Earnings overshadowed by geopolitical issues

Marktanalyse - 19-10-2018

In another turbulent week on markets, geopolitical issues like Saudi Arabia, Brexit and Italy overshadowed better-than-expected results as the earnings season kicked off. (English version)

Italian government bond spreads moved to 3.4% vs. the German Bund and Italy’s tussle with the European Commission sparked concerns as Rome seemed clearly intent on defying EU rules.

The ongoing correction has brought market variations closer to their 10-year median.

The global economic cycle does not look like running out of steam for at least 12-18 months, and certainly not in the US.

That is why we view this correction as fleeting. We have already started to take advantage of some price falls to tactically reinforce our equity exposure. 

  European equities

Tuesday’s technical bounce fizzled out and European markets continued to fall. Milan underperformed as 10-year Italian government bonds hit a fresh high amid persistent concerns that the EU would reject Rome's draft budget.

Performance was marked by strong dispersion as the earnings season began. Cyclicals like construction, autos and semiconductors led declines while defensives like telecoms rose on risk-off sentiment. Autos were pummelled by a plunge in September new registrations and Michelin’s announcement reducing company forecasts on its sector's growth. HeidelbergCement fell out of bed after warning on higher commodity prices. Bouygues also issued a warning on its construction division albeit it on exceptional problems over contracts. Danone retreated after a disappointing showing in China from nutrition, its highest-margin division. Despite solid like-for-like growth, SAP released disappointing margins which were hit by clients moving faster than expected towards cloud computing. Fresenius Medical Care cut its objectives to the low end of the scale, citing a slowdown in its US dialysis division.

Dia plunged after a fresh profit warning on strong competition in its local market and its decision to pass on its dividend. Airlines retreated after Flybe’s stock tumbled on management talk of less vigorous demand in the second half. Air France, however, bucked the trend thanks to a looming wage agreement and increased capacity over the winter season. 

On a brighter note, Dassault Aviation rose after expressing more confidence in the jet market and Safran was also higher on a new contract for its Silvercrest engine. Thales said new orders and sales were particularly robust. Carrefour soared after its French hypermarket sales stabilised and on news that it had cut capex for this year. The group reaffirmed its full-year guidance. 

FNAC did the same, especially for margins, and added that it was to buy back 2% of its outstanding shares to take advantage of their low prices. Ericsson reported excellent sales and margins thanks to strong momentum in its Networks division on 5G deployment in the US and a successful restructuring plan.

  US equities

US markets were highly volatile with the S&P trading in a 2.5% range before ending flat over the last four trading sessions. It was the same story for the Nasdaq which gained close to 3% last Tuesday before ending the period unchanged. So far in October, the S&P has fallen 5%. Small caps have fared worse with the Russell 2000 down 8%. Markets are nervous as the earnings season starts and are mostly taking a wait-and-see attitude, chiefly because of worries over China’s economy.

The Empire Manufacturing Index came in at 21.1, up from 19 in the previous month, and September retail sales rose by a sequential 0.1%, or less than the 0.6% expected.

The latest FOMC minutes showed no change of stance overall. The Fed has no intention of adapting its approach to recent market falls. The new factor is its relative concern over the strong US dollar which nevertheless gained further ground, rising from 1.16 to 1.14 against the euro over the week.

Investment banks released upbeat figures and Goldman Sachs surged 6% after its quarterly results. Netflix saw new subscribers up by close to 7 million for a total of 130 million but the company expects spending on content to accelerate. 

  Japanese equities

Japanese stocks dropped early on in the week on persistent concerns over a Chinese slowdown. Investors were also unnerved when during the US-Japan trade talks, the Americans suggested an ‘FX rate clause” to prevent Tokyo encouraging Yen depreciation against the US dollar. Stocks later rebounded as short-term investors bought back on a US market rebound. The TOPIX rose 0.13% for the week.

China-related names like Shiseido and Kao remained weak on falling tourist traffic in September after Kansai International Airport closed temporarily due to typhoon damage. Economic-sensitive sectors such as Marine Transportation, Oil & Coal, Chemicals, Machinery and Autos underperformed on worries over a weak Chinese economy.

On the other hand, domestic demand sectors like Real Estate and Pharmaceuticals outperformed. Takeda Pharmaceutical gained 7.06%. Mitsui Fudosan and Sumitomo Realty & Development rose 5.23% and 4.18%, respectively.

Prime Minister Shinzo Abe confirmed his intention to raise the Consumption Tax rate from the current 8% to 10% with effect from October 2019. But he also said he wanted to mitigate any negative impacts on the economy with measures like fiscal stimulus, and VAT relief (reduced tax rate) for foods and beverages. This sales tax hike is expected to have less impact than the last one in 2014. 

  Emerging markets

Sino-American conflicts continued to play out this week. The US spared China the currency manipulator label but the Trump administration decided to withdraw from the Universal Postal Union, a move which could significantly increase shipping costs for China-made products purchased online. The renminbi lost 0.13% against the US dollar over the week. Total social financing growth decelerated to 10.6% in September from 10.8% in August despite the inclusion of special purpose bonds in its new definition. M2 growth accelerated modestly to 8.3% YoY in September while shadow lending continued to shrink. Third quarter GDP and September industrial production slowed on reduced domestic demand while retail sales and fixed asset investment rebounded. Some town councils in China are creating special funds providing financial support to A-share listed companies in an attempts reduce stock pledge risks. 

At the beginning of the third quarter earnings season, Sinopec’s profits fell 21% QoQ due to fewer inventory gains and higher one-off costs. CATL pre-announced an 88-99% profit surge on soaring EV battery demand and a capacity ramp-up. Ping An gave a cautious outlook on investment on its investors day and expects future returns to be lower than the average of the past 10-20 years. TSMC guided on 8-10% YoY growth in 2019 despite an industry inventory correction.

