particularly hard hit. Airbus tumbled 3% in a single trading session. STM was also hit despite upbeat fourth quarter figures and very favourable prospects in the autos business. Banks, on the other hand, performed well higher long bond yields. 

Carrefour unveiled its 2020-22 transformation plan which is mainly as markets expected. It breaks down into pillars:

  1. a voluntary redundancy plan for 2,400 out of 10,500 employees in the various head offices. 
  2. Improved competitiveness with plans to save a gross €2bn which will mostly be reploughed into investments as and when they arise.
  3. Creation of a single channel universe with €2.8bn to be spent over 5 years on a digital platform, a 100,000m² reduction in hypermarket surfaces and the development of drive-in solutions and local outlets.
  4. An offer revamp to attract shoppers with more emphasis on organic foods, and a 22% increase in own brand products so that they account for a third of French sales.

Suez slumped after cutting guidance for 2017. The group now expects Ebit to fall 2% like for like mainly because of non-recurrent items in the fourth quarter. But the outlook for 2018 also looks disappointing. LVMH’s annual results surged thanks to a13% jump in sales. Fashion and leather goods made strong contributions as did the integration of Dior. The dividend for the year will be raised 25% to €5. Wirecard fell on a “dubious” press report that suggested that the acquisition of the payments business of Great Indian Retail Group (GIRG) in December 2015 was fraudulent in more ways than one.  

In M&A, Sanofi acquired US haemophilia specialist Bioverativ ($847m in sales). Strategically, this will reinforce the group’s presence in rare diseases, already one of its strong points. 

  US equities

US markets motored higher, adding 1% and taking year-to-date returns to 7%. Investors cheered quarterly results which came in 11% higher than expected and US dollar weakness (-3.3% so far, this year) which slid to a level not seen since the end of 2014. To date, investors are shrugging off (i) the fact that no lasting solution to avoid another shutdown has been found, (ii) Donald Trump's protectionist poses and (iii) the move up from 2.4% to 2.62% in long bond yields since January 1st. 

The Senate confirmed Jerome Powell's appointment as Fed chairman by 85 to 12. Janet Yellen will stand down on February 3 and so will chair the January 30/31 FOMC. The Fed is planning 3 rate hikes in 2018 and thinks that tax reform will cause growth to accelerate to 2.5%. Powell is viewed as the candidate of continuity, so these forecasts should be maintained.

In a persistently strong M&A market, Celgene forked out $9bn for Juno Therapeutics (immunotherapy). 

  Japanese equities

The TOPIX shed 0.27% over the week. The Nikkei 225 closed above 24,000 on Tuesday but then the market dipped more than 1% on Thursday on as the US dollar weakened to below 110 against the Yen. Exporters, such as electronics makers and auto companies lost ground on the day. Financials were downbeat and selling of high-tech names also pushed down the market. Some investors refrained from active trading ahead of third quarter 2017 earnings from major Japanese companies.

The best performing sectors of the week included Real Estate (+3.74%), Mining (+2.04%) and Pharmaceuticals (+1.88%). Pharmaceutical manufacturer Daiichi Sankyo Company surged 6.33%. Real estate firms including Mitsubishi Estate Company (+5.54%) and Mitsui Fudosan (+5.09%) were buoyant after a private research institute announced the average unit price of new condominiums put up for sale in the Tokyo metropolitan area had hit a 27-year high. Some investors also expect some signs of inflation could lead to higher rents.

In contrast, there was weakness in Air Transportation (-2.18%), Electric Appliances (-2.17%) and Banks (-2.04%). Sony (-4.77%) met selling after a broker lowered its target price and investment rating for the company. Mega-bank groups such as Mitsubishi UFJ Financial Group (-3.11%) and Sumitomo Mitsui Financial Group (-2.45%) were also soft. 

  Emerging markets

The CBRC, China’s banking authority, fined SPDB, China’s 9th largest lender, $72m million for masking NPLs with a $12bn loan to shell companies this week. This symbolic fine is a continued deleveraging effort from the Chinese authority to clean up the financial system. 

If only trade policy could give any evidence on the competitiveness of the manufacturing sector, we observed an interesting contrast this week: Donald Trump decided to impose 30% import duty on solar modules and 50% on washing machines while China announced it was to gradually cut import tariffs on built-up vehicles from the current 25%.

In the education sector, results varied: TAL, the Chinese education and tutoring service provider, reported better-than-expected EPS growth of 113% due to margin expansion (while New Oriental suffered margin contraction with EPS only up 8%). Industrial profits growth slowed to 10.8% YoY in December from 14.9% in November. Looking into 2018, we expect industrial profits to moderate due to lower PPI inflation and a mild deceleration in economic activity.

As planned, the Indian Government will inject INR 881bn into PSU banks to shore up their capital bases. The consumer space continued to see good results: Asian Paints up 19% YoY despite flat sales (due to advertising cost cut) and a positive surprise from Maruti with 22% EBITDA growth. ICICI Prudential surprised positively (+80% in YoY EPS) also due to higher than expected margins in ULIP products.

