Wait-and-see mode ahead of Jackson Hole

Market analysis - 25/08/2017

Equity markets stabilised, adopting a wait-and-see attitude before investors return from holiday to face a period with numerous political and economic events. The Jackson Hole Symposium will see central bankers tackling the monetary policy issue.

Janet Yellen and Mario Draghi will most probably try to avoid wrong-footing markets. At a time when persistently low inflation has people wondering if this really is a temporary phenomenon, both the Fed and the ECB should nevertheless decide to move further towards monetary normalisation, albeit at a very gradual pace. The big challenges in September will therefore be the ECB’s moves to recalibrate its asset purchase programme and the Fed’s efforts to shrink its balance sheet. 

In the political arena, Congress is to vote before the end of September on whether to raise the debt ceiling and that will put pressure on the Trump administration to revive its tax reform plans, especially as they will have an economic impact. And the choice of a new Fed chair will probably be discussed before October. Preliminary PMI readings for August in Europe and the US served as a reminder that the US economy had now attained cruising speed and that growth in Europe was even outpacing its potential. Over the week, we took advantage of weakness to reshuffle equity hedges and increase weightings. In government bonds, we remain cautious on interest rate sensitivity.

  European equities

Markets trod water in a week which nevertheless saw some big news. Total paid $7.45bn for Maersk Oil & Gas, the group’s biggest acquisition since the merger with Elf in 1999. This is a countercyclical move which will help Total reinforce its presence in the North Sea while rebalancing its geopolitical risk. It will also raise growth potential by increasing Total’s output to 3 million b/d by 2020, up from 2.1 million b/d in 2014. 

In media news, the UK’s WPP issued a profit warning following a 0.5% drop in sales in the first half and a 2.6% fall in July. Management now expects like-for-like growth between zero and 1% this year compared to previous forecasts of +2%. The decline was particularly marked in North America and continental Europe, mainly because the group lost accounts like AT&T and Volkswagen. More importantly, there was also pressure on ad spending from large consumer product groups which are bowing to shareholder calls for cost optimisation. 

Dixons Carphone (a UK mobile phone and electronic product distribution group) pre-announced first quarter figures which showed like-for-like growth of 6%, or better than expected. But the big news was management’s focus on difficult trading conditions in UK mobiles and the negative impact on profitability of certain claims which had been revised higher. The group now expects pre-tax results of £360-440m or 20% below consensus expectations.

CRH (building materials) posted upbeat results but surprised the market by announcing the sale of its US distribution arm. It said this was an opportunist move as it could not create as much value for shareholders. The price tag is a demanding 15 times EV/EBITDA for 2016.

Fiat Chrysler was also in the news with press reports that it wanted to sell off more units (Maserati and perhaps Alfa, as well as Magneti Marelli) and that China’s Great Wall might buy Jeep, the group’s jewel. 

  US equities

The S&P edged 0.5% higher in a quiet week for macroeconomic news. Existing home sales fell 1.3% when they were expected to rise 0.5%. 

Markets held fire pending central bank declarations at the Jackson Hole Symposium during which Janet Yellen might provide fresh indications. Meanwhile, diverging views came from Esther George (Kansas Fed) who said she expected another rate hike this year while Robert Kaplan (Dallas) argued for more patience. Elsewhere, Donald Trump threatened Congress with a government shutdown if the debt ceiling was not raised. Republican representatives were already struggling to find a way of funding promised tax cuts. Speaker Paul Ryan then reassured the president that the debt ceiling would be raised. 

Macy’s has appointed Hal Lawton, eBay's former senior vice-president, as CEO in an attempt to tackle the changing retail landscape in the US. In e-commerce, Walmart announced a major partnership with Google so as to take on Amazon’s Google Express, a home delivery platform. Ford unveiled a memorandum of understanding with China’s Anhui Zotye Automobile to form a joint venture producing electric cars in China under a new brand name.

Eleven S&P sectors ended the period higher. In contrast, industrials slipped 0.1% and consumer staples ended the period 1.2% lower.

