Central banks remain in focus

Market analysis - 7/28/2019

Central banks once again remained centre stage. Judging from falls in the euro and European sovereign bond yields, investors were clearly expecting big developments over the week. And yet the ECB meeting raised more questions than answers.

True, the ECB confirmed that it was worried about growth rates, and inflation in particular, including inflation expectations. This led to a significant shift in communication so as to showcase the bank’s determination to introduce fresh easing from September onwards. Significantly, and rather like the Fed, Mario Draghi once again referred to a symmetrical inflation target, i.e. one which could leave inflation to overheat. The goal is to avoid inflation expectations running out of control.

However, the bank gave little detail on its easing options (fresh asset buying programmes, measures to mitigate the effects of falling rates on banks, etc.).

As recent eurozone advanced indicators are still trending lower, a rate cut in September looks like the most probable scenario.

Meanwhile, markets will remain on hold ahead of an almost certain cut from the Fed at its July 30/31 meeting. What is clear is that bond and equity market positioning leaves little room for investors to be disappointed.

  European equities

Markets brushed off the IMF’s downward revisions to global growth and worrying German IFO and manufacturing PMI data to hit new multi-year highs. Sentiment was buoyed by generally upbeat results and the ECB's accommodating stance. Rotation into cyclicals continued. Investors treated warnings in the overlooked autos sector as good entry points. Continental slashed 2019 guidance based on a 5% drop in the market and its stock surged after the results!

Markets reversed after Thursday’s ECB meeting when Mario Draghi hinted that easing did not have unanimous support on the board and sounded a more cautious note over the eurozone’s industrial outlook.

Like-for-like growth has been rather reassuring for Europe’s companies amid no sign of a marked downturn overall. Surprises have been positive on average with a particularly robust showing from the consumer sector. Unilever, and especially Danone, posted an improvement in like-for-like growth in the second quarter. Large luxury groups enjoyed strong growth but with varying momentum. Kering said Gucci's growth had slowed due to tougher competition while LVMH saw its leather goods and fashion divisions accelerate. Pharma continued to enjoy strong growth with Roche, Novartis, GSK and particularly AstraZeneca all clearly reflecting a favourable innovation cycle. In technology, Dassault Systèmes saw like-for-like growth accelerate to 10% in the second quarter, 2 points higher than expected by the consensus. In oil services, there were also beats from Technip, which announced record order book levels, and Vallourec whose EBIDTA came in significantly higher than expected. The few disappointments triggered heavy selling. Tarkett fell out of bed after a fresh profits warnings, Atos released poor free cash flow figures and said business was continuing to contract, especially in the US, STM gave lukewarm guidance for 2019 and JC Decaux disappointing guidance for the current quarter despite an upbeat first half. Elsewhere, the Private Equity Advent fund launched a bid on Cobham.

  US equities

The S&P stayed above 3,000 as the results season moved into full swing and ahead of the much-anticipated Fed meeting on July 30/31. 10-year US Treasury yields were unchanged at 2.07% and WTI oil remained around $56.

Defensive plays saw profit taking with utilities down 2.5%, and both healthcare and consumer staples down 1%. Cyclicals led gains. Industrials rose 2.1% and technology was 1.3% better due to a 4.4% rise in the SOX semiconductor index. Texas Instruments jumped 7.5% after beating expectations. Google surged 8% after the Thursday close due to a $25bn buy programme and an acceleration in its Website division's growth. In pharma, Bristol-Myers also beat expectations and revised full year guidance higher.  

  Japanese equities

Elections for the upper house of the bicameral National Diet on Sunday 21 July were a non-event. Tailwinds included the yen weakening to 108 against the US dollar (positive for exporters), US-China trade hopes, and a recovery in sentiment towards semiconductor stocks. Geopolitical uncertainties in the Middle East resurfaced after a British tanker was seized by Iran but, ahead of April-June earnings, there was no real will to bet on either direction. The best performing sectors included marine transportation, metal products and electric appliances while pharmaceuticals, fishery, agriculture & forestry and foods lagged.

After the closing on 24 July, Softbank Corp. (9434) (i.e. the communications subsidiary of Softbank Group (9984)) announced its intention to buy-back 46 million shares (0.96% of total number of shares outstanding) up to the amount of 74 billion yen, which was naturally received well and leading the stock price of Softbank Group (9984) to surge. In contrast, Asahi Group Holdings (2502) plunged. Its July 19 announcement that it would issue new shares to fund the acquisition of Anheuser-Busch InBev’s Australian business immediately ignited worries over earnings dilution.