Capital goods companies published decent earnings growth: +22% for Crompton, +30% for Havells, and +55% for Container Corp. The disappointments came from United Spirits (-7% EBITDA growth YoY) and Idea Cellular (-43% EBITDA growth) due to a severe price war in the telecom space.

In Brazil the highlight of the week was the confirmation of Lula’s conviction by the second level of the court system (TRF-4). The former president can still appeal to the Supreme Court to reverse the conviction.

In Mexico, as we wait for the NAFTA negotiation outcome (January 29), Banorte reported descent results with earnings up 24% YoY. However, on the negative side asset quality deteriorated and coverage decreased more than expected. The bank guided solid results for 2018 (EPS growth of 15-19%).

In Russia, X5 Retail Group’s 4Q17 results surprised positively with 23% YoY growth. The Central Bank of Russia reported rapid growth in retail loans (13% YoY), driven by mortgage loans. Asset quality also improved.

EM equity funds (ex China A) reported their largest ever weekly inflow of $7.9bn (which represents 0.6%of AUM, lower than the historical peak of 1.6% seen in Feb-2003). We remain upbeat on emerging markets. 

  Commodities

Commodities rose across the board on US dollar weakness. Brent crude moved back above $70 and WTI traded above $65. The LME base metal index advanced and so did precious metals. 

Oil price were also lifted by the ongoing fall in inventories. In the US, crude inventories rose by an average of 9.3m barrels between 2012-16 over the first three weeks of January but have fallen by 12.9m this year. This was also the 10th drop in inventories in a row. The decline in global inventories, especially in the US, is proof that the OPEC/non-OPEC strategy of production cuts is starting to bear fruit. OPEC and Russia also reaffirmed their commitments at last weekend’s meeting and said they were ready to work together beyond 2018. All in all, sentiment on oil markets is still bullish. Nevertheless, the supply/demand picture could be hit if US shale oil production were to return in force. In its monthly report, the IEA highlighted rising US output and expected to see non-OPEC supply rise by 1.6 million b/d in 2018, mainly from the US, Canada and Brazil, compared to a 1.3 million b/d rise in demand. Note that both OPEC and the US Energy Information Agency are going for a more optimistic 1.7 million b/d. 

Comments from US Treasury Secretary Steven Mnuchin on the weak dollar also helped the gold price move above $1,350, its highest level since August 2016. Geopolitical tensions are also a support factor. The gold price could benefit from the fact that the US shutdown has only been put off till the next deadline on February 8 along with tensions in Iran and North Korea.

At the fundamental level, investment demand for gold has been strong since the beginning of January. ETF holding have risen 1.4% to 72.5m ounces. Last year, gold largely shrugged off the Fed’s rate hike cycle news and we believe it will do the same in 2018. Only an acceleration in rate hikes is likely to hit the yellow metal. 

  Corporate debt

 

Credit

Bond markets fell after the ECB monetary committee because traders felt the ECB’s determination to remain accommodating after September 2018 was waning. The short end of the yield curve was the hardest hit. However, credit markets overall proved rather resilient with investment grade down 0.14% and high yield 0.09% lower. Credit risk premiums widened by 1bp for investment grade and 3bp for high yield. As a result, most of IG’s negative performance (-0.14%) was down to the interest rate component. The Main and Xover credit indices were unchanged at 43bp and 230bp respectively. 

S&P upgraded Cirsa from B+ to BB- on upbeat results for the first nine months of its financial year. Azyzta slashed its EBITDA guidance for FY 2017/18. And two companies in our universe are planning IPOs. Swissport, owned by the struggling conglomerate HNA, wants to list in 2018 and Dufry announced the IPO details for its US subsidiary Hudson

Convertibles 

The primary market remained busy, especially in Asia, with CFOs looking to capitalise on impressive equity returns since January 1st. Chinese real estate developer, CIFI Holdings, issued a HKD 2.79bn, 1Y zero coupon convertible for debt repayment and working capital purposes. State-owned China Shipbuilding Industry Corp issued a USD 1bn, 7Y, zero coupon bond exchangeable into shares of Postal Savings Bank of China.

In the US, Biotech company, Insmed, came to market with a $400m, 7Y, 1.75% coupon convertible bond to finance the ongoing clinical development of its drug for a rare lung disease. Oil States International (oil services) issued a $200m 5Y, 1.5% coupon convertible to finance its acquisition of GeoDynamics. The third deal came from an oil transportation company, Teekay Corp, which issued a $125m, 5Y, 5% coupon convertible, simultaneously raising $97.5m in fresh equity to finance debt repayment.

In the news this week, more Steinhoff operating subsidiaries secured independent financing: Conforama in France secured a €115m funding facility and Kika/Leiner in Austria also secured additional liquidity.

Elsewhere, Medicines Company rallied 34% this week on the back of a reassuring investor day and analyst upgrades. The biotech company, which is developing a cholesterol lowering drug, Inclisiran, announced that the Data Safety Monitoring Board had recommended continuing its phase 3 study as planned and that patient enrolment was ahead of schedule. And semiconductor test equipment manufacturer, Teradyne, reported stronger-than-expected 2017 results with its robotics business surging 70% YoY. However, the share subsequently fell 4% on underwhelming guidance.

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