The geopolitical context remains uncertain

Market analysis - 9/27/2019

Once again, markets danced to the tune of developments in US politics and the trade war. The Democrats started a pre-impeachment procedure against Donald Trump. Washington is still looking for a broad agreement with Beijing, one that goes beyond simply settling agricultural issues. However, Donald Trump's speech to the UN rekindled fears on further talks being jeopardized.

US and Chinese officials are meeting in Washington on 10 and 11 October. Beijing has increasingly committed to buying more US agricultural products, not just to show its willingness to talk but also because of swine flu.

Meanwhile, the Conference Board’s confidence index remained at all-time highs in September. Even so, US consumers are increasingly concerned by the geopolitical situation and expectations fell to 95.8 from 106.4 in August.

Elsewhere, Donald Trump and Shinzo Abe signed a limited trade agreement. Japan will cut import duties on $7bn-worth of US agricultural products. The agreement also regulated digital commerce. Abe also succeeded in securing lower tariffs on Japan’s agricultural and industrial exports to the US but failed to get any concessions on vehicles. The threat of a 25% tax on car imports remains even if Donald Trump has agreed not to act before talks resume next April.

In the conflict on possible EU subsidies to Airbus, the WTO has given Washington the go-head to slap 7.5bn in annual tariffs on European imports. This leaves Airbus and Boeing in a stand-off. For the last 15 years, each has been accusing the other of benefiting from government subsidies with the WTO periodically taking one side or the other.

At the fundamental level, PMI data in the US and Europe confirmed that economies were slowing but equity markets largely brushed off the news. Germany’s manufacturing sector fell to a 2009 low, mainly due to autos and a hefty fall in international new orders. Yields on 10-year government bonds quite naturally fell. Equity markets initially dropped as risk aversion returned but the fall was only limited. In the US, the final GDP growth reading fall the second quarter was confirmed at an annualized 2% and markets also failed to react.

In the UK, the Brexit saga continued. The Supreme Court overturned Boris Johnson’s decision to prorogue and said the Commons could go back to work. The decision reduced the Prime Minister's options but left the overall situation unchanged.

In France, the 2020 draft budget marked a change in government strategy. After 2 years of focusing on improving company competitiveness and encouraging investment, the priority has shifted to consumption.

In this complex geopolitical and macroeconomic environment, we remain cautious on risky assets.

  European equities

Markets in Europe edged lower on poor macroeconomic data in Germany and political uncertainty in the US.

Iliad bucked the trend, rising 2% after launching a new 4G+ box which will allow subscribers without fibre broadband to enjoy ultra-rapid internet speeds. And Capgemini gained 1.8% after the US regulator gave it the green light to acquire Altran. Elsewhere, Total used its investors day to unveil an extra $1bn in cost cutting. More importantly, the group said its annual dividend would now rise by 5-6%, up from 3% previously.

This week’s bad news included a money-laundering enquiry into ABN Amro. In the steel sector, the climate remained very complicated for companies due to lower prices and stagnant demand. Arcelor fell 6% over the week but markets reacted favorably to a press report that it might be considering selling some production sites. The IPO of AB INBEV’s Asian business went ahead. The company was valued at close to $45bn and will start trading on Monday, September 30. AB INBEV will make $5bn from the sale of some of its shares.

  US equities

Equity markets were down 0.5% as of Thursday's close (26 due to political fall-out from Ukraine-Gate and a sharp drop in household confidence levels. The Washington Post claimed Donald Trump had threatened to freeze $400m in military aid to Ukraine unless its newly-elected President Volodimir Zelenski launched an enquiry into the business interests of Joe Biden’s son in the country. Donald Trump authorized the publication of the complete transcript of his July phone conversation with the Ukraine President to show that its contents were fully appropriate. However, the House of Representatives chair, Democrat Nancy Pelosi, said last Tuesday that there would be a preliminary enquiry to see if an impeachment process should be launched against the president.

Elsewhere, there was renewed optimism on the US-China trade war after Treasury Secretary Steven Mnuchin confirmed that talks would resume in a fortnight.

Sectors which had underperformed in the first half of the month rebounded sharply over the week. Consumer staples gained 1.29%, utilities 1.65% and property 0.95%. Healthcare, in contrast, lost 2.6% on political uncertainties and fears that the fortunes of the Democratic Party in the electoral race were recovering. Energy also shed 2.6% as oil prices retreated. WTI ended the period 2.6% lower. Nike beat expectations with a 7.2% rise in YoY sales. Despite the trade war and US dollar strength, sales were strong in China and the group also benefited from its direct selling strategy.

  Japanese equities

Japanese stocks posted marginal gains on improving market sentiment. The TOPIX rose 0.44% over the week. Low PE value stocks like insurance companies continued to gain ground but the recovery has recently begun to spread from large-cap value stocks to mid & small cap stocks as well as growth stocks with strong fundamentals. Better sentiment has clearly driven the rally, but the market appears to be looking for an earnings recovery after spring next year.

