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Trade war nerves

Market analysis - 7/6/2018

Mounting trade war rhetoric and the actual roll-out of measures against China dominated market sentiment.

Talks with the EU are still ongoing, but Washington has already indicated that it could withdraw planned tariffs on EU car imports if the EU did the same for US imports into Europe. The EU had yet to reply officially but Angela Merkel said she was open to discussions as long as all countries Germany sold cars to were involved. Meanwhile, Germany’s industry is firing on all cylinders with new orders up 2.6% in May, or much better than the +1.1% expected.  

Duties on $34bn in Chinese imports to the US came into force on Friday July 6. China is to tax a similar amount in US agricultural produce and cars. But the threats continued to escalate with Donald Trump saying a further $16bn in goods would be targeted in two weeks’ time and that he could go as high as $550bn, which is actually more than total Chinese imports to the US. 

It is, of course, tricky to assess the actual impact of all these measures but the sheer length of the escalation will weigh on company fundamentals. And the repercussions on China’s economy are worrying as they could undermine the global growth cycle. Beijing is nursing domestic growth by trying to underpin household spending with a fiscal stimulus plan. 

In the US, the latest FOMC minutes showed the Fed was just as keen to continue gradually raising rates although it acknowledged that threats to global trade and current turbulence on some emerging markets might offset the benefits of the 2017 tax reform. Manufacturing ISM rose from 58.6 in May to 59.1 in June, one of the highest levels in recent years. The business component hit a high not seen since 2005. In Europe, markets were pleased to see the ECB specifying that its initial rate hike would be between September and October 2019. 

The upcoming results season will be very closely watched. Estimates are starting to factor in growth flattening out and further possible trade restrictions between China and the US, both of which will no longer be offset by the positive impact of the weaker euro. And even if the eurozone’s economic surprise indicator has started to recover, the 2018 and 2019 earnings adjustment period will be crucial for European equity indices. 

  European equities

Markets recovered but in thin trading. Autos were the best performing sector over the week thanks to the US ambassador in Berlin who suggested that Donald Trump might back down from his threats to impose tariffs on EU car imports. 

Meanwhile, Germany's ruling coalition managed to avoid collapse by reaching an agreement on the migrant issue and European indices bounced back at the end of the week. Germany’s industrial production rebounded.

Ahead of the half-yearly earnings season, company news was thin on the ground. Export stocks, led by autos, rose on more reassuring news on the threatened US/Europe trade war on car imports. Thyssenkrupp said its CEO was leaving, a move that could speed up the restructuring process promoted by the activist Cevian and Elliott funds which own close to 20% of the shares.  As expected, Generali sold 89% of Generali Leben in Germany, a deal which will have a 2.6bp impact on its solvency ratios and result in a €275m capital gain. The shares rose on the news. STMicroelectronics fell after Micron Technology was banned from selling certain products in China. Holland’s SBM lost ground when a court ruled that Petrobras should withhold payments to ensure the Dutch company pays any fines due in a corruption case. Capgemini, Altran, Akka and Alten fell after all three said May's calendar would have a negative impact. Food retail rebounded from very low levels after Carrefour and Tesco agreed to set up a joint buying group. Trigano plunged 20% intraday after sales came in much lower than expected. Management pinpointed UK market weakness and said some production sites were struggling to hire.

  US equities

In a short July 4th holiday week, the S&P gained +1.1% and the Nasdaq +1.24%. The FOMC minutes showed that many committee members were worried about the consequences of a trade war between the US its main trading partners. 

In company news, semiconductor giant Micron was hit by a provisional ban on some of its products being sold in China. The group said the products concerned only account for a little more than 1% of its sales and that earnings would not suffer. It also reaffirmed its annual objectives. A new enquiry by several US federal agencies into Facebook’s part in the Cambridge Analytica scandal is not expected to mean fresh fines for the group. IBM unveiled several new IBM Cloud contracts with leading European companies to give them access to AI technology. 

All sectors rose apart from energy which dipped 0.5%. Telecoms (+3.5%) and tech (+2.16%) once again outperformed. Financials lagged by only gaining 0.5%. The week starting July 9 will see the beginning of the second quarter earnings seasons in the US. 

  Japanese equities

Ahead of the roll-out date for the 25% retaliatory tariffs on US-China trade, Japanese equities were generally weak in line with falling Chinese stocks. Amid the uncertainty, the TOPIX declined 3.16%. 

Recent trading volume on the Tokyo Stock Exchange was smaller than usual as investors stayed on the sidelines, leaving the market in the hands of short-term dealers in stock index futures. Economic sensitive sectors remained weak and domestic demand shares were relatively firm overall. 

By sector, Rubber Products (-6.34%), Nonferrous Metals (-6.07%), Marine Transportation (-5.20%) and Electric Appliances (-4.81%) sectors were among the worst performers. Economic sensitive companies like SMC and Sumitomo Metal & Mining tumbled 9.82% and 8.92% respectively and Keyence sank 8.86%. 

While domestic demand stocks were relatively firm in general, outperformers such as cosmetics producers or drugstore chains were hit by profit-taking as investors turned risk-off. Shiseido lost 7.19%. 

For the future, after the crucial date for US-China additional tariffs, we believe the market will pay more attention to individual names, especially if their Apr-Jun earnings results underpin their (conservative) earnings guidance for FY2018 (ending on 31 March 2019). 

  Emerging markets

Against a backdrop of a patents dispute between UMC and Fujian Jinhua, China suspended the marketing of 26 Micron DRAM and NAND models.

