Investors are still in wait-and-see mode

Market analysis - 2/24/2017

As investors kept a close eye on shifts in European political risk, especially in France, economic data confirmed that the outlook for growth and inflation was on an uptrend.

January's Conference Board consumer confidence index rose further while inflation in the eurozone accelerated and company confidence levels staged a surprise recovery, notably in France and Germany. Germany’s IFO index pointed to a global industrial recovery, a development that is, of course, good for the country’s export companies. More astonishingly, company confidence has not yet been dented by concerns over Donald Trump’s push to introduce protectionist measures. The rebound in both European and Asian producer prices is undoubtedly behind this upswing in the industrial cycle.

And yet, despite this encouraging macroeconomic backdrop, investors are still in wait-and-see mode. As markets try to assess the various scenarios that Donald Trump's economic stance might entail, the Treasury Secretary said the administration’s tax reform would be introduced before the August recess and that it would boost US growth towards the 3% mark in 2018. Markets read between the lines and concluded this meant nothing major would happen in 2017. Note that these initial declarations caused the base materials sector to underperform over the week. 

Current investor worries are also due to political risks: Matteo Renzi is said to be keen to launch parliamentary elections in Italy before the autumn and in France the possibility of a joint Benoît Hamon/Jean-Luc Mélenchon left-wing ticket is a frightening prospect for foreign investors. As a result, French and Italian government debt remained under pressure and the Bund-OAT spread momentarily broke above 80bp. 

Our allocation remained pro-equity this week even if we continued to trim positions and hedge via options. Earnings upgrades for European companies show the fundamentals are still positive over the medium term. We have maintained our bond market positions and remain neutral on US and European duration but with a negative bias on core countries and a positive stance on curve steepening strategies and inflation-linked bonds. 

  European equities

Amid an avalanche of company results, macroeconomic data remained upbeat - German consumer confidence level came in below an all-time high but eurozone PMI data was better than expected. 

Nevertheless, markets remained focused on possible alliances between European politicians and parties. 

Shifts in European interest rates weighed on banks and agribusiness was hit by Kraft’s decision to scupper its approach to Unilever. Telecoms, particularly Deutsche Telekom, rose on the possibility that Sprint might merge with T-Mobile US. Higher sales and operating profits from Orange and Bouygues pointed to a sector recovery. Airbus swept past expectations thanks to record plane deliveries. Atos, Bayer and Henkel all released high quality results that were often better than expected. Accor easily beat consensus expectations but disappointed the market by failing to give more information on future divestments. Intercontinental also fell despite strong results and its surprising decision to pay a dividend. 

Peugeot raised its operating margin target as part of its strategic Push to Pass plan. The group’s tie-up with Opel is taking shape following Carlos Tavares' visit to the UK and Germany. Axa, Saint-Gobain, Veolia, Bureau Veritas, ADP and Safran all reported in line with expectations. Tourist spending on luxury items jumped 17% in January, providing further support to the sector. 

  US equities

The S&P gained another 0.6% over the week while the NASDAQ was flat.

The Trump administration gave a few more indications on its legislative calendar and the size of reform measures while the Fed said nothing really new. Sales of existing homes continued to rise, revisiting levels seen in February 2007 while property prices rose 1.5% in the fourth quarter compared to the preceding quarter. 

New Treasury secretary Steven Mnuchin said tax reform would take shape before the August recess. He expects growth to pick up speed and hit levels not seen in 10 years. Press reports, meanwhile, suggested that mega infrastructure programmes would not be unveiled before the end of 2018. Possible delays to fiscal reform and spending on infrastructure caused cyclicals to undergo their first big down session since the election. 

Fourth quarter results have been surprisingly good with earnings up 5.4% over a year. Toll Brothers' quarterly figures beat estimates and Wal-Mart gained 3% on upbeat sales. Both DuPont and Dow Chemical rose 4% after the European regulator approved their merger plans. Energy stocks underperformed. 

  Japanese equities

The TOPIX edged 0.3% lower after hovering within a box range as the yen strengthened due to the Fed minutes and exporters came under selling pressure. Large caps underperformed mid-and-small cap stocks, suffering more from profit-taking due to their exposure to foreign markets and the yen’s exchange rate risk. Smaller, mainly domestic demand-oriented, companies were relatively firm and attracted investor interest over the week.

Rubber Products and Marine Transportation gained 5.7% and 3.3% respectively, while Real Estate sank 2%.

Nippon Yusen, Japan’s top shipping company, rose 3.7%, hitting its highest level since last December as the Baltic Dry Index, a leading indicator of shipping activities, advanced on the back of strong natural resources markets.

Japan’s largest real-estate developers, Mitsubishi Estate and Mitsui Fudosan, lost 2.8% and 3% respectively. Slightly lower JGB yields were positive but investors took a cautious view of a possibly massive supply of office buildings in Tokyo next year. 

  Emerging markets

GEMs advanced as the US dollar remained relatively stable and worries mounted in Europe. Emerging market countries continued to deliver reasonably positive economic data and results, most noticeably in India, and both the Mexican peso and Turkish lira made further gains.

Good news in Brazil where the central bank cut its SELIC target rate again, by 75bp to 12.25%. The most positive feature was the accompanying dovish tone. The monetary committee emphasised the benign outlook for inflation, with strong supply capping food prices, and said low prices were widespread across sectors and that low expectations should persist. The inflation forecast for 2017 is currently 4.2%, down from 4.4% previously.

