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Onwards and upwards

Market analysis - 8/24/2018

Equity markets moved higher in a quieter week. The US-China trade talks were described as “constructive and frank” or in other words, ‘we haven’t yet reached a deal but at least we’re talking’.

The FOMC minutes suggested rate hikes would continue as initially planned, i.e. with no increase in pace despite the buoyant US economy, maintaining a rather favourable environment for markets. 

However, the Fed also stressed that the global economy would be at risk if trade conflicts were to intensify, a stone in Donald Trump's garden. The US president also resumed attacks on the Fed, sending the US dollar slightly lower and commodity prices a little higher. 

The equity market rebound resulted in bonds falling very slightly after a fortnight of safe haven status. Recent market falls helped us reshuffle our options hedging so as to tactically increase equity exposure. 

  European equities

Indices rebounded ahead of US-China trade discussions and thanks to the Turkish lira stabilising. Manufacturing PMI were practically in line with estimates. 

Autos and suppliers nevertheless fell sharply after Germany’s Continental issued its second profits warning in four months. The group has revised sales, earnings and free cash flow lower for 2018 due to sales falling short of expectations, higher costs and guarantee claims. The sector is now almost the worst YTD performer, just behind banks.

But buoyant oil prices lifted the oil sector across the board. Saipem also gained on new offshore contracts in Guyana and the Congo. 

Atlantia continued to fall after Rome officially engaged a procedure to strip the group of its Italian concessions. The fate of the group’s shares and bonds now hangs on the details. Will all or part of the concessions be cancelled and will indemnities be paid? The degree of responsibility for the bridge’s collapse will also count. 

Elsewhere, faced with a simultaneous pilots strike in Ireland, Germany, Belgium, Sweden and the Netherlands, Ryanair reached an agreement with unions and the stock rebounded sharply. Altice also performed well on news it was mulling a split bid for football rights with a separate deal for people with no SFR subscription. Vinci acquired the US asphalt business of Salini Impregilo for $555m, doubling its presence in the country. 

  US equities

In a good week for equities, the S&P gained 0.6% and the Nasdaq 0.8%, taking their YTD gains to 7% and 14% respectively. Trading remained thin, however, with volumes 25% lower than in recent months. With no major macroeconomic news and little of microeconomic interest, investors focused on the FOMC minutes and recent developments in the US-China trade conflict. 

The minutes hit a relatively hawkish note with the Fed stressing excellent momentum in the domestic economy. A shift in its forward guidance looks more and more likely. A number of FOMC members think the accommodating monetary policy formula should soon be abandoned. The bank also warned on the risks from any prolonged trade war, citing possible consequences like lower household purchasing power, disruption in the supply chain and a drop in US corporate productivity. 

Energy led gains over the week due to a fall in US oil inventories. Retailers rose on upbeat quarterly reports from Target, TJX and Lowe’s. In healthcare, Medtronic jumped 5% when its results beat estimates. But utilities, telecom and consumer staples fell by 1.5%, 1% and 0.9% respectively. 

  Japanese equities

The Japanese equity market stopped retreating and the TOPIX edged up 0.04%. The second round of the US-China trade war, with each side slapping an additional 25% on import duties, had no immediate impact on shares as the moves had been discounted. However, by market-cap, small and midcaps significantly underperformed primarily due to selling by foreign investors including hedge funds. 

By sector, Oil & Coal Products rose 4.10% with JXTG Holdings jumping 6.02% on better margins due to higher oil prices, while Other Products rose 3.12% led by Nintendo (+5.53%). Fast Retailing climbed 6.02% on reports that it intended to increase the number of stores in Asia & Oceania.

On the other hand, three major telecom stocks, KDDI, NTT DoCoMo and SoftBank Group, sank 5.29%, 5.07% and 4.34% respectively after Chief Cabinet Secretary Yoshihide Suga pointed out that their service charges were making huge profits and needed to be substantially reduced for the benefit of customers. He suggested more deregulation to promote competition. 

  Emerging markets

Despite increasing volatility, the MSCI EM index bounced 2.5%, led by China, Mexico and South Africa. 

Chinese companies generally presented a good set of second quarter results. Wuxi Biologics reported revenue and net profit growth of 61% and 171% (above first half guidance). The outlook for the second half is also positive as well: management announced 26 new integrated projects, or more than the 20 expected. Alibaba reported strong top line growth of 61% YoY with core commerce up 61%, digital media 46%, cross-border e-commerce (LazGlobal) 64% and cloud 93%. Net income increased 33% (excluding a one-time share based compensation expense relating to Ant Financial’s awards to employees). Adjusted EBITDA fell from 47% to 33% due to strategic investments in New Retail, Cainiao and Ele.me. Alibaba’s guidance for 2019 remained unchanged. PingAn reported strong life assurance growth, with market share gains. Agent headcount also increased. 

