US GDP came in above expectations

Market analysis - 10/31/2019

Yet again, the European Union agreed to push back the Brexit deadline, this time to January 31 2020. After numerous twists and turns, Boris Johnson finally got MPs to vote for parliamentary elections. They will be held on December 12.

It is highly likely that the third poll since 2015 will act as a quasi-referendum on EU membership. The latest polls suggest the Conservative party has a comfortable 15% lead but they have been very unreliable in the past and we cannot rule out the possibility an equally divided house will be returned.

In economic news, GDP growth in the US slowed to 1.9% but was still well ahead of the 1.6% penciled in by economists. Growth is essentially being driven by consumer spending (+2.9%) and investment in residential housing (5.1%). In contrast, company investment fell 3% but spending on intellectual property (software and R&D) jumped 6.6%. This gap -0.8% vs. 2% - also shows up in GDP estimates for 2020, depending on whether the models use opinion polls or data on monetary, fiscal and credit policy.

Even so, growth in the US has slowed markedly since the Fed’s last meeting in September. Services, durable goods orders and retail sales have all weakened, justifying the Fed’s 25bp cut, a move that was largely anticipated by the market. The Fed has been quite clear that rate adjustments have now been put on hold. It says they are now at appropriate levels given its positive assessment of the situation, low inflation and risks to global trade.

Soothing comments on US-China relations have multiplied but Chinese growth levels are still very soft: manufacturing PMI is still in recessionary territory at 49.3 and there has been insufficient lending stimulus. Even so, investors are still optimistic and are focusing on the combined effects of reduced geopolitical risk and persistently accommodating monetary policy. This has sent US equities to new records. Despite the worsening global situation, the S&P 500 has gained 21% year to date and more than 350% since its 2009 lows.

Against this backdrop, we are sticking to our relatively cautious stance on risk assets.

  European equities

Ahead of the Fed and the ECB, quarterly earnings dictated market trends at the beginning of the week with big moves up and down.

Disappointing results from HSBC and Lloyds dragged down UK banks. Southern European banks also retreated after Santander’s third quarter results missed expectations. Even good quality figures like those from Credit Suisse failed to reward deserving banks. Auto suppliers also came under fire after Pirelli cut 2019 guidance further, reducing its EBITA margins for this year from 18/19% to 17/17.5%. Despite efforts to cut costs and capex, the group's profitability fell more than expected. Telecoms fared no better due to relatively disappointing results from Orange and T-Mobile’s decision to rekindle a price war in the Netherlands. The household and personal care sector however, rose on excellent figures from L’Oréal. Thanks to persistently strong momentum in beauty and increased brand penetration, especially in the luxury sector, the group's third quarter saw the strongest growth in the last 10 years. Airbus rallied after Indigo submitted a huge order and in spite of disappointing indications on annual deliveries. Safran also had a good quarter and reiterated 2019 guidance which sees like-for-like growth of 10%.

Elsewhere, Peugeot and Fiat both rose on news they were in exclusive talks and a deal was later announced for a 50/50 merger. LVMH confirmed that it had tendered a bid for Tiffany and that talks were ongoing. A deal would help the group increase the jewellery sector’s contribution to profits and its US presence. Atos decided to accelerate its exit from Worldline. After distributing Worldline share to its own shareholders last May, it is to place more with institutional investors, leaving it with around 13%.

  US equities

It was another up week in the US with the S&P 500 gaining 1.41% and the Nasdaq 1.93% in the five trading sessions to the October 30 close. As expected, the Fed cut rates by 25bp, citing the strong labour market, moderate economic growth a sustained growth in consumer spending. The Fed Fund rate moved back below the yield on 10-year US Treasuries for the first time since May, auguring the end of restrictive monetary policy. The yield curve returned to normal after several months of inversion. Yields on 10-year US Treasuries fell to 1.78%. Third quarter GDP in the US came in at +1.9%, or above consensus estimates of 1.6%. Consumer spending grew by an annual average of 2.9%, or more than its historic mean of 2.4%. WTI edged 0.9% lower while gold ended 0.4% higher.

Eight out of eleven S&P sectors ended the period in positive territory led by Technology (+3.67%), Healthcare (2.59%) and Materials (+2.37%). The biggest losers were Energy (-1.98%), Property (-1.66%) and Utilities (-1.04%). With 60% of quarterly earnings now in, 80% of companies had beaten EPS expectations.

In healthcare, Align Technology and Centene jumped 16% and 11% on upbeat figures. Pfizer and Merck also gained on better-than-expected results. LVMH made a 100% cash bid for US jeweller Tiffany. At $120 a share, the premium is close to 30% on the last price. The stock soared 34% as investors are betting on a counter bid or a sweetened offer from the French luxury company.

  Japanese equities

Japanese stocks stayed firm as worries over US-China trade frictions abated, the risk of a no-deal Brexit eased, and the Yen remained stable against the US dollar. The TOPIX gained 1.13% for the week as of Thursday October 31. Companies, which had revised up FY 2019 earnings guidance, made strong gains with Fujitsu up 6.77% and Sony 4.93% better. Over the month, investors buying back large cap stocks initially led the market recovery and small cap stocks followed this with solid fundamentals gradually catching up.  

Given the solid market environment, the Bank of Japan decided not to go for further monetary easing at its monetary policy meeting on October 30 and 31. However, Governor Haruhiko Kuroda also suggested the bank might ease if necessary, by modifying current forward guidance on the policy rate.  

