Central banks once again in the driving seat

Market analysis - 6/7/2019

The week kicked off with an increasing amount of disappointing economic data, particularly in China, prolonging concerns over growth and driving investors’ risk aversion sharply higher.

Speaking at a conference in Chicago, J. Powell confirmed comments from several Fed members over a possible rate cut. On Thursday, he said he was ready to take appropriate action if protectionism were to have a bigger impact on the outlook for growth. All this has pushed back expectations of rate increases and even raises the probability of rate cuts in coming months.

The Fed chairman's accommodating statements and the optimism of Mexico’s foreign secretary helped equity markets rebound. Investors were also reassured by a robust Services ISM reading in the US.

Meanwhile, European political issues remained wide-open. In Italy and the UK, any political balance shifts will play a key role in risk aversion and sovereign bond yields. The prospect of a hard Brexit is a huge risk for growth in the UK and also in Europe, albeit to a lesser extent.

Last Thursday’s ECB governors meeting delivered an easing package. It included a 6-month extension for forward guidance up to mid-2020 and attractive conditions for the TLTRO-III. These accommodating messages nevertheless slightly disappointed the market as they stopped short of explicitly advocating a rate cut. Even so, the probability for future measures has risen significantly due to mounting threats to the growth/inflation equation and possible cuts by the Fed.

Equity market indices tried to extend their rally on these reassuring noises from central banks but investors are still aware that a rapid end to protectionist tension is not a done deal.

Against this backdrop, we have tactically raised our scores on European, US and Emerging Market equities and are now back to neutral. We believe central banks will keep on lending support to the economy. However, we note that this fresh caution from central banks is essentially due to the deteriorating growth outlook. 

  European equities

Markets ended the week higher thanks to accommodating statements from the Fed and the ECB. However, mixed macroeconomic data dampened a real revival in risk appetite and the rebound among cyclicals petered out. Bond yields continued lower, boosting defensives like utilities which also gained on a bounce in electricity prices. Banks continued to bear the brunt of the trend. Steel makers also suffered after downbeat comments from Voestalpine's CEO on the extent and duration of Europe's slowdown.

Worldline rebounded sharply after its Italian rival SIA said it was in favour of transborder tie-ups. Wirecard gained after winning new landmark customers like Sweden’s Enseigne NK and its CEO’s forecast of a record first half to come in terms of transactions provided an additional boost. LVMH rose further after the head of Vuitton said there were still no signs of a slowdown in China sales.

In M&A, the headline news was the end of merger talks between FCA and Renault with the Italians blaming French government demands. Infineon paid $10bn for Cypress. There are strong synergies ahead but the market found the acquisition multiples too steep (4.5x sales and 20x EBITDA) given today’s downbeat prospects for global demand. As part of its strategic assets review, Bayer is to sell its chemical production site services provider. 

  US equities

It was a volatile week in the US with downward pressure to start the week due to two developments: (i) big internet players like Google, Facebook, Amazon and Netflix had to contend with negative newsflow over fair trading concerns, so much so that regulatory authorities like the Federal Trade Commission and the Department of Justice might eventually intervene; (ii) the war of words between the US and its main trading partners escalated when Washington announced customs tariffs on Mexican imports.

The trend reversed on June 4th thanks to a speech from J. Powell which was seen as accommodating. He gave a veiled hint that rate cuts might be considered if the macroeconomic situation were to deteriorate.

The S&P gained 2% over the week (+4% since Tuesday) and the Nasdaq ended 0.4% higher.

There was no change on US 10-year Treasury yields and oil prices as the news had already been factored in during the preceding week with several downward revisions in Brent crude estimations for the end of the year.

Lagging sectors included telecoms (-2.5%) and index heavyweights Google and Facebook which tumbled by 8% and 6% over the week on regulatory worries. Rebounds were led by basic materials (+7%), utilities (+4%) and financials (+2.8%) as investors returned to sectors which had been left behind in the year-to-date advance. In company news, Campbell Soup surged 20% after rising guidance for 2019 on strong demand in the snack market. 

  Japanese equities

Following the Fed’s hint that interest rates might be lowered and the subsequent strong rally in the US, Japanese stocks also rebounded. The TOPIX ended the week 0.84% higher and the JPY/USD exchange rate stayed at 108 as the interest rate gap narrowed.

The Bank of Japan has already implemented a strong easing policy so room for further monetary easing is limited.

Auto-related sectors such as Transportation Equipment and Rubber Products, which had been severely hit by US trade policy, outperformed over the week.

The Real Estate sector also outperformed amid the lower interest rate environment. Property stocks and J-REITs have been attracting investor attention recently as they are seen as relatively safe investments. 

  Emerging markets

Emerging markets ended the week on a positive note, rising 0.48% (as of June 6th), spurred by a more dovish stance from global central banks. 

China said it would establish a list of so-called “unreliable" entities suspected of damaging the interests of domestic companies. This could potentially affect thousands of foreign firms as tensions escalate after the US put Huawei on a blacklist. Elsewhere, in an effort to compensate any negative impact from failing trade negotiations, the National Development and Reform Commission announced on June 6th a stimulus package easing new license plate restrictions for the auto, home appliance and consumer electronic sectors. However, at this stage, discussions on a nationwide fiscal subsidy or tax cut have not yet been disclosed.  

India's economic growth slowed to 5.8% in January-March 2018-19 from 8.1% a year ago. In its first cabinet meeting, the new Union government extended its agricultural support scheme to all farmers - originally only small farmers were concerned- and the creation of pension schemes for small farmers, shopkeepers and retailers. More positive news came on Thursday with the Reserve Bank of India cutting interest rates by 25bp to 5.75% and changing its stance from "neutral" to "accommodative".

