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Confusion reigns

Market analysis - 8/10/2018

Confusion reigns on markets. Investors are stuck whether to go with the good news on economic growth, company earnings and the financial environment or be worried by risks. Markets are effectively being prevented from rising by risk perception, on the up since the beginning of the year.

Of course, traditional worries over interest rate and oil price trends have been compounded by concerns over threats to global trade, especially as experts find the consequences hard to assess. It is pointless to play down this risk as tensions increase. This week, fresh tensions arose between the US, China, Russia, Iran and Turkey. And the diplomatic conflict between Canada and Saudi Arabia has taken an unexpected turn. 

However, today's risk perception is already at historically high levels and has triggered an unusual drop in the equity market valuations normally observed at this stage in the cycle. As economies throughout the world are expected to see growth accelerate in the second half, we remain overweight US and eurozone equities but with some options hedging. 

  European equities

The second quarter earnings season came to an end in Europe with mostly financials reporting. An acceleration in like-for-like growth has been confirmed but earnings growth has only been in line and there have been no real upward revisions, notably because of currency effects. The euro slid to a year low against the US dollar while Turkey’s precarious position and the persistently weak lira prompted concerns from the ECB over the exposure of 3 European banks, BBVA, UniCredit and BNP. 

Insurance companies reported stronger results than banks where solvency ratios have generally stopped improving while digital investments have continued to weigh on profitability. Italian banks are being hit by political instability and widening spreads but UniCredit still managed to post positive quarterly results and even beat net earnings estimates. 

The bank is sticking with its objectives and pursuing its restructuring drive by improving asset quality. Commerzbank, Germany's second largest bank, returned to profits and did better than expected in the second quarter but the bank is still busy with transformation and has slightly upped expected costs for the full year. It is nevertheless convinced it will once again be able to pay out a dividend. At least €200m in cost savings are planned by 2020 following the sale of its derivatives and asset management divisions to Société Générale in July. HSBC's half-yearly results rose 2.5% compared to the same period in 2017, or in line with expectations, thanks to its Asian banking business. Management presented a 2020 plan which should see $15-17m invested in technology and in its main markets in Asia, notably China. This marks the group's return to expansion after years of cost-cutting. ABN Amro reported excellent results with good shareholder return prospects.

Results from Deutsche Telekom and Ahold Delhaize confirmed that telecoms and food distribution were confronted with top line stagnation. Novo Nordisk delivered disappointing guidance for 2019 and price momentum but second quarter like-for-like growth remained strong in healthcare as a whole. Atos saw its share price tumble after a research note questioned the way it calculated free cash flow. Adidas, on the other hand, rose sharply after the group reaffirmed its annual guidance, reassuring investors on like-for-like growth and EBIT.  

  US equities

US equities continued higher in a relatively quiet week for domestic news. Of note, however, were producer prices which came in as expected. The ongoing earnings season has generally been very robust. With 84% of company results in, sales are up 9% on aggregate and earnings 10% across most sectors apart from property. However, the S&P500’s 25% earnings growth is largely down to the energy sector (+120%) and tax reform and so should be put into perspective. 

The headline company news was a tweet from Elon Musk that he might delist Tesla. We have some doubts on the feasibility of such a move. The charismatic Musk has recently been increasingly prone to outbursts and this tweet could be another example. It might also trigger an enquiry from the Security & Exchange Commission, the US market watchdog. Elsewhere, the tech sector has rallied strongly since the recent plunge and stocks like Amazon are once again flirting with all-time highs. 

Over the last 5 trading sessions, telecoms and consumer discretionary led advances while consumer staples and energy suffered sharp falls. 

  Japanese equities

Japanese equities were little changed this week in thin trading and the TOPIX edged 0.14% lower. Market sentiment remained in thrall to US-China trade frictions.

Financials had outperformed after the BOJ’s slight monetary policy adjustment of monetary at the end of July but underperformed this week. Market attention focused on quarterly corporate earnings announcements for the April-June period. 