  Japanese equities

The TOPIX lost 0.32% over the week. After a rebound on Wednesday, Japanese stocks declined again for two days in a row. With a slightly stronger yen, investors stayed on the sidelines ahead of the Jackson Hole Economic Symposium due to increasingly sceptical views of the Trump administration as well as concerns over North Korea.

Small-and-mid cap stocks with robust earnings growth prospects remained relatively firm compared to large caps which are generally seen as more vulnerable to external risks.

By sector, the best performers for the week were Mining (+2.5%), Oil & Coal Products (+2%), followed by Nonferrous Metals (+1.9%). Among individual stocks, Keyence remained strong (+7.1%) on the back of robust demand for factory automation. Toshiba (+6.7%) also made further gains.

On the other hand, Iron & Steel (-2.8%) and financials like Securities (-2.4%), Banks (-2%) and Insurance     (-1.5%) saw broad selling. Steel makers such as JFE Holdings (-5.9%) and Nippon Steel & Sumitomo Metal (-2.3%) continued weak. Nomura Holdings (-3.5%) and Mitsubishi UFJ Financial Group       (-2.9%) were hit by selling as investors adjusted positions. 

  Emerging markets

After the resignation of Infosys’ CEO, investors were reassured to see the come-back of a co-founder, Nadan Nilekani as a non-executive chairman. He was arguably the best previous CEO of the company.

In India, the cabinet approved in principle mergers between PSU banks. This is important as public banks are quickly losing market share to their private peers due to the weakness of their balance sheets.

Chinese companies continued to publish good quality earnings. Samsonite saw EBITDA jump 26.9%. In healthcare, we had a good set of numbers with Sino Biopharm reporting in line results, up 16% YoY and Wuxi Biologics’ operating profits 61% higher for the first half of the year.

In the IT sector, results were in line. Baozun reported above consensus net income of RMB 30m (up from1.5m in the second quarter of 2016). However, the stock suffered a severe correction as accounting changes led to lower-than-expected top line growth. It was, in fact, more an excuse for profit taking after a strong run and illustrated the weakness of companies where valuations have no margin of safety. AAC reported in line results (+44.7% YoY). In the auto space, Guangzhou Auto reported strong results, above consensus (adjusted for an impairment loss). Sales were up 32% and net profit 57% higher.

Elsewhere, Bank Indonesia cuts its reverse repo rate by 25bp, in line with expectations, thanks to inflation remaining under control, a narrowing current account deficit and higher forex reserves.

In Russia, Sberbank’s results were up 20% YoY with and asset quality was stable.

In Mexico, inflation continued to rise and the pace of retail sales growth declined. The first NAFTA renegotiation round ended with no major surprises. This process is expected to last until December. Second quarter GDP of 1.8% was in line with expectations but down from 2.8% in the previous quarter.

In Brazil, the highlight of the week was the government’s announcement of its intention to privatise Eletrobras, a sign of its commitment to reduce the fiscal deficit. Although, July credit growth remained sluggish, loans to individuals continued to accelerate (1.7% YoY in real terms versus 1.3% in June) helped by the stabilising economy. NPLs were stable and spreads rose due to the change in the mix of the credit portfolio. Inflation surprised on the downside in June, retreating to 2.7% (mid-August), driven by lower food and service inflation. Randon reported July revenues 16% higher YoY due to improvements in the second quarter.

In Argentina, consumer confidence soared 12% MoM in August. Real GDP grew at a robust rate of 4% YoY, up from 3.4% in May. The economic recovery is mainly being driven by construction and household consumption. We expect the economy to continue to improve as real wages are growing due to lower inflation, government investment is also increasing and the Brazilian economy has stabilised.

However, there was some deterioration in the trade balance as imports also rose. Since the positive outcome of the primary elections, the Argentinean market has gained more than 15% in US dollars. 

  Commodities

Hurricane Harvey, currently en route for Texas, could well be the most powerful in the zone since 2005. And it has already caused 10% (167,000 b/d) of output capacity in the US Gulf of Mexico to shut down. Some Texan onshore production might also be hit, particularly in Eagle Ford. At a time of plentiful oil, the price impact should be limited but trading may be more volatile in coming days. US oil inventories once again fell over the week and have declined 13% since the end March highs to levels last seen in January 2016. Meanwhile, the drill count fell for the fourth time in 2 months, an indication that the high is probably behind us now.

