Respite for Europe against the backdrop of the trade war

Market analysis - 5/17/2019

In a week full of twists and turns, US-China trade talks turned complicated. Donald Trump is now expected to postpone the introduction of tariffs on European car and spare part imports to the US.

This coincided with a news that auto sales in China and Europe had fallen again, down 2.9% YoY since January 1st with a 24% YoY plunge in China in the first week of May. China remained centre stage with industrial production, exports, PMI and new lending all missing expectations. Meanwhile, Donald Trump issued a thinly-veiled anti-Huawei decree forbidding US companies to use telecom equipment produced by companies that might pose a national security risk.

In the UK, T. May said she would resign at the end of June but would nevertheless put her draft Brexit agreement once again to a Commons vote at the beginning of the month. B. Johnson returned to the spotlight by bidding for the position of Conservative party leader. And in Italy, Matteo Salvini eventually opted for a deficit with EU rules (130-140% of GDP), abandoning his tough approach. US-Iran tensions rose a notch after the US embassy in Iraq recalled its staff.

Against this eventful backdrop, equity markets had a chaotic run, switching between up and down days but Europe ended up higher over the week while the US and Japan were flat. Systematic investors underpinned the market while discretionary investors stayed cautious. Chinese equities fell by more than 2% in Hong Kong and Shenzhen. Currency markets also saw big swings with the renminbi taking 10-day losses to more than 2% on higher customs tariffs. That said, a cheaper renminbi is in China's interest. The ongoing split between equities and bonds continued with equity markets failing to go for defensives while bonds sought out quality, taking yields down a few basis points.

Our asset allocation is unchanged. We remain cautious on equities and are maintaining low interest rate exposure. Looking beyond technical factors, we feel that equity markets currently carry asymmetrical downside risk. Earnings have not been disappointing but, in today's top-of-the-cycle situation with neutral valuations, high margins and strong YTD market gains, they have not been positive enough to justify a new upswing. 

  European equities

Confusion reigned on markets due to sometimes contradictory news as the trade war continued. Sentiment initially took a knock when China riposted to Washington’s new tariffs but improved on hopes that a favourable solution might be found at the upcoming G20. Macro data was also mixed. China’s industrial production fell but US housing starts and the “Philly Fed” ended up being more reassuring and France’s unemployment rate dropped to a 10-year low. Autos followed a similar trend, first falling because of possible US import tariffs and then rallying on news that any measure would be postponed for 6 months. Renault, however, tumbled after Nissan issued a profit warning and on mounting concerns over the group's governance.

First quarter earnings reports continued and were generally upbeat. Markets cheered pleasant surprises like Salvatore Ferragamo’s results. Allianz also released solid figures as strong non-life business offset weakness in its asset management arm. STM reiterated its 2019 objectives and medium-term targets are for an encouraging €12bn in revenues with a 17-19% margin. Vodafone, however, confirmed that the telecoms sector was in difficulty and cut its dividend to spend more on bidding at 5G auctions in Germany and Italy. Bouygues bucked the trend after halting the Average Revenue Per User (ARPU) erosion and reporting upbeat sales.

In company transformation news, there was speculation that Finland’s Kone might want to bid for ThyssenKrupp’s lift division even though it is gearing up for an IPO. ThyssenKrupp nevertheless saw selling after making cautious forecasts and focusing on cutting debt rather than returning cash to shareholders. Volkswagen confirmed the IPO of its truck division before the summer as part of a broader disposal programme of non-core assets. Norway’s finance ministry gave Euronext the green light to buy Oslo Bors. Arkema is paying $570m for US chemicals group Arrmaz. UniCredit is being advised on a possible bid for Commerzbank. Vinci finalised its acquisition of most of Gatwick airport. 

