Traders brush off the Brexit deadline extension

Market analysis - 4/12/2019

The headline event in Europe was Brexit being postponed to October 31 at the latest. The agreement will prolong uncertainty but at least there is no short-term risk of a no-deal exit.

The April 10 ECB meeting left interest rates unchanged. Mario Draghi’s tone was even more cautions than when the bank’s economic scenario changed direction. Manufacturing continued to struggle because of worsening global demand while services gained from resilient domestic demand. Growth in the eurozone in 2019 is now estimated at 1.1%. September’s TLTRO conditions might be even more favourable than expected in an attempt to offset the impact of negative interest rates on banks and thus their capacity to finance the economy.

Beijing’s stimulus measures aimed at households, notably lower income tax for 2018, helped stop Chinese consumption falling further. And, faced with the economic slowdown, other measures like lower VAT will continue to boost consumer spending.

China’s first-quarter GDP is due for release on April 17 and expected to be slightly lower. However, the Caixin manufacturing PMI came in at 50.8, moving back into expansionary territory for the first time in 3 months. A resilient Chinese economy will reassure investors on global growth and especially Europe which is particularly exposed to exports to Asia.

All eyes will now turn to US quarterly earnings announcements, especially banks like JP Morgan and Well Fargo, the first off. They will be followed by Goldman Sachs and Citigroup. Analysts will be scrutinising any negative impact on margins due to higher wages and also production costs (up 2.2% YoY in March). So far, companies have maintained margins thanks to tax reform and a bounce in productivity. The Fed has been astonished not to see higher costs being passed onto consumers and therefore onto price inflation.

Despite excellent visibility on the fundamental environment and strong central bank support, investors should remain cautious on equity markets. Technically, they are looking a little vulnerable after the rebounds seen in the first quarter. 

  European equities

The outlook worsened: the IMF cut its global growth forecasts from 3.5% to 3.3%, US negotiators said there were still sticking points with China and concerns rose that Washington might impose new customs tariffs on European exports to the US. However, Mario Draghi lifted market sentiment by saying that the ECB would remain accommodating due to slower growth. The decision to postpone Brexit had little impact on markets.

In company news, Airbus initially rose when Boeing said it was cutting production of its 737 Max model but the stock was then threatened with US customs retaliation after Washington accused the group of receiving subsidies from Europe. Safran, which is heavily exposed to the 737 MAX, fell sharply. SAP was another casualty this week after the head of its cloud division left; this followed on from the departure of its chief technical officer last month. After losing the Roundup case in the US, Bayer was deemed responsible by a French court for harm caused by another of its weed killers. Prysmian fell after revising its objectives lower due to new incidents in the Western Link submarine project. Siltronic’s profit warning ultimately had little impact on the semiconductor sector.

LVMH rose sharply after beating expectations thanks, once again, to its fashion and leather goods division. The entire sector gained on the news. The new Brexit postponement lifted airlines. Lufthansa also unveiled a 4.4% rise in passenger traffic in March. Worldline gained on rumours that it might join some indices after the deal with Atos. Unibail signed an agreement to sell the Majunga tower for €850m.

  US equities

In quieter trading, US equities pushed higher with the Nasdaq gaining 0.7% and the S&P500 adding 0.3%. Investors were in cautious mood ahead of first quarter results. Yields on 10-year Treasuries were stable at around 2.5% following the FOMC minutes and the ECB meeting.

Energy was the best performing sector, rising 1.3% as WTI and Brent crude hit fresh YTD highs. Technology followed (+0.9%) as IPOs performed well on the secondary market and lifted sentiment.

Laggards included healthcare (-0.8%) with managed care organisations like Humana and Anthem both tumbling 5% on Washington’s determination to increase pressure on drug pricing and reimbursement schemes. Industrials slipped 0.7%. Boeing was one of the week’s worst S&P performers, down 6.5% after cutting its expected deliveries of the 737 MAX model from 52 to 42 a month. In contrast, Exploration & Production stocks like EOG (+5.5%) and Apache (+6.8%) were boosted by higher oil prices. The focus will now be on first quarter results with major banks expected to report shortly. 

  Japanese equities

Japanese equities moved slightly after the IMF’s downward revisions in global economic growth and on rising concerns over US-Europe trade frictions following comments from Donald Trump. However, declines were limited and competitive names were relatively firm. The TOPIX shed 1.18% over the week.

Economy sensitive sectors such as Oil & Coal Products, Precision Instruments and Electric Appliances were relatively firm on expectations for a recovery in China. Sony gained 6.44% and Nidec and Shin-Etsu Chemical also advanced.  

On the other hand, Europe-related names with significant sales abroad were relatively weak. Domestic demand related sectors such as Banks, Securities and Construction also underperformed.

Investors remained on the sidelines ahead of results for FY2018 (to March 2019) and earnings guidance for this year, which is re expected to be cautious, but the market focus seemed to be gradually moving to economy sensitive sectors. After a ten-week hiatus, non-domestic investors turned net buyers of the market in the first week of April on China’s improved PMI in March. 

  Emerging markets

Chinese exports recovered much faster than expected, rising 14.2% in March (or much higher than the +6.5% expected), a sign of resilient global demand amid further signs of trade tensions. Trade talks between China and US reportedly added a concession on cloud computing to the final agreement that would give foreign companies greater access.

CPI also rebounded to 2.3% in March as expected versus 1.5% in February. Although better than market expectations, March’s retail auto sales fell by another 10.5%. Inventories fell to 1.5 months for certain OEMs. Geely this week unveiled Geometry, its stand-alone Premium EV brand with plans to launch 10 new EVs by 2025.

