OPEC falls short of investor hopes

Market analysis - 5/26/2017

With trading relatively quiet, European markets were flat overall. However, emerging countries rose by close to 1% and US markets actually hit fresh highs.

Global growth momentum continued. ISM confidence indicators suggested activity was still on a favourable trend. This was particularly true in Europe, where PMI data hit a level not seen since 2011 and it was the same story for Germany’s IFO readings. With this optimism spreading throughout the eurozone, we believe the cyclical upturn is sustainable. Elsewhere, the much-awaited OPEC summit extended production cuts to March 2018. In theory, this was good news but markets were disappointed as they had been banking on the size of cuts being increased. Hence the profit taking when the news broke.

But taken together, all these factors will underpin developed country growth rates and keep them on track. The FOMC minutes quite logically reaffirmed that rates would soon rise again. Markets now expect a move in June. The minutes also indicated that the USD 4,500bn Fed balance sheet might begin to shrink at the end of 2017 or early in 2018, albeit at a very slow pace due to ongoing rate rises. Long bond yields edged lower on the news, wiping out last week's rise.

We remain upbeat on equities. With today’s solid cycle and encouraging company results, we believe eurozone equities still offer the best risk-return profile for the rest of 2017 even if we may witness some short term volatility. After years of underperforming, the zone has still not finished catching up. On bond markets, we remain cautious over core eurozone country debt but have maintained yield curve steeping strategies in the US and in Europe. We have also maintained our corporate debt and convertible bond positions.

  European equities

European markets ended a quiet week almost flat. Even so, M&A deals continued apace. Swiss chemicals group Clariant and Huntsman unveiled a USD 13bn all-share merger between equals. The deal is primarily a quest for size as Clariant only expects USD 3.5bn in value creation, or 25% of its current capitalisation.

Elsewhere, the Zodiac/Safran saga appears to be close to ending. Zodiac has received a 100% cash bid at EUR 25€/titre (or less than the EUR 29.47 made in January). Zodiac’s family shareholders and the boards of both companies have already approved the deal. If Safran decides to walk away, it will have to pay EUR 150m to Zodiac providing all other conditions have been met.

But if Zodiac issues another profit warning, Safran can cancel the arrangement. Pressure is mounting on AkzoNobel. On Thursday, the Dutch Enterprise Chamber heard investors who were worried about Akzo’s reluctance to discuss a bid with PPG and will decide on May 29 if an EGM should be held. A hostile bid must be made before June 1st but PPG's CEO now say that it could be extended by 2 weeks depending on the Enterprise Chamber's decision.

Vivendi’s CEO said the group was mulling listing a minority stake in Universal Music. China’s Tsinghua bought 3.2% of Dialog Semiconductor last week and has reportedly gone to 4.2% this week.

In other headline news, Nokia said it had settled all intellectual property disputes with Apple and signed a patents agreement covering several years. The details are confidential but Nokia will receive an initial cash payment and additional royalties throughout the duration of the agreement. The disputes have, in fact, been settled faster than analysts expected.

LafargeHolcim says Sika’s CEO Jan Jenish, who has an excellent track record, will replace Eric Olsen as CEO from October 16. The news sent the stock 7% higher.  

  US equities

US indices closed at fresh highs with the S&P500 up 2% over the last 5 trading sessions on a strong showing from tech stocks and industrials. However, energy sector stocks fell back 1% after the OPEC summit decision.

May’s PMI data were in line with manufacturing at 52.5 and services at 54. New home sales in April were disappointing but March was revised slightly higher. The FOMC minutes showed almost all members were in agreement about holding fire on an interest rate rise if the early 2017 slowdown proved to be more than fleeting. They also agreed to start reducing the Fed’s balance sheet at the end of the year, albeit very gradually.

Results from Toll Brothers (a luxury home builder) beat expectations. Management said they had registered the best spring sales in 10 years. They also managed to improve gross margins despite pressure on building costs throughout the industry.