The renminbi stabilised against the US dollar after China’s central bank officially promised that it would not use currency depreciation to counter US trade sanctions. Moutai reported a 46% increase in sales and a 51% jump in earnings for the first half of 2018. China's June manufacturing PMI came in at 51.5 or slightly down on last month’s 51.9. To encourage domestic consumption, Beijing plans to expand income tax brackets for the middle classes. 

Samsung Electronics’ prelim figures were slightly below expectations with annualised operating profits rising 5.2% instead of +8.5%. This was down to lower margins on smartphones and screens as well as higher-than-expected start-up costs for their new DRAM/NAND production lines. South Korea’s exports slipped 0.1% in June. In the run-up to elections, the Indian government has unsurprisingly raised minimum cereal prices by 5% as two-thirds of the population live in rural areas. This will increase inflation from 0.5% to 1% and raise the fiscal deficit to 0.2-0.4% of GDP so further rate hikes are even more likely. Titan (jewellery) said it had gained market share but that June sales were soft. To cool down its property market, Singapore has decided to increase stamp duty on second homes and for developers by 5% and to raise the loan-to-value ratio by 5% for all buyers. 

As expected, Andrés Obrador won Mexico’s presidential election and will have a parliamentary majority. His inaugural speech took a reassuring tone and reaffirmed his intention to conduct a responsible budget policy. Consumer confidence improved further in June with Walmex even registering a 10% jump in sales. In Brazil, there were two encouraging developments: the National Congress approved the accelerated privatisation of Electrobras before the elections and the lower chamber authorised Petrobras to sell excess crude production to the government from this year on. 

We expect emerging markets to remain volatile in coming months as the US/China war of words over trade issues gets worse. We simply hope this climate will not weigh too much on company investment decisions.

  Commodities

Oil is one of the most actively traded assets on financial markets. Its price depends essentially on economic indicators like supply and demand and inventory data as well as more subjective geopolitical factors. But a new indicator has recently emerged: the Donald Trump Tweet. Ahead of November's mid-term elections, he is increasing pressure on OPEC to cut prices and went so far as to send a “REDUCE PRICING NOW!” tweet in capital letters. 

Russia and Saudi Arabia have reaffirmed their agreement to increase output by 1 million b/d although no breakdown of each country’s share has been given. The first indicators suggest the increase is already effective as Reuter's estimates OPEC’s June production at 32.32 million b/d, up from 32 million in May. Bloomberg estimates show a slight increase from 31.8 million to 31.82 million b/d. Tankers leaving Saudi Arabia show that exports increased from 7.15 million b/d to 7.47 million in June. Saudi Arabia can theoretically produce 12 million b/d, but its November 2016 record was 10.72 million and June production was 10.3 million. This shows slack capacity rapidly falling, i.e. not much wriggle room for another problem, namely a threat from the head of Iran's Revolutionary Guard to disrupt or block the Strait of Hormuz through which 17.2 million barrels pass each day (2017 data), or 17% of global production and 30% of maritime oil transportation. US strategic reserves represent 660m barrels or 33 days of US consumption and 112 days if we exclude US domestic output.

Worries over global trade and China's economy weighed heavily on the rest of the commodity sector. The LME index peaked on June 7 after gaining 2.4% YTD but has since gone into sharp reverse, losing 12% with copper down 13.5% and zinc 14.6% lower. Global manufacturing PMI came in at 54.1 in June, up from 53.9 in the previous month, a sign that activity is robust, but the US-China trade war has only just begun. 

  Corporate debt

 

Credit

Markets started the week on the back foot due to political uncertainties in Germany and fresh global trade tensions. But the trend reversed on Tuesday and the Xover tightened by 15bp over the rest of the week thanks to a coalition compromise in Berlin and new talks over abandoning import duties on cars. 

Bonds issued by Italian telecom operator Wind Tre (B1/BB-) soared by 11-13 points after Veon sold its 5% stake in Wind Tre to CK Hutchison Holdings for €2.45bn. CK Hutchison will now own 100% of Wind Tre, thereby simplifying the group’s shareholding structure. 

Shipping group Hapag-Lloyd’s bonds fell sharply on the preceding Friday on a profit warning. The group said an expected surge in earnings would now be jeopardised by insufficient cost savings due to higher fuel prices and uncertainties over global trade. 

Ineos (Ba3/BB-, chemicals) is to invest €2.7bn, an effort which will increase capex and leverage over 4 years. 

In financial bonds, the Netherlands said coupons on Additional Tier 1 and Restricted Tier 1 bonds would no longer be tax deductible from January 1st 2019. This could qualify as a tax event and allow issuers to exercise a tax call at par. However, ABN AMRO and Rabobank both said they were not going to do so. 

Convertibles 

The new issues market practically dried up due to the US July 4th holiday and the looming earnings season. Only European TopSoho issued a 1-year exchangeable bond into SMCP (consumer discretionary) at 4%, raising €50m that could be increased to €100m. €60m was immediately placed.

Elsewhere, Glencore was ordered by the US Department of Justice to submit documents on its dealings in Nigeria, the Democratic Republic of Congo and Venezuela. The stock slumped on the news as did the convertible which has a delta of a little above 60%. But management succeeded in stopping the rot by saying there would soon be a share buyback for up to €1bn.

Econocom, an IT services company, announced a big profits warnings on full-year 2018 results after posting first half operating profits of €33m, or much less than the €57m expected by the consensus. The main causes were a €15m drop in IT equipment leasing and €10m in provisions for litigation and client risks. 

In telecoms, Inmarsat's stock could come under pressure after management rejected a new bid from EchoStar at 532p a share.

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