Waiting for the results period

Market analysis - 7/13/2019

Markets are still strongly influenced by central bank announcements. Jerome Powell’s statement this week at the House of Representatives was eagerly anticipated. He stressed the confirmation that uncertainties regarding global trade and the strength of economic growth were still in evidence, against a backdrop of a moderate inflation.

This position confirms a Fed interest rate cut in July. This was already clearly anticipated by bond investors, and long-term yields rose despite this dovish message. The 10-year German yield returned to levels reached prior to Mario Draghi’s speech in Sintra. The movement was more positive on the equity side.

US equities returned to their peaks, as the S&P 500 exceeded 3,000 points on a trading session, but failed to close above this level. In Europe, equities fell slightly over the week. The volumes traded on the markets were low. Given the levels reached, the rally is struggling to going on and investors are waiting to see what happens. Now that Jerome Powell has made his statement, earnings releases are the focus of attention. These will start next week in the US, and profits are expected to be slightly down this last quarter compared to those of last year. In Europe, some, mainly cyclical, companies (BASF and Daimler) have already issued profit warnings.

In these conditions, we are benefiting from the slight pressure on interest rates to add sensitivity, preferring 5 year maturities to longer ones (10 and 30 years). In terms of equities, we are continuing to be cautious and we believe that it is preferable to have convexity in the portfolio in view of the low volatility, by using options.

  European equities

The ECB confirmed the possibility of an interest rate cut in the near future in the minutes of its last congress. This prospect was not enough to buoy up European equities this week, which, however, were mainly affected by downward revisions of company earnings. Only the energy sector seems to hold up. The reasons have mainly been 1) the slowdown in activity, more specifically in the automobile sector, and 2) the impact of the trade war between China and the United States.

BASF announced, for instance, a 30% downward revision in its operating profit, the group being particularly exposed to the automobile sector, although other factors are also taken into account.

Further to the footsteps of BMW, Daimler released its fourth profit warning in the course of a year, citing reasons such as the impact of the vehicle recall due to defective Takata airbags, and the increase in expenses in response to the legal and government action on diesel (€1.6 billion). Hexagon's share fell sharply after it revised down its earnings, explaining that this was attributable to very weak demand in China in June, particularly for electronic components.

Deutsche Bank unveiled an aggressive restructuring plan, including 18,000 job cuts worldwide and cost-cutting of 25%, and other complementary measures. The banking group decided, for example, to close down the whole of its equity sales business within its investment banking arm. After they were warmly welcomed by the market, the bank's projections could prove to be somewhat optimistic and there was a subsequent correction in the share price. The German bank is also being investigated for its involvement in the Malaysian fund 1MDB.

UniCredit has permanently divested FinecoBank, which is now a wholly independent company. Relations between France and the US are becoming fraught. Donald Trump is threatening to retaliate following the vote on the draft law for the creation of a digital services tax, which was adopted this Thursday 11 July in France.

  US equities

 

The S&P 500 reached a new record high this week, exceeding the 3000-point threshold on Wednesday and during the trading session on Thursday. The US equity indices the S&P 500 and Nasdaq gained 0.32% and 0.71% (at closing on Thursday evening), supported by the message from the Fed's Chair, which continues to be highly accommodative. Jerome Powell, during his statement on Wednesday evening, in fact confirmed that interest rates would be cut at the next FOMC meeting.

Oil prices rose by 5% over the week, with Brent trading at more than $67 (WTI at $60) on Friday given the steep fall in oil stocks. The US Energy Information Administration (EIA) officially confirmed this trend on Wednesday, reporting that crude stocks plummeted by 9.5 million barrels during the week ended 5 July. A tropical storm also hit the Gulf of Mexico and seems to be heading towards the US coast, which may affect oil production offshore the Gulf of Mexico.