In another blow in the trade war with its long-term partners, the US announced its decision to end preferential tariffs on $5.6bn of Indian exports from June 5. The measure would have a limited impact as only 10% of India’s exports to the US benefit from these tariffs. Washington also vowed to impose a 5% tariff on Mexican goods to encourage the authorities to stop immigrants from entering the US illegally. The tariff would take effect on June 10th and could rise as high as 25% by October 1st. The US was later on reported to be considering delaying imposition of tariffs on Mexico, allowing for more time to negotiate.

One of the main risks of this tariff issue in the short term is Mexican peso depreciation. The currency has already lost 2.5% since May 31st. Typically companies like KOF (FEMSA) could be most impacted as 25% of its costs are in US dollars.

Mexico May Consumer confidence fell to 108.1, or below expectations. We expect sentiment to continue deteriorating on mounting uncertainty over trade and tariffs. On the company front, OMA (Grupo Aeroportuario Centro Norte) said total traffic had risen 12% YoY, led by domestic traffic which was sharply above consensus and better than its peers. 

In Brazil, positive but weaker-than-expected industrial production was caused by a large drop in mining and oil & gas. Bill 871 to save $26bn in pension fraud over the next 10 years was approved by the Chamber of Deputies. This, along with the ongoing pension reform, is part of measures to stabilise Brazil’s debt. 

  Commodities

Oil prices recovered from the previous week's fall and stabilised around $62. Volatility, however, continued and prices reacted strongly to rather worrying US inventory data mid-week which showed a big rise in crude stocks to a high not seen since July 2017. This also came with a significant increase in petrol and distillate inventories, triggering worries over demand prospects. There seems to have been a genuine slowdown in demand over the last two months, especially evident in lower refining margins. Note, however, that Russia’s output hit a 3-year low of 10.87 million b/d in the first few days of June. Production is still being hit by pipeline contamination at Droujba, the longest in the world, which stretches over 4,000 km from South-West Russia to Germany.

This is, however, a temporary problem unlike Venezuela where exports fell by 17% in May to 874,000 b/d, leading to a default on debt interest payments. Creditor banks reacted: Deutsche Bank, like Citibank previously, seized possession of gold which had been pledged as collateral, reportedly $750m or 20 tonnes of gold for Deutsche Bank and $1.1bn (27 tonnes) for Citibank.

Gold itself returned to its traditional safe haven status over the week. The ounce gained 4% to $1,330, a high seen in February and over the first quarter. Investor appetite was reflected in physical gold ETF inflows, notably in the US. Fresh US-China tensions and a new threat to raise tariffs on Mexican imports also played a part. Nevertheless, the main issue is the more accommodating tone from Fed members which seems to be in tune with expectations of a rate cut in the second half, a move that is already partly priced in. 

  Corporate debt

 

Credit

The market bounced sharply at the beginning of the week after accommodating comments from the Fed reinforced the possibility of a rate cut this year. In Europe, the ECB struck a less accommodating tone than expected but said it would leave rates unchanged until the first half of 2020. The bank also provided details on its third TLTRO. The possibility that the European Commission might launch an excessive deficit procedure against Italy had little impact on spreads. The Xover tightened by 18bp and the Main by 6bp.

Aldesa's bonds continued to fall on last week's disappointing results. Intalot also came under pressure after its first quarter figures showed the situation had deteriorated further: EBITDA fell 14.7% over a year due partly to Argentina and Turkey while net leverage hit a record 5.8 times. Lecta’s bonds rebounded after management struck a more optimistic tone in its EBITDA guidance for 2019 as a whole. Casino saw further selling when Moody’s joined S&P in cutting its rating by one notch to B1 with a negative outlook. The agency cited uncertainties from Rallye’s safeguard procedure. CMA-CGM saw heavy selling after rival Hapag-Lloyd’s somewhat negative guidance and also a research note that suggested the group could run into liquidity problems in a trade war.

Press reports said Altice Europe had received firm bids for its Portuguese fibre network. It would appear, however, that the valuation is less than the group expected and that it could end up holding onto the division. FCA said it was ending merger talks with Renault due to political considerations in France.

In financials, BPCE said it had concluded a new shareholder’s pact with the La Banque Postale which had acquired the insurer CNP. BPCE was keen to remain a shareholder. UniCredit no longer wants to buy Commerzbank according to Italian press reports.

On the new issues market, Barclays raised $1.2bn with an AT1 at 7.125%. 

Convertibles 

It was a busy week for new issues thanks to the end of the earning seasons and a market rebound after the end-May sell-off on trade war worries. There was strong demand for more cyclical players and companies jumped on the occasion to increase issue size.

Coupa Software (SaaS and a leading Procure-To-Pay company) raised $700m over 6 years, including a $105M greenshoe, at between 0% and 0.125% and a 35% premium to fund normal business and any acquisitions. The issue was initially for $500m at between 0.125% and 0.625%.

Q2 Holdings Inc., a fintech offering digital platforms and related services to bank,) raised $270m (up from $200m initially) over 7 years with a 15% over-allocation option, and a coupon between 0.75% and 0.875%. The premium was 27.5% and the group also sold new shares for around $155m.

Derwent London (London’s biggest REIT with 5.4 million m² of mainly commercial property) raised £175m over 6 years at 1.5% and a 37.5% premium.

Altair Engineering (simulation software for engineering and industrial design in the aerospace and ship building industries etc.) raised $200m (up from $175m initially) with a $30m greenshoe, a 0.25% coupon and a 30% premium.

Yaoko (supermarkets and chemists in Japan’s Saitama region) raised ¥15bn over 5 years with a zero coupon bond and a premium of between 17% and 27%.

Elément complémentaire