  US equities

US markets initially fell on Chinese ripostes to US measures before rebounding on news that tariffs on European imports had been postponed. The S&P500 edged 0.2% higher and the Nasdaq was virtually unchanged. US 10-year Treasury yields fell by 8bp on mounting expectations that risks to global growth from the US-China trade dispute would lead the Fed to cut. There was a perceptible rotation into defensives. Financials fell 1%, quite logically given lower bond yields, while industrials shed 0.5% and semiconductors tumbled 3% on US-China tensions. Utilities (+2.4%) and consumer staples (+2.3%) led gains. Cisco jumped 6% after beating expectations. The group's security division saw profits rise 20% and management was confident they could adjust production chains in China despite import tariff risks. Electronic Arts and TakeTwo both advanced 5% on news of the Microsoft-SONY partnership in cloud gaming. TakeTwo was also lifted by reassuring quarterly figures and positive reactions to its video game, “Red Dead Redemption”. 

  Japanese equities

Japanese equities remained weak on worries over the US-China trade dispute and the impact of any further escalation on Japan’s economy. The TOPIX lost 0.77% this week.

Following the disappointing Economic Composite Index for March from Japan’s Cabinet Office, the fundamental view on the economy was downgraded to ‘deteriorating’. This put pressure on the Abe administration to change the government’s official take on the situation and consider postponing the consumption tax hike. The government has so far maintained the rise, which comes with some stimulus measure, and plans to continue so long as there is no serious event like the 2008 global financial crisis.

The Nikkei reported a fall of approximately 2% in aggregate net earnings for 849 listed companies for the financial year ending March 2019. Second half earnings fell more quickly due to non-domestic factors. However, though uncertainty remains, earnings for the 2019 financial year are expected to return to positive territory. 

  Emerging markets

The US-China trade war continued to dominate the headlines with signs of escalation this week. In retaliation to the increase in tariffs in the previous week on Chinese imports, China now plans to raise tariffs on $60b of US goods from June 1st. There was also a change in terminology from the state media, shifting from “trade tension” to “trade war”. The US also announced further measures, by banning domestic telecom companies from using Huawei equipment. Meanwhile, economic data in China pointed to a broad-based slowdown in April. The auto market remained under pressure, with CAAM reporting wholesale shipments down 14.6% YoY. Real estate was the only bright spot, with April sales value up by 13.9% YoY, an acceleration in growth compared to the past 2 months.

Tencent, Alibaba and Baidu reported their quarterly numbers. Tencent announced mixed results, with weakness in advertising offset by gaming and fintech. Alibaba revenues and profit were above consensus expectations, driven by strong core commerce business with 54% revenue growth. The company also forecast 33% organic sales growth for fiscal 2020. Baidu, on the other hand, disappointed, with slowing ad revenue growth (+3% vs. +10% last quarter) and lower margins.

In India, market was waiting for the results of next week’s Lok Sabha election. ITC reported solid numbers, with 8% cigarette volume growth and an EBIT margin expansion for the FMCG business to the highest level ever. LG Chem (Korea) and CATL (China) both signed a long-term contract with Volvo to supply batteries for their electric vehicles.

Brazil was down for the week, with concerns from investors about the government’s ability to get pension reform through. PagSeguro announced upbeat results, driven by a higher-than-expected 45% increase in revenues and operational leverage. Cosan reported good numbers as well, driven by solid performance on Comgas.

In South Africa, the final results of the election put the ruling African National Congress (ANC) at 57.5%, or 5% less than in the previous elections. While the number of seats in parliament for the ANC will fall by 19 to 230 out of 400, it should still alleviate concerns about sufficient parliamentary support to execute Cyril Ramaphosa’s reform agenda.

We remain upbeat on emerging markets. 

  Commodities

Oil prices gained more than $2, taking Brent crude above $73. US-China trade tensions remained acute after an escalation in tariff threats, but the fact that both sides were still talking reassured markets and helped oil to rise. Attacks on Saudi interests made the oil headlines. Two tankers in the Persian Gulf were hit. This was followed by an attack on two pumping stations which led to the temporary shutdown of the gulf’s biggest pipeline. Production was untouched but the events showcased rising regional tensions with Saudi Arabia openly accusing Iran.