In terms of sector contributions, there was a wide disparity in performance between sectors this week. Energy gained 1.8%, supported by the rise in oil prices, followed by the consumer discretionary sector at +1.1%, while basic materials lost 1.8% and the industrial sector 0.5%, as they continue to suffer the effects of weak macroeconomic data and negative earnings pre-releases by European companies in these sectors. In the chemical industry, Corteva and Dupont shed 8% and 6% respectively following BASF's profit warning this week. The biopharmaceutical leading companies lost ground at the end of the week following press articles reporting the risk of adverse regulations that could now shift from insurance companies to pharma companies. Controlling healthcare costs continues to be a priority for the Trump administration, with the possibility of regulations governing drug prices that could be bad news for producers.

In the tech sector, semi-conductors performed well, as Western Digital and Micron made gains of 13% and 10% over the week after Samsung announced its intention to increase NAND memory prices by 10%.

  Japanese equities

The Japanese equity market started with a decline in response to strong US employment data which shrinked people’s expectation for a US rate cut, but rebounded on Thursday in favor of the FED Chairman’s congressional statement suggesting a policy rate cut. However, upside of stock prices was capped by concerns on JPY appreciation and investors’ cautious mood on potential disruption of supply chain in world semiconductors production. TOPIX edged down 0.88%.

Stock prices of the Japanese key materials producers, which are subject to be affected by the government policy on export restrictions to South Korea of three key raw materials for manufacturing memory-chip, were mixed. JSR (4185:photo resist producer) lost 4.16%, Tokyo Ohka Kogyo (4186: leading photo resist producer) rose 1.75%, and Stella Chemifa (4109: Hydrofluoric etching gas producer) lost 1.26%.These Japanese companies which Korean semiconductor manufacturers rely on have a high global market share in the field of the key materials - essential to produce semiconductors and displays.

By sector, Marine Transportation (-3.27%), Machinery (-3.05%) and Chemical (-2.18%) sectors underperformed while Mining (+3.99%), Oil & Coal Products (+2.89%) sectors outperformed partly due to rising tensions in the Middle East

  Emerging markets

Emerging markets were down 0.45% this week on mixed news on the political and macro-economic front. Both exports and imports in China declined slightly in June as expected while aggregate financing rebounded to 2.26trn CNY, much better than market expectation of 1.9trn CNY. Chinese auto manufacturers sales to dealers in June fell for the 12th straight month, by 7.8% YoY. On the other hand, retail sales of cars rose in June +4.9% marking the first increase in a year thanks to the heavy discounting by dealers’ clearing inventory.

On the company front, TSMC Q2 2019 sales beat expectations thanks to a strong rebound of 22% topline growth in June. Largan reported better than expected Q2 results with +20% YoY EPS growth thanks to better margins despite weak June sales dragged by Huawei issue.

As another spillover of the deteriorations of the South Korean/Japanese relationship, executives at Samsung Electronics and SK Hynix expressed concern to the South Korean government that chip plants could stop operations at the end of this month unless Japan withdraws export curbs. Executives said they have only 2-4 weeks of stockpiles for some materials such as etching gas. In parallel, DRAM spot price went up for the 1st time since December 2017 as a consequence of DRAM supply uncertainty from Japan's export controls and a shift in DRAM sentiment following change in NAND price. 

In India, Tata Consultancy Services reported quarterly revenue growth of 10.6% YoY, a slight slowdown compared to the previous three quarters. Growth was in part impacted by weakness in European banks, autos and retail. On the positive side, EBIT margin was resilient and order book was healthy, up 16% YoY.

In Brazil, another important milestone was achieved with the adoption in first reading by the Congress of the social security reform. Market was expecting the vote to start in September. This earlier than expected vote outcome is clearly indicating that (1) the reform momentum is moving in the right direction and (2) Brazilian Government has the political strength to pass relevant economic reforms in Congress. In terms of the range of savings expected by the social security reforms, this has also been revised upward R$850mn-950mn in the next 10 year vs (R$700-800mn).