On the macro side, policymakers said that they were considering lowering risk weightings for government bonds held by banks from 20% to 0%. This would encourage banks to hold more local government bonds.

In Brazil, IPCA-15 inflation rate for August was higher than expected, with core inflation accelerating to 3.6% (but well below the mid target of 4.5%), mainly due to food outside home. Brazilian stocks plunged 5% during the week on mounting uncertainty over the election outcome after the latest poll put former President Lula at 39%. In Mexico, retail sales in June rose by a robust 3.7%, or more than the +3.4% expected. The market expects a NAFTA deal between the US and Mexico to be announced next week.

Russia’s banks came under heavy pressure from Donald Trump’s comments on new sanctions. In Argentina, Supervielle had a significant miss in the second quarter, with results coming in 50% below market consensus due to a sharp NIM contraction. 

We remain cautious on emerging market prospects over the short term. 

  Commodities

Last week’s rapid move higher from the US dollar (DXY at 97 and 1.13 against the euro) triggered a correction in commodity prices. Commodity traders accentuated the movement, closing positions in oil, oil products, gold and precious metals. For WTI, it was the second biggest closing out of long positions since 2006 while COMEX gold shorts were also at their highest since the same year. For gold, it was the first net short position since 2001. Typically, these excessive moves should not last, at least not unless sentiment deteriorates. 

This week’s fallback in the US dollar helped these commodities rally with Brent crude returning to $75, the middle of the $70-80 trading range since April, while gold moved closer to $1,200/oz. The yellow metal has nevertheless been trending lower since mid-June and has failed to act as a safe refuge due in part to COMEX selling by traders and ETF sales by investors. But Venezuela's problems- massive inflation and its recent devaluation- and Turkey’s less acute problems are a reminder that gold is still a foreign reserve asset and is unlikely to be replaced in this role by Bitcoins and other cryptocurrencies. 

Note also that Russia’s central bank stepped up gold purchases in July, acquiring 26.1 tonnes, its biggest monthly purchase since November 2017. The bank now holds 2,10 tonnes. For the first time, Russia’s gold reserves amount to more than its US dollar holdings. 

In news on oil fundamentals, US weekly inventories fell, helping prices rebound. The big news concerned Iranian exports.

Tanker movements from Iran show that exports for the first fortnight in August came to 1.68 million b/d, or 640,000 less than in July. Exports to India slowed markedly. 

  Corporate debt

 

Credit

The market gained ground with the Xover tightening by 17bp between Monday and Wednesday on hopes for a new round of US-China trade talks. Peripheral debt outperformed on Tuesday after Moody’s pushed back its report on Italy's credit rating from end August to end October. On Thursday, however, fresh tension between both countries and slightly disappointing European data weighed on sentiment and spreads widened. 

Bonds issued by Atlantia (Baa2/BBB+) fell further at the start to the week after Rome said it was officially looking to rescind concessions held by the group’s subsidiary Autostrade (Baa2/BBB+). But prices rebounded slightly on Wednesday on news that the state-owned Cassa Depositi e Prestiti (CDP) might buy a controlling stake in Autostrade. 

The new issues market in senior financial debt was very busy. Numerous banks like Intesa Sanpaolo, Belfius Bank, Commerzbank and Deutsche Bank issued Senior Preferred debt. Rabobank sold its first Senior Non Preferred bond, a 5-year maturity at 0.75% which raised €1bn. And Bank of Ireland Group raised €750m with its first Senior (Hold Co) bond with the same maturity but at 1.375%. 

Convertibles 

Concerns in the previous week saw investors return to risk-off, but things improved this week. The S&P500 hit an all-time high on Tuesday on its way to a record bull run, and the VSTOXX fell back below 13.5%. 

It was a busy week with two new deals for more than $1.3bn. Mercadolibre operates a leading online shopping site for Latin American markets, with Brazil, Argentina, Chile, Colombia and Mexico producing the most revenue. Online shopping is just 3% of total retail spend in Latin American markets compared to 19.6% in China and 13.3% in the US. The company raised $800m over 10 years at 2% to repurchase its 2019 2.25% convertible. On the same day, Cree in the US raised $575m over 5 years at 0.875% to repay a revolving loan. Cree makes and develops LED and semiconductor products for power and radio frequency applications. Both deals were priced at best.

Elsewhere, the Illumina 2023 (issued in the previous week), continued its incredible run on the back of strong demand. 

In other convertible related news, Exact Sciences rallied 39% this week as the company announced a co-promotion agreement with Pfizer on its colon cancer test Cologuard. Rallye announced that it would redeem a €370m exchangeable into Casino shares in cash in October as investors exercised the put option.

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