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Donald Trump rekindles investor concerns

Market analysis - 6/22/2018

Not for the first time, the Trump administration's attitude to China revived investor concerns. Even leading central banks at their recent meeting in Portugal clearly spelt out why a trade war would hit confidence and harm the global economy.

The governors of the Fed, ECB, and Bank of Japan think Washington's attitude is already having visible effects and they are now assessing its economic impact, especially any possible delay in large company investment. True, the SP500 only lost a modest 1.1% and the MSCI World in local currency 1.3%, but worries are mounting and despite upbeat earnings reports, international blue-chip valuations are waning. After China slapped $50bn in duties on US imports ($34bn from July 6) or close to 40% of US goods exported to the country, Washington threatened to add another $200bn in 10% duties in an attempt to get China to back down at the US-China trade talks. Slowly but surely, retaliatory measures are being planned through the world. The amounts concerned are on the rise and could hit an increasing number of economic sectors. 

Elsewhere, sensitivity to Italian political risk is simmering. The appointment of Claudio Borghi and Alberto Bagnai, both eurosceptics, to head up the parliamentary budget and finance commissions in both chambers triggered another wave of risk aversion. Even so, the fundamentals are still robust and we remain slightly overweight European equities as they should gain from more favourable financial conditions in the US. Nevertheless, we are sticking with our options hedging strategy to weather this choppy market phase. 

  European equities

Markets retreated on concerns that a US-China trade war would flare up. Exports stocks, led by autos, and tech were hit by US customs duties. Cyclical sectors like chemicals, building materials and industrials all moved lower. Luxury also reversed after starting the year in very buoyant mood. Kering plunged 6% but was still up by more than 30% year to date. Banks lost ground on last week's accommodating statements from Mario Draghi. And the appointment of two eurosceptics to head up the Italian parliament’s budget and finance commissions led to Italian spreads widening. 

Oil stocks tracked the barrel as it edged lower ahead of the OPEC summit. Uncertainty over global growth has led to higher volatility and any disappointing company news triggered strong selling. Nexans said some contracts had been put back and the stock sank 17% while Ceconomy (electronic product distribution) tumbled 14% on talk of an increase in capital. EDF, however, rose on rumours suggesting the French government was reviewing the regulatory framework. Engie’s decision to halt nuclear reactors in Belgium was seen as bad news. Daimler revised its guidance lower for the fourth time this year and now expects a slight drop in EBIT. But JCDecaux gained ground after making a hostile bid for an Australian billboard company. 

  US equities

In a relatively calm week for economic news, US indices headed south on persistent protectionist rhetoric and trade frictions. 

Housing starts rose 5% compared to the previous month, or much higher than the +1.9% expected. Existing home sales, however, came in very slightly lower but remained at lofty levels. 

Oracle’s quarterly figures were in line but the group, whose approach to governance and transparency is controversial, once again changed its presentation format and delivered mixed prospects for coming quarters. The stock plunged more than 6%. 

Elsewhere in the corporate software field, Red Hat’s figures were upbeat but fell short of admittedly extremely high expectations. Fedex’s results were as expected but Starbucks issued a profit warning on less buoyant growth in US customer footfall and higher-than-expected investments in China. 

Over the last five trading sessions, defensive sectors like utilities, property and consumer staples rose while materials, industrials and energy suffered sharp falls. 

  Japanese equities

Japanese stocks declined across the board on mounting trade tensions between the US and China. The TOPIX ended the week 2.15% lower. 

Worries over the US slapping extra duties on imports and China retaliating, a situation which could result in world trade and economies stagnating, hit Marine Transportation (-7.30%), Iron & Steel (-5.04%), Nonferrous Metals (-5.00%) and Mining (-4.38%). China-related stocks such as machinery producer Komatsu (-6.54%) and banks (-5.20%) also came under fire. 

On the other hand, Pharmaceuticals (+0.40%) and Information & Communication (+0.03%) edged higher. Daiichi-Sankyo climbed 8.31% and Takeda gained 2.96%. Mercari, a flea market application, soared on its first day of trading on the main board. 

A strong earthquake hit Osaka on Monday, temporarily disrupting social infrastructure in the region, but had no significant impact on the stock market. 

  Emerging markets

Indices were under pressure due to mounting US-China trade tensions. In China, ongoing deleveraging has caused financing to tighten and SMEs are starting to suffer. The SME PMI index for May was weak. Widening credit spreads and increasing bond defaults have made Beijing more vigilant. The last State Council discussed introducing a targeted drop in RRRs to improve liquidity and fiscal stimulus to boost SME businesses. We can therefore expect to see some fine-tuning in coming weeks so as to underpin domestic demand and prepare for any trade conflict.