By sector, Information & Communication was the top performer (+4.75%) led by SoftBank Group and NTT group stocks. SoftBank Group surged 13.63% on record earnings for the April-June quarter due to upbeat performance from its JPY 10 trillion strategic investment fund. NTT DOCOMO and NTT gained 5.01% and 4.27%, respectively, on news of streamlining. Rakuten gained 4.49% and Keyence rebounded by 6.88% on favorable earnings growth. 

On the other hand, Construction (-4.06%), Textile and Apparel (-2.73%) and Food (-2.70%) were among underperforming sectors. Daiwa House Industry declined 7.15% and beer producer KIRIN lost 7.23% on disappointing results. 

  Emerging markets

The PBoC imposed a 20% reserve requirement on trading of foreign-exchange forward contracts as the renminbi lost another 0.4% against the US dollar. In 2018, China’s fixed investment on railways will return to RMB 800bn from 732bn to support domestic growth. China’s financial authorities also said they wanted to promote stable and healthy growth in the country’s capital markets and would be announcing further moves to open them up soon. Macro data has so far been little hit by trade tensions with the second quarter current account surplus coming in at $5.8bn. July foreign reserves stood at 3,118bn or slightly higher than June and more than markets expected. 

China is still enjoying 12.2% YoY export growth with imports up 27.3% while the trade surplus has fallen to RMB 176bn from 262bn in June. July’s CPI edged higher to 2.1% while the PPI stayed at +4.6%. 

Internet companies continued to publish upbeat results: Weibo reported 68% YoY growth in 2Q18 revenues with net income up by 80% or better than expected. Hengrui Medicine announced 22% top line growth in the second quarter with earnings up 21%, accelerating from +17% in the first quarter. Indian biscuit maker Britannia industries reported first quarter revenue and earnings in line with Revenue/EBITDA/PAT growth at 14%/19%/20% YoY thanks to domestic volume growth. Eicher Motor reported better-than-expected 30% EBITDA growth in its first quarter. Thailand convenience store operator CPALL reported 3% YoY net profit growth for the second quarter, a reduced pace compared to the previous quarter due to higher spending on personnel and utilities. 

In Latin America, Meli reported strong GMV growth of 53% YoY in local currency. GMV in Brazil soared 44%, well ahead of the market's 12%, despite an estimated 12% drag from the strike and the World Cup. In Brazil, results at the BVM&F exchange were strong across the board with revenues up 28% YoY and an EBITDA margin of 76%, up around 690bp YoY. Banco do Brasil ‘s recurring earnings rose 22% YoY and 7% QoQ to R$3.24bn, 3% better than our forecast and market consensus. ROE improved by 1% YoY and 0.6% QoQ to 12.7%. Asset quality also improved. 

So far, 48% of the companies who have reported have announced better-than-expected second quarter results, with 16% posting weaker-than-expected figures. Better operating margins (with companies more focused on cost control), a pickup (finally) in sales growth, and better financial results (boosted by lower interest rates & deleveraging) are behind the improvement. In Peru, Credicorp’s net income came in 5% below expectations due to lower trading gains. Adjusting for this, operating profit would have risen 19% YoY. Loans, fees and NIM were up QoQ. Management also revised 2018 guidance higher on better loan growth and a lower cost of risk. Russia’s currency, bond and equity markets came under pressure this week after the US Senate introduced the Defending American Security from Kremlin Aggression Bill which could mean more sanctions on Russia.

Also, on Wednesday the US State Department announced that it would impose sanctions on Russia under the Chemical and Biological Weapons Control and Warfare Elimination (CBW) Act, which will take effect on August 22. The ruble sank 5% against the US dollar.

  Commodities

Given the potential US-China trade war, China’s economy is reassuringly strong, all thanks to domestic and external demand. The latest foreign trade data showed that commodity imports were still rising, notably iron ore (+4% over a year +5% over a month, and -1% YTD), copper (+16%, -2% et +16%) and oil (+3.6% over a year and +1.4% over a month). Meanwhile, Beijing is actively rolling out stimulus measures, not through sweeping plans as in the past but by targeting areas like infrastructure spending or by injecting liquidity. Remember that China’s Blue Skies policy will see a significant part of production close down again over the winter, making the country more dependent on imports. A sword of Damocles is hanging over the copper market: the Escondida, Chuquicamata, El Teniente and Caserones mines in Chile which produce 2.2 million tonnes or 11% of global capacity, could see production stoppages due to prolonged wage talks.  