  Emerging markets

We are seeing renewed optimism on the emerging markets concerning the US-Chine trade deal. The two parties are said to meet next Monday in Shanghai while China approved tariff-free US soybean purchases as a sign of goodwill this week.

The STAR board, China’s equivalent to Nasdaq, launched this week to provide a platform for innovative technology companies to list in China rather than overseas. BYD and Toyota Motor announced a JV to develop sedans, low-floor SUVs and batteries for the Chinese market. Following Geely and Great Wall Motor earlier this month, SAIC revised down its sales target for 2019 this week, now expecting a 7% yoy sales decline, versus an earlier target of 1% yoy volume growth. Hikvision saw a recovery in its 2Q19 results, particularly in the large enterprises segment, with an improved outlook despite strong headwinds in the overseas market. New Oriental Education published better than expected revenue growth and margin expansion due to lower than expected selling and marketing expenses while TAL missed on 1QFY20 results and 2Q guidance under the margin pressure from the ramp-up in marketing spending.

In India, the market was lower on concerns about growth. Among companies that reported, HDFC Bank showed a slower loan growth of 17% yoy and higher credit costs on higher provisioning. Hindustan Unilever, the leading FMCG player, saw sales decelerate to a 7 quarter low level of +6.6% yoy, but was able to increase margins thanks to improved product mix and cost cutting. Asian Paints on the other hand reported a strong growth in revenue and margin expansion on the back of soft commodity prices. Reliance also published good results, driven by the consumer and telecom business, which now makes up 25% of total revenues.

In South Korea, Hyundai Motors and Kia Motors published better than expected results, mostly driven by the weaker Korean won and the introduction of new models. SK Hynix saw a sharp deterioration in its earnings, impacted by lower prices for DRAM and NAND, and announced production cuts.

Inflation in South Africa remained in the middle of the central bank’s target corridor. South Africa lowered its policy rate last week to 6.5%. In Brazil, Cielo showed early signs of success in its new market share driven strategy : while profitability once again took a hit, payment volume growth was at its highest in 7 quarters. Mexican bank Banorte 2Q19 results met estimates but seeing a sharp spike in NPLs. Argentina’s consumer confidence kept improving into July reaching 44.2, 8.9% higher than June and the strongest since March last year. 

  Corporate debt

 

Credit

Markets rose on hopes of easing from the ECB and the Fed. But last Thursday’s ECB meeting was seen as disappointing as investors were hoping for more detail on accommodating measures. The Xover tightened by 13bp between Monday and Thursday and the Main by 3bp. French retailer Casino said it had new offers for Vindémia and several loss-making stores. The group’s results also surprised by coming in better than expected with like-for-like sales rising 3.5%. Management reiterated its targets and said it wanted to speed up debt reduction in France to get it under €1.5bn by 2020. Vallourec rose when sales and EBITDA both beat expectations. Management confirmed its 2019 goals. Heidelberger Druck's bonds clawed back some of the previous week’s losses. Prices had previously fallen after 2019 targets were revised down, and especially EBITDA margins.

Moody’s raised UniCredit and Bankinter, citing improving asset quality as the main reason. As a result, both bank’s Tier 2 bonds now qualify for the three investment grade indices and UniCredit’s Tier 2 debt performed very well.  Deutsche Bank’s €3.15bn loss was disappointing, more than indicated at the beginning of the month, and was down to higher-than-expected restructuring charges. Excluding these charges, performance was slightly below expectations. Revenues fell 6% over a year. UBS reported a 1% rise in net profits over a year, or better than expected, due to strong investment bank performance. However, Global Wealth Management (GWM) fell short and saw net outflows of $2bn and a slight fall in net margins.  

The high yield new issues market was rather busy. Intrum raised €800m over 7 years at 3.5% and Vivion €700m over 5 years at 3%.

Convertibles 

Worldline (digital payment solutions) raised €600m with a 7-year zero-coupon OCEANE with a 60% conversion premium. The proceeds will go in part on funding a bridging loan for its acquisition of a 36,4% minority stake in equensWorldline. Turning Point Brands (tobacco substitutes) raised $150m at 2.5% over 5 years.

In results news, European luxury plays had diverse fortunes. Kering once again disappointed investors as Gucci’s growth decelerated while LVMH had a very good second quarter, particularly in fashion and leather goods. In the US, ServiceNow reported upbeat second quarter results but gave cautious guidance for the current quarter of +27-28% in billings, down from today’s +34% and a contrast with +70% year to date. The stock was hit by profit taking. Tesla also dismayed investors after once again reporting higher-than-expected losses and big changes at top management levels.

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