The geopolitical climate improves to some extent

Market analysis - 10/21/2019

The US-China agreement and hopes of a solution to avoid a no-deal Brexit supported risk assets this week.

The US-China agreement stipulated that Washington would not raise tariffs on $250bn-worth of Chinese imports by 25-30% on October 15. In return, Beijing undertook to gradually double imports of US agricultural products, refrain from currency manipulation, open up its markets more and increase efforts to protect intellectual property rights in China.

Larry Kudlow, Donald Trump's economic advisor, rekindled hopes for a rapid resolution of the conflict by sounding confident that agreements would not only be signed with China but also with Canada and Mexico before the Thanksgiving holiday on November 28.

In the UK, Thursday’s announcement that Brussels and London had reached an agreement initially reassured investors and equities, sterling and government bonds all rose. But Northern Ireland’s DUP poured cold water on these hopes, thereby putting ratification by the House of Commons in doubt.

Markets then appeared to be betting on the worst outcome despite Jean-Claude Juncker opening the European Council summit by saying that there would be no further extension.

Elsewhere, Berlin unsurprisingly cut its growth forecasts for 2020 to 1%. Economy minister Peter Altmaier nevertheless said there was no risk of an economic crisis.

Uncertainties will persist over coming months, weighing on investor sentiment and advanced indicators. Central banks will continue to lend support. The Fed said it would resume asset buying by focusing on short-term government bonds.

The earnings season in Europe and the US will play a decisive role in equity market trends.

Investors are facing contradictory forces so relatively cautious exposure to equities is still appropriate. 

  European equities

Sentiment on European equity markets was dominated by Brexit developments. Indices rose to new year-to-date highs as the chances of an agreement increased. Buying even accelerated late on Thursday morning as an accord looked imminent but indices retreated after Northern Ireland’s DUP and the Labour Party reaffirmed their opposition, thereby jeopardising ratification in the House of Commons.

Elsewhere, third quarter results poured in, bringing with them a slew of warnings on organic growth across all sectors. Pernod Ricard said growth had been particularly disappointing in China and India and Remy Cointreau referred to unrest in Hong Kong and slow restocking of cognac in the US. The autos sector was once again hit: Faurecia now expects the market to decline more than previously feared and Renault cut its 2019 guidance, citing a less favourable economic environment than expected and a steep rise in costs due to regulatory pressure. Thalès said provisional third quarter revenues were in line but warned on full-year organic growth. Danone’s third quarter figures fell short of expectations and the group revised down its annual prospects. Accor’s third quarter sales came in below expectations with RevPAR trending lower than estimated due to softer sales in the Asia Pacific zone. Wirecard returned center stage after the Financial Times published more articles alleging the group had artificially boosted sales. The group denied the report but the stock still fell sharply.

Exceptions to the downbeat mood were Assa Abloy, which saw third quarter sales rise 3.8%, or better than expected, Teleperformance, which raised guidance for 2022, and Ericsson, which revised up 2020 guidance for sales and operating margin targets. Tele2 also stood out with excellent results and strong FCF. Its Swedish business benefited from a surge in subscribers and ARPU and its cost-cutting programme remained on track. In M&A, the private equity firm Thoma Bravo made a 100% cash bid for cybersecurity specialist Sophos. Moreover, Arkema rose on news that it had sold its industrial specialties division to SK Global.

  US equities

US markets staged a sharp rebound with the S&P500 up 0.9% to flirt with its 2019 highs and the NASDAQ 1.3% better as of Thursday's close. This renewed optimism was due to:

Firstly, an improvement in the global geopolitical situation with a US-China trade truce and the likelihood of a Brexit agreement in Europe.

Secondly, an initial third quarter results which were on the positive side.

Yields on US 10-year Treasuries reacted to these developments by gaining 7 basis points to 1.75%. WTI oil prices ended the period practically unchanged at around $54. The market advance was driven by communication services (+2.2%), healthcare (+2.4%) and industrials (+1%). Defensives underperformed with utilities down 0.5% and consumer staples 0.4% lower.

Banks reported better-than-expected third quarter results and Bank of America and JP Morgan rose 4.7% and 3.6% over the week. Upbeat results from financial heavyweights are seen as a token of the US economy's relatively good health. Netflix gained close to 3% over the week after its third quarter results showed resilience to mounting competition from Apple and Disney. Netflix’s international subscriber base rose more than expected. Honeywell climbed 4% on better-than-expected figures, notably upbeat performance in its civil aviation division. However, the selling picked up speed for some software stocks after ForeScout cut its earnings guidance and Workday released disappointing news on its strategy. 