Positive economy data came out in Argentina with industrial production expanding 0.6% MoM in May, reaching a level of 6.1% above the cyclical bottom in December 2018. Moreover, construction activity expanded 2.3% MoM in May, more than offsetting the contraction in April (-0.3% mom sa).Finally in Mexico, the Minister of Finance resigned and evidenced strong differences within the Cabinet, casting some shadow over the independence of the Ministry of Finance within the government.

  Commodities

Oil prices ticked up this week, by nearly 4% for Brent and 5% for WTI, bringing them to levels seen in March and at the end of May (67$/b for Brent and 60$/ for WTI). While the recent weakness has been driven by fears about demand (fears that have seen the specialised agencies reduce their oil demand growth expectations for 2019) the rise in recent days shows that the market has not forgotten that there are still pressures on supply. This is reflected in the sharp drop in weekly stocks in the US (note that at the start of the year there was a considerable rebuilding of stocks and the situation is beginning to normalise). Hurricane season, which has just begun in the Gulf of Mexico, with tropical storm Barry, is a further cause for concern about short-term supply. A third of production (600kb/d) has been suspended for the time being, as a preventive measure. History shows that the scope of these weather phenomena, and their impact on production, are impossible to predict. History also shows that these events, linked to climate change, are intensifying, despite President Trump's views. Finally, the rising tensions in the Persian Gulf, with the recent attempt by Iranian vessels to block a BP tanker, add a psychological dimension. Note that the members of OPEC decided at the start of the month to extend the agreement to reduce production to the end of March 2020. The cartel's output fell again in June, by 130kb/d to 30Mb/d, while production in Venezuela continued to drop, and reached 734kb/d in June, its lowest level in 16 years, whereas its output was 2.4Mb/d in June 2015.

  Corporate debt

 

Credit

The week was marked by Jerome Powell's message to the Congress, in which he reiterated the fact that the uncertainties regarding international trade are a continued drag on the economic outlook in the US. Such statements strengthened expectations of monetary policy easing from the end of July.

The positive US employment and inflation figures, beating consensus expectations, prompted a sell-off on the bond markets. The German 10 year yield tightened by 15bps to -0.21%. The Xover and the Main did not change over the week at 245 and 50bps.

Capital flows are still very much focused on Investment grade and High Yield bonds, with an inflow of €1bn and €960m respectively over the week, representing €12.5bn (5.8% of total assets) and €5.8bn (8.6% of total assets) year to date.

As expected, Deutsche Bank (BBB+) announced a wide-reaching restructuring plan, with 18,000 job cuts (20% of its workforce) and changes within its senior management team. The execution risk is high given the plan's scope.

Suedzucker (BBB-) disclosed earnings that dropped sharply in the first half of 2019, as they were still affected by the low prices agreed to in Europe.

Moody’s revised the outlook for Telecom Italia from stable to negative. The agency believes that its branch TIM will continue to operate in a highly competitive environment with high leverage, despite the management's strong commitment to deleveraging.

On the primary market, FinecoBank issued a EUR 300m PerpNC5 AT1 bond (BB-) at 5.875%, which was very well received by the market, with more than EUR 2.5bn in the order books. The National Bank of Greece returned to the markets, issuing a EUR 400m 10NC5 Tier 2 (CCC) bond at 8.25% (versus a price indication of around 9.0% at the start of syndication).

Convertibles 

Unusual activity over the week on the CB market with valuations surging after another dovish message from the FED’s Chairman. Since the 4th July, with companies in blackout period just before earnings, primary markets was less active. We just saw Malaysia’s sovereign wealth fund, Khazanah Nasional Berhad, selling $500M zero coupon exchangeable convertible bond into the Malaysian Bank CIMB (5Y with put option 3Y and premium offered at 15% to 20%). In the rest of the news, worth noticing the 2019 outlook cut from BASF; the German Chemical company Is lowering targets on sales / EBIT amid slowdown in global economic growth and industrial production, mainly due to the trade conflicts. In the US, Illumina (life science equipment) pre-announced its Q2 revenues at $835 million (more than $50 million below consensus); and announced its growth guidance to 6% (from 13-14%) mostly driven by lower than expected revenue from population genomics initiatives. 

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