After a few disappointing quarterly reports from retailers last week, the sector rebounded thanks to beats from Best Buy, Sears and PVH (the holding company which owns Calvin Klein and Tommy Hilfiger).

  Japanese equities

Over the week, the TOPIX gained 1%, turning high on Wednesday following the advance in US equities. It then rose for two days in a row. Institutional investors increased purchases of undervalued stocks such as companies with brisk earnings estimates. Domestic demand related stocks unlikely to be affected by currency fluctuations were also buoyant and gains in heavily-weighted index components like SoftBank Group helped the Nikkei225 advance. However, the market rise came to a halt when the yen stopped weakening against the US dollar.

By sector, the best performers were Other Financing Business (+3.9%) and Electric Power & Gas (+3.4%). Toshiba Corporation jumped 11.5% on the news that Western Digital had offered JPY 2 trillion for its Toshiba Memory subsidiary, the world’s second largest producer of NAND flash memory chips.

SoftBank, the mobile phone carrier, advanced 5.4% on the news that it had acquired a stake in US chipmaker Nvidia. Other major winners included the world’s No.1 comprehensive motor manufacturer Nidec Corporation, the internet services company Rakuten and the game-maker Nintendo

In contrast, Oil & Coal Products (-0.9%) and Air Transportation (-0.8%) dipped. Japan Airlines (-3.0%) and Sumitomo Metal Mining (-2.2%) were all weak.

  Emerging markets

Emerging markets moved higher over the week, partly due to US dollar weakness but other factors also played a part. For example, S&P upgraded Indonesia’s sovereign debt. Unlike Fitch and Moody's, the agency had stopped short of giving the country an IG rating - a position held since 1997 - but has now gone from BB+ to BBB-, citing lower deficit risks and improved fiscal policies. Indonesia’s currency and stock market rose on the news and yields on the country’s 10-year debt fell. This should add weight to the scenario of gradually improving growth in 2017. The first quarter saw GDP rise 5% and we expect to see an average of 5.2% over the full year. As we saw with Hungary and Romania, markets in recently upgraded countries tend to do well in subsequent months.

In Brazil, macroeconomic indicators were upbeat despite political turmoil. April’s current account posted a USD 1.2bn surplus, up from 0.4bn a year before mainly because of the trade balance. The capital account showed a USD 2.7bn surplus due to USD 5.6bn in direct foreign investment.

Elsewhere, MSCI and China’s domestic stock markets are blowing hot and cold over the possible inclusion of Shanghai and Shenzhen in the MSCI indices. A June go-ahead for a 2018 roll-out seemed unlikely a few days ago. But now China is pushing to use Connect, the Hong Kong-mainland China investment channel as an initial step with a possible 5% weighting in the MSCI emerging market index. In the end, China could represent 30% and even 40% in the index as the domestic Chinese market represents USD 6,500bn compared to Japan’s 5,500. We are not there yet but China is applying the pressure.

Rumours in Taiwan and South Korea suggest the future iPhone launch could be delayed. Press reports say Taiwan Semiconductor Manufacturing, which makes the A11 processor for the new model, is undergoing quality issues. The company is reportedly still not satisfied with the processor after three mass production trials. The new model might be delayed by 2 or 3 months and only emerge at the end of 2017.  The company appears to be denying the allegations and says production is in line with expectations. It expects to turn out 120 million processors this year.


There were high expectations for OPEC’s 172nd meeting on May 25 in Vienna. In the end, the summit decided to extend the November 2016 production cut that came into force on January 1st 2017, viz. a 1.17 million b/d cut to 32.5 million b/d for OPEC members and a 558,000 b/d reduction for others, mainly to be borne by Russia. This has now been extended by 9 months, a decision that the market had largely discounted by sending oil prices USD 4 higher in the two weeks preceding the meeting.

Profit taking set in after the news and oil slipped back by USD 2.5-3 to end the week at USD 51 for Brent crude and 48.5 for WTI. This was because some investors had been expecting an increase in the size of cuts and/or the inclusion of a new, non-OPEC country.