India’s industrial production for August came in at +4.3%, or lower than previous 2 months' print of more than 6% due to a higher comparison base. September CPI rose 3.8% YoY, or marginally higher than August’s 3.7%, but remained benign due to lower food inflation. Infosys’ revenue rose 3.2% QoQ in USD for the second quarter of FY 2019, or way ahead of consensus, with 16% YoY EPS growth thanks to a turnaround in the banking, financial services and insurance (BFSI) and retail segments. Hindustan Unilever delivered a neat beat for the same period with Ebitda up 24% and volumes 10% higher on improved operational efficiency.

Mexico’s central bank released its monetary policy committee’s minutes which took an unexpectedly hawkish tone due to the peso’s depreciation and higher oil production costs (an indirect impact of higher oil prices). Banorte reported a good set of results on higher margins as well as synergies from its acquisition of Interacciones. Banco del Bajio reported earnings 8% ahead of consensus due to strong loan growth. Sberbank is reportedly in talks to become a major shareholder in Yandex. In Argentina, headline core inflation accelerated significantly in September to 6.5% MOM vs. 3.9% in Aug and 3.1% in July. This was due to the falling Argentine peso and higher regulated prices/tariffs.

We remain cautious on emerging markets due to a potential escalation in the trade war and possible further tightening of financial conditions. 

  Commodities

Tensions between the US and Saudi Arabia resurfaced at the beginning of the week due to the disappearance of journalist Jamal Khashoggi. As usual, Donald Trump assuaged tensions by warning that the disappearance should not jeopardise US-Saudi relations as a whole. This comment was doubtlessly linked to the looming mid-term elections as any sanctions against Riyadh would trigger an uncontrollable surge in oil prices. 

As this risk receded, the market focused on fundamental supply and demand statistics from the AIE, the EIA and OPEC. All three pointed to demand in 2018 and 2019 declining because of the IMF’s recent cuts to its global growth forecasts, weakness in emerging country currencies and higher oil prices. On the supply side, the trend is towards higher non-OPEC production, led by the US.

The statistics led Brent crude to move back below $80 at the end of the week. But the situation is still fraught, with Iranian exports down further to 1.3 million b/d over the first two weeks of October compared to 1.6 million in September. Interestingly, South Korea stopped importing Iranian crude in August, and India more recently but Italy has for the moment not shifted.

In Russia, domestic producers are no longer subject to restrictions. And, as we might have expected, talks between Saudi Arabia and Kuwait -over restarting drilling in the neutral zone between the two countries- stumbled over a sovereignty problem. The zone’s potential output of 500,000 b/d would have been a breath of fresh air on markets.

As for oil price levels, $80 for Brent crude is probably a floor. 

  Corporate debt

 

Credit

At the beginning of the week, investors focused on the start to the earnings seasons and spreads tightened as US companies reported upbeat figures. But the market subsequently retreated due to concerns over the Italian budget, lambasted by the European Commission as an unprecedented departure from the rulebook, and the failure to make much progress in Brexit talks. The Xover widened by around 10bp between Wednesday and Thursday.

Trading was dictated by a number of specific company risks. Spanish food retailer Dia issued its third profit warning in a year on falling sales and higher operational costs. The group appears to be reviewing its asset base so as to organise disposals. Press reports suggested the Max Descuento brand as a possible candidate. In Italian construction, CMC Di Ravenna’s bonds were hit by liquidity concerns. The group has still not received 6 delayed payments due June 30 which were supposed to be settled at the end of September. Softbank also came under pressure at the beginning of the week due to its relations with Saudi Arabia. Riyadh has been accused of involvement in the disappearance of a Saudi journalist.

On a more positive note, there was sustained buying of Casino’s bonds, and to a lesser extent, those of Rallye. Casino is looking to cut its debt load and announced the previous Friday that Tikehau Capital and Bpifrance were to take stakes in its GreenYellow subsidiary. On Thursday, Casino also  unveiled an initial agreement to sell 14 Monoprix properties to AG2R La Mondiale. Netflix bonds performed well after its results beat expectations. New subscribers rose sharply by 6.96 million and all geographical zones gained ground. Hema’s bonds outperformed after the retail chain was sold to Ramphastos Investments. The new owner intends to slash the company's debt. 

In new issues, Italian pharma company Rossini (B2/B), Recordati’s controlling holding company, raised €1.3bn over 7 years in two tranches, one variable and the other at a fixed 6.75%. UGI (energy distribution) raised €350m over 7 years at 3.25%.  

Convertibles 

After a heavy week-long correction, markets rebounded but the upturn needs to be confirmed. Volatility may have declined but it is still high, and markets react in line with absolute levels.

Markets have also proved fragile because of concerns over the Italian budget and US-Saudi tensions following the disappearance of journalist Jamal Khashoggi.

Sector rotation remained higher and was amplified by the earnings season. Semiconductors rebounded sharply with ASML exceeding analysts’ expectations with five new orders in the third quarter for its newest machines. The Stoxx Europe 600 Retail outperformed with Carrefour posting robust results and a cost-savings programme in line with its €2bn target. Casino also managed good earnings and also delivered an upbeat outlook. The group remains heavily leveraged but announced the sale of another 14 Monoprix properties.

Europeans banks were under pressure as 10-year German Bund yields moved back up to 0.40% and Spanish bank shares underperformed after Spain’s Supreme Court ruled that they, and not the borrower, must pay mortgage-documentation taxes.

In new issues, Evolent Health (application software for health care organizations) raised $150m due 2025 at 1.5% to finance working capital and for other general corporate purposes.

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