Elsewhere, Beijing reacted to Washington's decision to raise import duties on $200bn of Chinese imports from 10% to 25% by publishing a list of $16bn of US goods which will be taxed at 25%. Crude oil is not on the list -China imports around 400,000b/d of US crude compared to 700,000 from Iran- but oil products like petrol and diesel fuel are, so Chinese demand could drop. Note, however, that China is a net exporter of oil products. The prevailing mood of anxiety and a reduced fall in US inventories coupled with a rise in product stocks sent oil prices down by 2-3%. But Brent crude still remained above $70, or the low end of our expected $70-80 price range. Note also that the EIA has reduced its forecasts for US oil output in 2018 from 10.79 million b/d to 10.7 and for 2019 from 11.7 million b/d to 10.8. Production in 2017 was 9.4 million b/d. 

  Corporate debt

 

Credit

In a quiet week of light summer holiday trading, there were enough buyers to help spreads tighten between Monday and Wednesday despite fresh worries over Brexit. The Xover contracted by 5bp. But the trend reversed on Thursday due to rising tension between the US and China. The move accelerated on the Friday, especially in financials after an FT report said the ECB was worried about bank exposure to Turkey, especially at BBVA, UniCredit and BNP Paribas

Casino/Rallye’s shares and bonds had a bad week following a research report from Bernstein which slashed its target price, citing Casino’s poor relations with its French franchises. Casino denied that there was any impact on its cash flow. 

New Look (Ca/CCC, global clothing retailer) saw its bonds rise sharply after better figures. Sales were down 2.7% but EBITDA rose 1.5% thanks to cost savings. Japanese telecoms operator SoftBank (Ba1/BB+) released upbeat results (+4% in sales and +2.8% in EBITDA) while UPC Holdings disappointed with sales down 6.9% and EBITDA 14.8% lower on pricing pressure in Switzerland. Auto and industrial parts maker Schaeffler (Baa3/BB+) posted satisfactory figures with sales up 2.1% and EBITDA 2.6% better but suffered negative currency effects. 

A profit warning from AP Moller-Maersk (Baa2/BBB) due to higher fuel prices and lower freight prices had only a limited impact on bond spreads at CMA CGM and Hapag Lloyd. Higher sales and EBITDA at Hapag Lloyd were down to its merger with UASC but on a like-for like basis the group actually lost €100m. 

Convertibles 

Trading was muted amid earnings reports and due to the summer holidays. There was only one new deal. US software company Rapid7 raised $200m over 5 years at 1.25% for working capital and general corporate purposes. 

In the rest of the news, Germany’s Brenntag (industrial chemicals) reported a 12.2% YoY increase in sales to €3.2bn, or slightly above consensus, thanks to overall contribution from all three main regions (North America, Asia Pacific and the EU). Switzerland’s Glencore (mining and commodities trading) had a record first half with a 23% increase in EBITDA to $8.3bn (albeit below consensus) and strengthened its balance sheet after reducing net debt by 16% since the end of 2017. 

In the US, following a tweet from Elon Musk saying he was considering taking his electric carmaker company private at $420, Tesla jumped more than 10% (previously the FT had reported that Saudi Arabia’s sovereign wealth fund had taken a $2billion stake); the stock ended the week back around $352, a 1.23% gain over the last 5 days. 

In Asia, property developer China Evergrande Group jumped more than 36% on the back of an exchange filing where it said it expected after-tax net profit to increase by more than 125%. It also announced that it was considering paying a special dividend of 50% of accumulated distributable profits since 2016. In Japan, Kansai Paint disappointed investors with recurring profit down 14% YoY to JPY 9.3bn on high input costs. The shares lost 5%.

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