In Korea, first quarter duty-free sales climbed 26% YoY, with revenue from Chinese visitors up 34% and the cosmetics segment 45% higher.

India’s elections began and the exit polls are expected on May 19, followed by final results on May 23. Opinion polls that suggested a surge in support for the BJP-led NDA coalition between February and March now show a slight loss of momentum in April on the margins (by 5-10 seats). But polls still point to the NDA remaining in pole position to form a government (with ~275-300 seats vs. 272 seats required for a simple majority).

In Mexico, the highlight was Banco Santander Group’s offer to acquire all shares of Santander Mexico at a 14% premium. The news is reassuring for the Mexican banking sector given the lack of visibility on the regulatory framework.

In Brazil, February retail sales were slightly stronger than expected, up 3.9% YoY vs +2.9% expected. IPCA inflation printed at a higher-than-expected 0.75% in March, up from 0.43%, driven by food and transportation. The reform road remained very bumpy. The President of Congress indicated that there would be further delays before the vote. We expect this execution period to remain volatile. In company news, CCR held its investor day with the Governor of Sao Paulo in attendance and a positive message regarding contract amendments and leniency agreements.

In South Africa, Pick n Pay (retail) reported better-than-expected results. Same store sales rose 6% in the second half to March vs. +3.8% in the first half. The focus in the country is now on the May 8 elections.

We remain upbeat on emerging markets. 

  Commodities

Brent crude finally moved decisively above $70 after fresh tension in Libya between General Haftar’s army and the UN-recognised National Union government. The country’s oil output, back to highs of 1.1 million b/d after the main Sharara field restarted, is not necessarily in danger, unlike exports which transit through terminals close to the fighting. In the new monthly reports from the IEA, EIA and OPEC, demand growth was relatively unchanged at 1.4, 1.4, and 1.2 million b/d respectively but the IEA and OPEC see potential risks from the slowdown in global economic growth. Nor was there much change in non-OPEC production growth. US output is expected to rise by between 1.6 and 2 million b/d and represents 90% of non-OPEC production growth.

OPEC's efforts to reduce output remained significant. The cartel has cut by 550,000 b/d to 30 million, a 2.3 million b/d drop compared to last October. Saudi Arabia, Venezuela and Iraq were responsible for drops in March. As a result, markets tightened with a fall in OECD commercial inventories in February. The trend is expected to continue in the second quarter.

Futures, especially for Brent, are now in pronounced backwardation territory. Traders will nevertheless be increasingly focused on any extensions to dispensations from anti-Iran sanctions.

As Donald Trump has labelled Iran’s Guardians of the Revolution terrorists, the mood is getting tougher even if he will undoubtedly remain pragmatic and put any impact on oil prices first.

For the fourth month in a row, China’s central bank increased its gold holdings in March. They now represent 60.6 million ounces (1,886 tonnes) or 2.5% of the country's foreign exchange reserves. 

  Corporate debt

 

Credit

The Xover and Main tightened by 3bp and 1.5bp thanks to the Brexit postponement and the ECB’s persistently accommodating stance.

Levi Strauss & Co (Ba1/BB+) saw first quarter sales rise by 11% at constant exchange rates thanks to growth across most geographical zones. The group raised 2019 guidance slightly and expects single-digit growth and around 100 new store openings. Tesco (Ba1/BB+) posted better than expected 2018/19 results, with sales up 11.5%. Hema’s bonds lost as much as 14 points after fourth quarter EBITDA fell 17.9% and leverage rose to 6.6 times, up from 5.5 in 2017. But the bonds clawed back 6 points after the group highlighted its deleveraging plan. Standard Chartered is to pay a $1.1bn fine to end an embargo violation lawsuit in the US and money laundering charges in the UK. The bank had already set aside $900m so the fine will have little impact on the group's capital base.

The situation at wind turbine producer Senvion worsened and its bonds lost as much as 8 points on news that it was struggling to secure funding from creditors. The company has asked to be placed under court administration while it pursues its restructuring plan. OHL’s bonds lost 8 points after its former concessions branch, Aleatica, ended two major building contracts in Mexico worth €289m and €210m in its order book. On a more positive note, buyers returned to Dia after the board unanimously accepted a bid from LetterOne, its biggest shareholder.

In new issues, Ineos raised €770m over 7 years at 2.875%. The proceeds will go on refinancing its 2023 bonds with a first call in 2019. Orano sold a 7-year bond at 3.5 to refinance several bond tranches. Telecom Italia, which was downgraded by Fitch from BBB- to BB+ for failing to respect its leverage ratio at end 2018, raised €1bn over 6 years. The issue weighed on secondary valuations. The coupon, initially indicated at 3.375%, was slashed to 2.875%. Banco BPM sold its first AT1 but demand was soft and it only raised €300m at 8.75%. 

Convertibles 

Sacyr (construction and infrastructure concessions) raised €150m over 5 years at 3.75% and with a 35% premium to go on repaying its May 8 2019 convertible (€250m).

Prysmian (electrical components) remained mired in difficulties over the roll-out of its high-voltage direct current cable on the Western Link which provides Scottish renewable electricity to Wales and England. The company’s new technology has suffered multiple breakdowns and resulted in expensive repairs. The client has also asked for penalty payments. The group has postponed its AGM to revise its financial statements for 2018. The group’s securities lost 6.6% in one day and the convertibles, which had practically no delta left, shed 2 points to 93.13%.

Elsewhere, LVMH posted excellent results with first quarter sales up 11%, or better than the +9% expected. Once again the F&LG division led the field with sales up 15%, mainly due to Louis Vuitton. The news sent the stock more than 4% higher and also helped Kering gain 2%.

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