At any rate, the reaction looks overdone to our eyes:

1/ the extension is good news and will provide visibility up to March 2018. That will take the measure to15 months in all although it could be extended again if necessary (an additional 3 month option was on the table) so as to bring global OECD inventories back to average levels seen in 2012-16.

2/ high compliance with cuts -111% in April, 110% in March - shows that OPEC is going beyond its initial promises so we should put any fears of US output accelerating into context. According to the IEA, the market is now balanced out.

We are reaffirming our positive take on oil as fundamentals should improve significantly in 2017 as global inventories fall sharply. Weekly US Department of Energy data support this view as they show crude inventories fell by 4.4 million barrels, the 7th down week in a row.

In base metal news, iron ore prices stabilised at USD 60/t. Trader sentiment is still mixed due to liquidity tightening measures in China and high inventories in ports but fundamentals seem to be improving: Chinese demand for steel is still rising, steel prices and margins are improving and steel and iron ore inventories in steel works are at record lows. Note that major sector players like Rio, BHP and Fortescue appear unconcerned by any possible Chinese slowdown.

  Corporate debt


The high yield market was flat with the Xover and iTraxx Main hovering around 250bp and 60bp respectively. Apart from Peugeot’s EUR 100m tap on its 2024 maturity (which initially raised EUR 600m), there were no new deals. In financial debt, Crédit Mutuel Arkéa raised EUR 500m with senior non-preferred Notes.

Company results were encouraging. Selecta Group (Caa1/B) saw sales rise 3.1% to EUR 180m and a 27.7% jump in EBITDA. This followed on from strong performance at the end of 2016 but the group now has to integrate Pelican Rouge and show it can generate synergies. BUT (B2/B) posted better-than-expected results with like-for-like sales up 2.7% and all segments, whether white, brown goods and online sales, higher. EBITDA edged 0.8% higher but this was a pleasant surprise given January sales promotions and marketing and logistic efforts. Loxam (BB-) also reported excellent results thanks primarily to a rebound in French construction. Like-for-like sales rose 11.8% to EUR 297m and EBITDA jumped by an impressive 27.5%. However, due to investments in its fleet, the company’s free cash flow should remain negative for the second quarter.

Europcar (B1/B+) is acquiring Buchbinder, Germany’s leading low cost car and van rental company (EUR 200m in sales in 2016). The deal should represent five times EBITDA.


It was a busy week for new convertible issues across all regions with 5 new deals totalling approximately USD 2.2bn. It seems we are getting back into normal issuance momentum following the end of the first quarter results season. Three of the 5 deals came from repeat issuers:

- ServiceNow (US software company) offered USD 750m (+ plus a greenshoe of USD 112.5m) in 2022 Convertible Notes with a zero coupon and a 32.5% premium. The company plans to use the proceeds to retire the existing 2018 zero coupon convertibles, hedge transactions and buy back up to USD 100m in common stock.

- Impala Platinum (South African mining company) issued a dual tranche (USD and ZAR) convertible bond with a concomitant repurchase of their existing dual tranche 2018 convertibles. The total issue size will not exceed USD 450m (the coupon of thuds-denominated CB will be around 3.25% for a premium of 32.5%).

- PRA Group (US Financial services) issued USD 300m (plus a greenshoe of USD 45m million) in 2023 CBs with a 3.5% coupon and a 35% premium. The proceeds will go on repurchasing around USD 45m in shares and repaying its outstanding revolving credit facility.

The other two deals, from the US and Europe respectively, were:

- LendingTree, an online mortgage origination business, which issued a 5Y, 0.625% coupon CB with 32.5% premium. The net proceeds will be used for hedging together with general corporate purposes “not limited to working capital and potential M&A operations”; and

- GN Store Nord, a Danish manufacturer of wireless hearing aids and headsets, which sold a EUR 225m, zero coupon, 5y maturity CB (40% premium) and intends to use the cash to refinance existing debt facilities, repurchase shares and finance growth opportunities.


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