Teheran, meanwhile, said it would only remain in the nuclear agreement if it could increase exports by 1.5 million b/d. US sanctions make this unlikely. The IEA’s monthly report cut its demand growth outlook by 92,000 b/d to 1.3 million b/d for this year. The drop concerns OECD countries for two-thirds, and especially Asia. A large part, 400,000 b/d, concerns the first quarter as the situation is seen improving subsequently. OPEC and EIA forecasts were unchanged at +1.2m and +1.4m respectively. Non-OPEC production growth was revised up by 131,000 by the AIE and the IEA, mainly because of increased US output. OECD inventories fell in March to flirt with their 5-year mean and are expected to decline in the second half. No decisions were expected at the weekend OPEC meeting but there might be indications on any extension to production cuts. 

Industrial production in China, which only rose by 5.4% over a year in April (down from +8.5% in March), is a typical sign of the current slowdown. As a direct result, metal prices fell. Copper is so far down 6% this month and traded close to $6,000 a tonne over the week before rebounding to $6,100. Future metal prices will be dictated by decisions on whether or not taxes on autos are introduced.  

  Corporate debt

 

Credit

US-China trade tensions initially weighed on sentiment but the market rallied on more reassuring comments from Donald Trump. Uncertainty over Italy’s budget deficit also prompted concerns. The Xover eventually tightened by around 6bp between Monday and Thursday and the Main by 2bp.

Credit Agricole’s net earnings were disappointing, mainly due to exceptional items. Loan metrics remained robust. Revenues were flat but French retail banking and trading activities performed well. Rising costs were offset by lower provisions and write-backs in its major clients division.

Thomas Cook issued a profit warning and now does not expect to meet its targets. Losses worsened to £1.46bn in the first half of the 2018/19 financial year, partly due to goodwill depreciation in the UK. Dia’s bonds fell after first-quarter sales and EBITDA fell by 7.2% and 78% on lower sales and restructuring costs. Talks to save the company were not making much progress according to Spanish press reports. Santander was reportedly opposed to LetterOne’s terms and would like bond holders to take their share of losses. Europcar Mobility Group (B1/BB-) saw first-quarter sales fall 0.6% while EBITDA slipped to minus €30m vs. minus €21m the previous year, mainly due to Easter falling in April this year. Full-year objectives were nevertheless maintained with sales expected to top €3bn. Vallourec managed to cut losses by half thanks to a sharp rise in sales.

Teva, the global N° 1 in generic drugs, came under pressure after 44 US states accused it of colluding with another group on price fixing. Moody’s cut Picard from B2/Stable to B3/Stable citing competitive pressure in France that could delay the group’s debt reduction programme.

M&A rumours swirled in financials over the week. Following the end of talks between Deutsche Bank and Commerzbank, there were press reports that talks between Deutsche Bank and UBS on merging their asset management affiliate had also stalled. UniCredit and ING are reportedly interested in Commerzbank, but there are as yet no official talks. Liberbank and Unicaja ended their merger talks..

In new issues, Sampo (insurance) raised €500m with a 30 year non-call 10 at Tier 2 bond 3.375%. The issue saw strong demand and the bond performed well on the secondary market.  

Convertibles 

The European convertibles market was reasonably active this week with three deals.

Retirement Homes Group ORPEA raised €500m with 8-year convertibles at 0.375% and a 47.5% premium with the proceeds going on general corporate purposes. Communication solution company GN Store issued €330m with a 2024 bond + warrant structure to finance the repurchase of its outstanding bond + warrant structure due 2022. And JP Morgan raised €400m with a cash-settled exchangeable bond into Siemens due 2022. The bond has a 10% premium and was issued at 107.5% (corresponding to a -2.38% yield to maturity).

Elsewhere, SONY announced a share buyback programme for up to JPY 200bn and the stock jumped by 10% on Friday. It also announced an agreement with Microsoft on the joint development of cloud solutions for game and content-streaming services. Video game studio Ubisoft reported disappointing fourth-quarter bookings amid a shortfall in “The Division 2” console unit sales (negatively impacted by fierce competition from Apex Legends among others). More announcements should be made at E3 next month. Cloud based application provider New Relic saw strong 28% rise in fourth quarter billing, but its margin outlook was lower than expected due to higher investment in new products.

Elément complémentaire