  Japanese equities

Japanese stocks rose after the US and China reached a partial trade agreement. Sentiment was also lifted by a recovery in the semiconductor market and expectations that corporate earnings would bottom out. The TOPIX gained 1.81 over the week, led by Marine Transportation, Rubber Products, Electric Appliances and Nikkei 225-related names. An extraordinarily strong typhoon, Hagibis, hit Eastern Japan bringing heavy rains, extensive flooding and traffic disruption but its impact on the stock market was relatively limited for such a violent storm. Market participants are now focusing on July-September earnings in the manufacturing sector for any confirmation that they and CAPEX have seen the worst.       

Despite the continuing fall in tourists from South Korea (-58.1% YoY), the estimated total number of foreign inbound travellers to Japan increased 5.2% YoY to 2.27million in September. An impressive increase in tourists from Europe, the US, Australia and Asian countries offset the South Korean effect. Furthermore, total consumption by inbound visitors rose 9% to JPY1.2 trillion over the third quarter. This stems from the fact that Korean visitors spend less than others. Despite political factors, total foreign consumption YTD hit a record JPY3.619 trillion as of the end of September. 

  Emerging markets

The MSCI Emerging markets index was up 1.7% as at Thursday’s close, led by China on increasing chances of a trade truce with the US.

US Treasury Secretary Steven Mnuchin announced on the previous Friday that tariffs on $250bn in Chinese imports (which were set to rise from 25% to 30% on October 15) would not now take effect. This was subsequent to President Donald Trump’s previous statement confirming that both sides had reached a “very substantial phase one deal” addressing intellectual property and financial services concerns and including purchases by China of about $40-50bn in US agricultural products.

On the macroeconomic front, China's exports and imports shrank more than expected in September, reflecting the ongoing slowdown in global trade. Exports decreased 3.2% in US dollar terms from a year earlier while imports declined 8.5%, leaving a trade surplus of $39.65bn, the customs administration said Monday. The slowdown also had some direct impact on China’s third-quarter GDP which rose 6%, or slightly lower than market estimates of +6.1%, a sequential decline on the second quarter’s 6.2% rise.

In India, industrial production declined 1.1% YoY in August after a 4.3% rise in July. Auto retail sales rose by 6.48% in September YoY, rebounding from a low base, although wholesale sales fell for the 11th consecutive month.

On the corporate front, Russian Internet Company Yandex plunged 16% on the previous Friday following discussions the day before in the Duma over implementing a 20% limit on foreign ownership of strategic internet businesses.

In Mexico, SoftBank announced an investment in Mexican used car platform Kavak, adding to its growing Latin American portfolio.

In Brazil, the secondary offering of payment company Pagseguros combined with a negative surprise on third quarter EPS due to higher than expected operational expenses led to the stock selling off. 

  Corporate debt

 

Credit

Brexit was uppermost in traders’ minds over the week. London and Brussels unveiled an agreement on Thursday but ratification by the UK Parliament was still not a done deal. On the trade war front, Donald Trump said an agreement was being drawn up but that it would not be signed before his meeting with China’s President. The Xover widened by 5basis points between Monday and Thursday while the Main ended up flat. 

Codere came under more attack over the week after S&P cut the group from B to B- due to accounting irregularities reported in the previous week. The rating agency said these irregularities would delay the refinancing process. Softbank’s bonds edged lower on rumors that the group might invest several billion US dollars in WeWork. Eurofins also came under pressure after a report criticized its opaque accounts and hefty leverage. However, Teva’s bonds performed well after the pharma group reportedly offered to supply $15bn in free drugs to wind up litigation over its part in the opioid scandal. Casino also outperformed on news that the sale of property assets to companies associated with Apollo Global Management had been finalised. Kedrion saw fresh buying after FSI confirmed it had taken a stake.

In results news, Rexel's third quarter sales rose 3.3% on strong momentum in Canada, key European countries and China. Guidance for 2019 was unchanged.

On a rather active new issues market, OCI raised €700m and £600m over 5 years in 2 tranches, 3.125% and 5.25%. Eir raised €350m over 5 years at 1.75% to refund part of its May 2026 term loan. VodafoneZiggo raised €425m and $500m over 11 years at 2.875% and 4.875%. La Mondiale sold its first Restricted Tier 1 (RT1) bond raising €500m at 4.375%. The order book was heavily over-subscribed and the bond gained 1.5 points when it started trading. 

Convertibles 

It was another blank week for new issues ahead of the blackout period.

In the rest of the news, Edenred’s third quarter results were in line with total revenues, up 20.7% to €393 million. The group reiterated its guidance for the full year.

The first profit warning in Europe’s convertible universe came from steel and metal distribution company Klöckner which lowered its EBITDA guidance for the full year to €120/130 million, citing softer markets and pricing pressures.

Of note elsewhere was a Financial Times report suggesting Wirecard’s accounting practices might be “abnormal”; i.e. a “concerted effort to fraudulently inflate sales and profits at Wirecard businesses in Dubai and Ireland”. The stock plummeted by close to 17%.

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