South Korea’s exports fell 4.8% over the first 20 days in June compared to the same period last year. The Philippines’ central bank raised its benchmark rate 25bp to 3.5% to shore up the peso.

The Reserve Bank of India said it was worried about rising inflation and that a rate hike would send a strong signal and help bring down inflation expectations. All monetary committee members had previously voted for a 25bp rise at the June 6 meeting. ICICI Bank's CEO will remain until an enquiry into a potential conflict of interests with Videocon, where his wife works, is held.

Brazil's central bank monetary policy committee decided unanimously to hold interest rates at 6.5% and its statement adopted a dovish tone. Inflation over the first half of June was higher than expected, mainly due to the truck drivers’ strike. Randon had sales of R$289m in May, a 17.5% increase YoY. Sales have risen 49% so far this year or much higher than the +23% expected by the market for the full year.

Colombia’s recovery continued with retail sales up 6.3% and industrial production 10.5% higher. Walmex appointed Ignacio Caride, former chairman and managing director of Mercado Libre in Mexico, as its new e-commerce head in a drive to catch up with Amazon and Melin. The MSCI ended up including Saudi Arabia (2.3%) and Argentina (0.3%) in its MSCI Emerging markets index. 

  Commodities

June 22 marks the new D-day for OPEC and its allies, its 174th summit. The OPEC/non-OPEC meeting is the day after. The June 22 meeting is as crucial as the 171st meeting on December 1st 2016 when the decision was taken to reduce output by 1.8 million b/d to stop excess oil stocks weighing on the market. The Joint Ministerial Monitoring Committee, with Russia in attendance, met last Thursday and recommended increasing theoretical production by 1 million b/d. The actual increase is more likely to be around 600,000 as most countries are unable to up production. Extra output would come mainly from Saudi Arabia and Russia with Kuwait, the Arab Emirate and Oman adding a total of 200,000 b/d. The end decision could, however, prove complicated due to Iranian opposition. Tehran is loath to lose market share, or rather prefers to see any fall in exports offset by higher prices. Iran’s oil minister, significantly, left the meeting before the end. 

In the meantime, US inventories continued to fall, with crude down by 5.9m barrels over the week, or more than the seasonal average of minus 1.7 million. Venezuelan exports continued to fall sharply, with exports down by 765,000 b/d on average over the first half of June after a 1.13 million b/d decline in May. In other words, the market urgently needs extra production. Ultimately, OPEC is aiming to maximise output and get sufficiently high prices so as to stimulate investment but avoid having a negative impact on demand. China and India represent 70% of increased oil demand year to date, with imports rising by an annualised 8% (to 9.2 million b/d) and 6% (4.6 million b/d) respectively. 

Other commodities continued to trade in line with developments in the US-China trade dispute. Fresh tension over the week sent the LME index 3% lower with zinc down 8% and copper 5% lower. All metals are now in negative territory over the year apart from zinc (+17%).  

  Corporate debt

 

Credit

The post-ECB-meeting period of lower spreads came to a halt and the Xover widened by 13bp between Monday and Thursday on fresh uncertainty on US-China trade wrangles and the appointment of two eurosceptics to head up Italy’s parliamentary finance and budget commissions. On an active new issues market, Bayer (Baa1, pharma), raised a total of €5bn with several tranches across 2022/26/29 maturities and with fixed and variable coupons. Portugal’s EDP (Baa3/BBB-, energy), raised €750m over 8 years at 1.625%. IGT et Telecom Italia issued bonds to refinance. Danske Bank sold an Additional Tier 1 bond for $750m at 7%. French life assurance group CNP raised €500 with a Restricted Tier 1 bond at 4.75%. Portuguese bank Caixa Geral sold a Tier 2 10-year bond at 5.75%, raising €500m. Takko (B2/B, textiles) posted a disappointing 19% fall in adjusted EBITDA. It is now expecting second half sales to contract with costs remaining high. As expected, Altice (B1/B+) is to sell 50% of its French and Portuguese telecom towers which are valued at €2.5bn or 18 times EBITDA.  

Convertibles 

The European primary market picked up with 2 repeat issuers. France’s Soitec (high performance semiconductor materials) raised €150m with a zero coupon 5-year convertible at a 37.5 premium.

The proceeds will be used for general corporate purposes including the repayment of short term €30m bank loan. Safran (aeronautics) raised €700m with a 2023 maturity (zero coupon, 37.5% premium) for general corporate purpose. 

The US new issues markets is still running at full speed. Wix.com (an online platform which creates mobile apps and websites) is offering a $350m 5-year convertible which could yield between 0/0.5% and come at a30/35% premium. The proceeds will go on purchasing a capped call and working capital and general corporate purposes. Of note too was QTS Realty Trust (a specialist in data center properties) which raised $275m with a perpetual 6.5% convertible that came at a 20% premium.

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