Second half earnings reports for FY 2019 (April-September) were in full swing. There were some disappointing results, but investors seemed to be focusing more on the earnings recovery outlook for the next fiscal year rather than this year’s downward revisions.

  Emerging markets

As of the October 30 close, emerging market indices were up 0.5% with Brazil (+1%) and India (+2.5%) outperforming other emerging economies. With the cancellation of the APEC summit in Chile, China offered to meet the US in Macau to conclude Phase 1 of the trade deal.

In China, President Xi Jinping said the country had to speed up research and development of block-chain technology to revive the private sector and accelerate digitalization of the economy.

Hong Kong’s economy entered a technical recession with third quarter GDP down 2.9% YoY due to the prolonged protests.

In company news, the mixed ownership reform of Gree Electric, the leading air conditioning producer, came out sooner than expected: 15% of the shares will be transferred from the SOE parent to Hillhouse. China International Travel Services reported third quarter results in line with net profits up 17% but unfavourable FX and Hong Kong related traffic put margins under pressure.

In South Korea, Samsung SDI reported weaker-than-expected results due to delayed normalisation of domestic ESS (Energy Storage System), and lower-than-expected sales of small batteries.

In Taiwan, Mediatek provided strong guidance for the fourth quarter on 4G market share gains and initial shipments of 5G SoC.

In India, Tata Motors subsidiary Jaguar Landover’s China retail sales rose 24% in the third quarter. And the supreme court ordered phone operators to pay the government Rs 920bn ($13bn) in past airwave and license fees.

In Brazil, the central bank cut interest rates again by 50bp. A credit report showed a healthy acceleration to +13.9% rise in numbers for private banks. In terms of results, Santander and Bradesco reported upbeat numbers, in line with consensus. Cielo disappointed as the price war continued in the payments sector. Magazine Luiza posted very solid results, beating already high expectations, and proving that e-commerce remains very strong in Brazil.

The highlight in Argentina was Alberto Fernandez’s victory in the Presidential elections. The central bank subsequently tightened currency controls and slashed dollar purchases by savers from $10,000 per month to $200. The main focus will now be on the new cabinet and IMF negotiations. 

  Corporate debt

 

Credit

The European Union formally adopted yet another Brexit deadline postponement, this time to January 31 and the UK parliament voted to hold early elections on December 12. On Wednesday, the Fed cut its benchmark rate by 25bp as expected. On credit markets, indices retraced some of the recent gains with the Xover widening by 8bp and the Main by1bp between Monday and Wednesday.

Huntsman’s results once again fell, across all segments, with sales down 14% and EBITDA 30% lower. Belden also came under pressure after releasing rather disappointing figures. In contrast, Grifols saw third quarter sales rise 14.9% and EBITDA increase by 13.7% on strength in its bioscience unit. The group also said it was refinancing its main banking and bond facilities to extend maturities and improve funding costs. Europcar's bonds fell again over the week. After the previous week's profit warnings, Moody's put the group on watch and S&P revised its outlook from stable to negative. Credit Suisse and Standard Chartered performed well but an 18% drop in YoY net profits at HSBC disappointed the market. Faced with the worsening outlook, the bank jettisoned its objective of 11% in tangible equity returns by 2020 and unveiled a restructuring plan that it said could entail heavy charges in the future.

Peugeot confirmed a plan for a 50/50 merger with Fiat. The Italian group had broken off talks with Renault in June. Kraton's bonds gained 3-4 points on news that it had sold Cariflex for $530m.

It was an active week for financials on the new issues market. LBBW and Skandinaviska Enskilda Banken (SEB) sold AT1 bonds at 4% (€750m) and 5.125% ($900m). The market reaction was relatively positive and order books were three times oversubscribed. RBS sold a 10-year Tier 2 bond at 3.754%. Elsewhere, Casino announced the launch of a secured bond due 2024.

Convertibles 

 

The focus remained on corporate earnings, especially Total, Safran, Fresenius, BP and Airbus, which beat expectations. However, Air France disappointed with an EBIT miss and a subdued unit revenue outlook for the fourth quarter.

In Asia, WuXi Apptec posted very strong earnings, which sent the stock up 12% with convertible trading volumes also accelerating.

In the US, the earnings season was in full swing, with positive surprises from ON Semiconductors, NXPI, Nuvasive, Zynga, Charter Communications and Akamai, and misses from Illumina and Exact Sciences.

We had a busy week in convertible new issuance. In Europe, Atos raised €500m with a November 2024 zero-coupon exchangeable into Wordline at a 35% premium. The new issue is concurrent with Atos selling 14.7 million shares of the company, via an accelerated book-building process. This exchangeable bond offering comes 3 months after the Worldline’s own convertible bond issue and provides another equity-linked instrument.

In the US, we had three new issues from different industries. Granite Construction GVA, an infrastructure contractor and construction material company, issued $200m in convertible bonds to repay a portion of its revolving credit line. Winnebago Industries WGO, a motor homes manufacturer, raised $270m with a convertible to fund investments ahead of expected industry growth. DTE Energy, an integrated utilities company operating mainly in Michigan, issued $1.15bn in mandatory convertible bonds. And in Asia, Pacific Basin, a marine transportation and services logistics company based in Hong Kong, offered a 2.5-3% coupon, 30-35% premium convertible bond maturing in 2025. The company is a well-known issuer in the convertible market.

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