The Russell/Nomura Japan Value Stock Index has outperformed the Growth Stocks Index by 2.76% so far this month due to a strong rebound in oversold large caps. This has often been seen in the past, especially during the initial stage of a market recovery. We now expect to see a catch-up among lagging mid & small cap stocks and growth stocks with sound fundamentals. In the past, robust growth stocks have usually rebounded more than value plays.

  Emerging markets

Emerging markets lost 1.2% as of Thursday’s close. Chinese equity markets (FTSE All Shares Greater China) retreated by 1.9% as uncertainty on the strength of China’s domestic economy and trade conflict outcome continued to weigh on market sentiment. Following the Fed’s 25bp cut, the PBoC cut its 1Y Loan Prime Rate (LPR) by 5bp to 4.20%, while the 5-year LPR remained at 4.85% as in August. The impact of a lower LPR on corporate funding costs remains to be seen, especially since the banks' funding costs (including the MLF rate) was unchanged. Central bank Governor Yi Gang said China was not in a rush to add massive monetary stimulus, unlike other central banks, and should maintain a prudent policy stance.

The GPO (Group Purchasing Organisation) office in Shanghai organized the price bid of the expansion round of the "4+7" centralized drug procurement of 25 drugs for 25 provinces. "4+7" winners became losers and multinational pharmaceutical companies became more active with the arrival of global generics players. Sandoz (Novartis), Sanofi and Merck all cut their prices aggressively. CSPC, a leading Chinese pharmaceutical company, won a national tender for clopidogrel (a drug to prevent clot formation). The price cut was 23% below the last “4+7 “round, or less than the 30-35% expected.

Elsewhere, China’s top technology hub Hangzhou plans to assign government officials to work with 100 private companies including e-commerce giant Alibaba, according to state media reports, in a move likely to raise concerns over the growing role of the state.

In India, in a spill-over from last week’s corporate tax cut, Maruti Suzuki slashed car prices immediately by Rs5000 on 50% of its portfolio to boost demand as the festive season, a key period for consumption in India, began.

In Brazil, Petrobras continued to streamline its balance sheet and struck an agreement with Eletrobras to receive R$8.4bn of the receivables recognized in the debt assumption agreement of 2014 with an original maturity date of January 2015. In the payments business, Ame Digital, the fintech of Lojas Americanas and B2W, signed a MOU with Mastercard for prepaid card offers. In the airline sector, Delta announced the acquisition of 20% of LATAM airlines. The $16 tender for the stake implies an 89% upside from the current LATAM ADR price. The news is bad for GOL, as Delta informed the company’s intention to sell its 9% stake. 

  Corporate debt

 

Credit

It was a very busy week for political developments but credit risk premiums were relatively stable. In the UK, the Supreme Court ruled that the proroguing of parliament had been unlawful and then a pre-impeachment process against Donald Trump was launched in the US. Even so, the Main and Xover indices remained at 55bp and 231bp.

In company news, Thomas Cook declared bankruptcy after failing to reach an agreement with creditors and shareholders. The group announced on Thursday that it was applying for liquidation. In other news, the Rallye rescue procedure was extended by 6 months and debt repayments will now be rescheduled over 10 years. For the moment, the group has no intention of offering creditors a debt-for-equity swap. Bain Capital is reportedly looking to offload its stake in Autodis, either through an IPO or a disposal.

On the new issues market, German semiconductor company Infineon raised €1.2bn in hybrid debt to fund its acquisition of Cypress in the US. Cirsa raised €400m in subordinated bonds to fund a dividend payment to shareholder Blackstone. CABB (chemicals) refinanced its entire debt outstanding.

ABN Amro said Holland was launching an enquiry into suspected money laundering and terrorism financing. The bank's shares plunged 9% on the news and its AT1 bonds lost around 1%. There is, as yet, little information but ING in similar circumstances had to pay a €775m fine. ABN Amro has a CET1 ratio of 19.2%, or well above the required 11.8%, so a substantial fine could be absorbed.

Commerzbank’s new strategic plan includes closing branches, selling its Polish affiliate mBank and cutting costs. Moody’s labelled the news “credit negative” but S&P, which already has a negative outlook on the bank, said the announcement was neutral. French banks this week issued sterling-denominated senior debt. Generali sold a euro-denominated Tier 2 bond after its offer to recall some of its Tier 2 debt.

Convertibles 

The convertible market remained bullish with several new issues in Europe as companies there continued to turn to convertibles for funding.

Pinduoduo, a Chinese e-commerce start-up, raised $1bn with a zero-coupon convertible that came with a 37.5% conversion premium. The proceeds will go on funding R&D and investments in tech firms active in areas where the company wants to diversify.

Kering raised €500m with a zero-coupon bond exchangeable into Puma shares. The bond has a 35% conversion premium and the proceeds will go on general corporate purposes.

US semiconductor company Broadcom raised $3bn with a mandatory convertible at 8% that will partly be used to refund a credit line.

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