Commodity sensitive economic data for July in China revealed a certain slowdown in property but the trend was in line with seasonal data and also suffered from high bases of comparison. Housing starts, for example, fell 31% for the month and 4.9% over a year but are still 8% higher YTD. Infrastructure spending was 15.8% higher over a year and up 16.7% YTD. Electricity generation accelerated sharply to +9.8% over a year. 

These data helped industrial metals perform well. Copper hit a 3-year high of $6,688/t. Of note, also, was Australian metallurgical coal which moved back above $ 200/t. The price had hit a high of $310 in November 2016 before starting 2017 around $150. These price levels reflect strong global demand for steel (PMI are all rising across major regions), relatively tight inventories, the impact of efforts to reduce emissions through industrial rationalisation and a certain amount of speculation, especially in China. At these levels, all producers are above their break-even points of between $80-100/t and that should limit the upside over the medium term. 

  Corporate debt

 

Credit

Markets stopped to pause ahead of the Jackson Hole meeting of central bankers and end of summer holiday trading was characteristically light. Volatility on spreads was low but there was some selling pressure, especially in financials. Elsewhere, Italian government bonds rose sharply on Tuesday following Silvio Berlusconi's comments in favour of a parallel currency but the movement only had a very limited effect on Italian corporate spreads. From Thursday, the mood turned more bullish and spreads tightened a little. 

Quarterly results were few and far between. Steinhoff (Baa3) said it was gearing up to list its subsidiary Steinhoff Africa Retail Limited (STAR) and hoped to complete by the end of September. However, the Oldenburg tribunal then said it had begun investigating the group’s CEO for alleged false accounting. It would appear that revenues had been overstated. The CEO has denied any wrongdoing and said the allegations were false. 

In M&A news, Adient (BB+) is to acquire Futuris Group (car interior design and production) for $360m. The deal will take Adient’s leverage to 1.9 times, up from 1.7. 

Air Berlin (CCC+ estimated), which has filed for insolvency, is moving towards selling various assets separately now that a block sale has now been ruled out. Executive chairman Thomas Winkelmann said he had had talks with more than 10 interested parties, including Lufthansa (Ba1/BBB-), Ryanair (BBB+) and easyJet (Baa1/BB+). 

Convertibles 

The convertible primary market continued its steady stream of issuance. In the US, we saw the debut of optical components manufacturer, II-VI (known as “Two-Six”), which came to market with a $300m, 0.25%, 5-year convertible with the proceeds to be used for refinancing its existing term facilities and funding potential acquisitions. In Europe, German real estate investor and serial issuer, Tag Immobilien, returned to the market with a €262m, 0.625%, 5-year convertible to repay its 5.125% straight bond maturing in 2018.

In the news this week, Steinhoff sold off aggressively on Thursday after an article in German Manager Magazin alleged the company was under investigation by the German authorities for fraud. With the shares down 10%, the convertibles underperformed as credit spreads also went wider. The company later issued a press release refuting the allegations as inaccurate and misleading; subsequently, both the shares and the bonds stabilised.

Elsewhere we saw the tail end of second quarter earnings. In the US, cloud software giant Salesforce reported results which reflected impressive top-line momentum (+26% y/y sales and billings) but somewhat disappointing operating leverage. Meanwhile, manufacturer of airport scanners and explosive detection systems, OSI System, reported an in-line quarter and stronger-than-expected guidance for the coming year supported by 12% organic growth in its Security business and book-to-bill for equipment and related services of 1.4x.

In Asia, Chinese gas distributors, Kunlun and ENN Energy, both reported this week. Both sets of results highlighted upgrades to volume expectations – overall, ENN expects volumes to increase over 30% in full-year 2017 – but both shares were down subsequently owing to concerns over margins and, for Kunlun in particular, the possibility of impairments in its LNG business.

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