The statement was comforted by the slow recovery of the domestic economy. Outstanding loans shrank 1% MoM in January after two months of increases, mostly on the back of a 2.4% slump in corporate credit. Household loans rose 0.3%. As a percentage of GDP, loan volume is now at 48.9%, down from 49.4% in December. Household lending is stabilising and the rate cut is a welcome move for companies. Further cuts will depend on the reform agenda, particularly fiscal issues. Another 200-250bp cut is the base case scenario this year.

In China, solid internet company results led to some profit taking on Thursday after a very strong run YTD which suggested it was time for consolidation. But the outlook remains extremely promising for most leaders with commanding positions in their segments like Ctrip in online travel agencies, Baozun in online marketing where it services global brands like Adidas and Nike, Netease in games like Minecraft and Clash of Clans and Weibo, China’s Twitter, which politicians shun but which has 313 million users every month and boasts robust cash flow and profits. All are guiding for a solid uptrend in 2017 and further leadership consolidation.

Elsewhere in China, there was good news in the healthcare sector which has been so disappointing for the past two years. The Ministry of Human Resources and Social Security released the updated list of medicines covered by its basic medical insurance schemes (i.e. drugs that can claim partial reimbursement from the State). The list had been unchanged for 7 years but has now been increased from 2,151 to 2,535, a move that will be implemented by August. Judging from the last round of NDRL revisions in 2009, the new list should help the drug sector deliver accelerated growth in coming 3 years. 3S Bio, a leading biotech player, and CSPC, are the two listed companies which are seen as most likely to benefit from the change. 

  Commodities

Brent crude edged higher due to a more moderate rise in US inventories and reassuring OPEC comments following a meeting to prepare the March 22-23 oil ministers summit in Kuwait. US crude stocks only rose by 0.53 million b/d and petrol and distillate inventories actually fell. Crude stocks at Cushing, which dictates WTI prices, also retreated. All this could mean we are at an inflection point before a bigger retreat in US inventories. Investors are almost certainly focusing too much on data which reflects increased OPEC output at the end of 2016 (it takes 5-6 weeks for tankers to sail from the Middle East to the US). But the January 1st introduction of quotas should start to hit US imports - this week they already moved lower. OPEC’s general secretary offered reassurance that the cartel would comply with quotas and added that the main goal was to get global inventories lower than the 5-year mean. 

Base metals continued to consolidate following reports that the Trump administration’s fiscal stimulus plans based on infrastructure projects might be delayed. Copper lost 3% as the situation in Indonesia seemed to be getting bogged down. A fight has started between Freeport, which runs the Grasberg deposit, and the Indonesian government. Freeport refused to accept a temporary export licence and decided to stop production and appeal for international arbitrage. Jakarta immediately riposted by threatening radical measures if a win-win agreement failed to emerge. Iron ore also corrected over the week. Investors are increasingly worried by rising Chinese stocks and comments from majors like BHP and Fortescue that prices are set to fall. 

Gold moved back above USD 1,250 for the first time since November despite the FOMC minutes suggesting that a rapid interest rate hike was still appropriate. Investment demand via ETFs for the yellow metal rose 1% MoM in January while speculative COMEX positions jumped 9% MoM. Russia’s central bank bought a further 31.1 tonnes in January. For the whole of 2016, its purchases amounted to 199 tonnes.  

  Corporate debt

 

Credit

The high yield market more or less shrugged off political tensions in Greece and looming election nerves in Europe. The Itraxx Main and Over indices were stable around 75bp and 295bp respectively. 

Among a crop of earnings announcements, Securitas reported strong 17% growth in sales driven by European clients. Salini also enjoyed a 9.3% lift to its EBIDTA and now has access to the US market after acquiring Lane Industrial. But’s figures were more mixed and its margins and free cash flow dipped. Vallourec came under selling pressure after its EBITDA for 2016 slumped 22% to minus EUR 220m. 

The new issues market revived with Levi Strauss (Ba2/BB+) raising EUR 450m with a10-year NC5 issue to replace its USD-denominated 6.875% 2022 maturity. Quintiles IMS Incorporated (Ba2/BBB-) raised EUR 850m with an 8-year NC3 bond that will also serve to refinance existing debt. Nokia (Ba1/BB+) mandated Bank of America Merrill Lynch, Citi and Deutsche Bank to arrange senior unsecured 4 and 7 year maturities to be issued at the beginning of March. 

Agrokor and IKKS bonds remained under pressure throughout the week. 

Convertibles 

The primary market was all about Deutsche Wohnen this week: the German real estate company issued EUR 800m in 0.325% convertible bonds, announced a tender offer for its outstanding 2020 convertible and launched a EUR 545m capital increase; the proceeds are to be used on further acquisitions.

In earnings news, Tesla released its fourth quarter results, its first earnings announcement since integrating SolarCity. Revenues jumped 88% YoY, just ahead of consensus, but the net loss was 69 cents a share, or worse than the 42 cents expected. The Model 3 production is still on track, more gigafactories are expected to be built (up to 5) and a capital increase ahead of the model 3 is now more likely. The shares tumbled 6% on the news.

China’s Ctrip.com, a NASDAQ-listed online travel company, reported better than expected results with a 2% beat on revenues on higher air ticket volumes. The operating margin also improved 4.6% YoY. 

In Europe, Indra jumped 9% after the Spanish technology company reported strong free cash flow generation in the fourth quarter on lower Capex, better margins and improved working capital. 

Elsewhere, Steinhoff terminated its plan to create a Retail Africa entity with Shoprite. The stock was up nearly 10% over the week as investors were not convinced the deal made sense to begin with.

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