Markets applaud new European appointments

Marktanalyse - 8-7-2019

Global growth is slowing smoothly but the week’s PMI and ISM data revealed some resilience in developed countries thanks to buoyant consumption and services (English version).

Data on unemployment remained upbeat, reducing further the risk of an imminent recession but global trading conditions continued to slow despite the resumption of US-China talks. Interestingly, the US trade deficit continued to worsen despite the introduction of customs tariffs.

Meanwhile, the European Union made a number of senior appointments. After lengthy negotiations, a reflection of Europe’s very politically diverse nature, Ursula von der Leyen was put forward as European Commission president while Christine Lagarde was proposed as ECB chair. Christine Lagarde’s appointment was welcomed by markets as investors expect her to pursue Mario Draghi's accommodating policies. Her appointment also echoes that of Jerome Powell in that it underlines a move by central banks towards an increasingly political and risk management approach.

Continuing central bank support will be of particular help to the more fragile countries but Italy also benefited from the decision not to go ahead with an excessive deficit procedure. Yields on Italian government bonds duly fell back, returning to levels below those before the elections.

But the trend lower in rates was widespread with the Bund descending to minus 0.4% and 10-year US Treasuries falling to 1.95%. Markets are now banking on 3 rate cuts from the Fed this year and two from the ECB. European and US markets also rose on further expansionist policy from central banks and gained 1% in the US, in a short, Independence Day week, and 1.4% in Europe. Asia and emerging country markets lagged a little.

We have maintained our cautious stance on both equities and European duration. 

  European equities

Equity markets flirted with 2019 highs after a reassuring outcome at the G20 summit and the admittedly fragile truce between the US and China. Tech stocks led the rebound, helped by Washington's decision not to increase tariffs on Chinese imports and a more flexible approach to Huawei. Auto stocks results were mixed. Parts manufacturers fell after Germany’s Schaeffler issued a profit warning. The group is expecting more weakness in the car market and sees China remaining soft in the second half of this year. But auto makers, and BMW in particular, gained ground on news that US car sales had rebounded in June. Trigano performed particularly well after its figures showed it had won market share and that dealerships had stopped destocking.

Investor optimism was reinforced when Christine Lagarde was confirmed as new ECB chair. The former IMF head is expected to pursue Mario Draghi’s accommodating stance. Bond yields fell sharply and rate cut and QE expectations even took the Bund below 0.4% intraday, or lower than the ECB’s deposit facility rate. The move triggered sector rotation towards defensives and long duration plays like property, utilities and telecoms. Food and beverages were especially strong and AB InBev is expected to raise $10bn from a listing in Asia. Despite falling yields, banks rebounded after the ECB decided not to pursue Rome for running an excessive deficit. This followed a statement from Giuseppe Conte that he was going to revise down the 2019 budget deficit target from its current 2.4%. Deutsche Bank was in the limelight as investors pondered the cost of possible restructuring scenarios and their solvency impact. And Searchlight Capital Partners said it planned to bid for Latécoère.

  US equities

The Nasdaq and S&P 500 hit fresh all-time highs, rising 2.8% and 1.8% respectively (as of July 3, the eve of the Independence Day holiday). The rise was mostly in response to reduced trade tensions following the previous weekend’s G20 summit. China and the US appeared to have put hostilities on hold with Donald Trump authorising US companies to export components to Huawei in China. Yields on 10-year US Treasuries fell further, moving below 2% to 1.95%.

Oil prices consolidated, after rising in recent weeks on mounting geopolitical tension, and WTI ended the period at $57. Many sectors rebounded with property stocks up 3%, telecoms +2.6%, technology +2.4%, healthcare +1.9% and financials +1.6%. Energy (-1%) and industrials (+0.6%) underperformed.  

Symantec, a cyber-security software specialist, jumped 20% on rumours of a possible bid from Broadcom. Boeing slipped 2.6% after postponing the return to service of its 737MAX plane. Cosmetics group Coty, also a leader in perfumes, plunged 12.9% after unveiling a restructuring programme that included a $3bn asset writedown. 

  Japanese equities

Japanese equities rebounded amid reduced concerns over US-China trade conflicts after both countries agreed at the G20 meeting to resume talks. The Tankan survey data (June) which revealed deteriorating business sentiment and the Abe government’s announcement of export regulations on semiconductor materials to South Korea had little impact. The TOPIX put on 2.49% but mainly because of strong US markets and rate cut expectations.

Marine Transportation and Electric Power & Gas outperformed and Pharma was also relatively strong. Otsuka Holdings (4578) jumped 9.76% and Daiichi Sankyo (4568) gained 7.49%. 

Looking back at the first half, Japan stands out as a laggard due to earnings concerns as well as selling by foreign investors. However, earnings deterioration for the April-June quarter is now thought to be priced in judging from the Revision Index (a corporate earnings momentum indicator) which is bottoming out at the lowest level seen in previous contraction periods. 

  Emerging markets

Markets made a positive start to July after the G20 Trade truce spurred more investor optimism. In China, June PMI stayed at 49.4, or slightly below the consensus forecast of 49.5. On the demand side, new export orders slipped deeper into contractionary territory. Production also slowed, though it remained in expansion. Non-manufacturing PMI edged down to 54.2 from 54.3, suggesting the impact of the US tariff hike on Chinese goods in May had so far been contained in the manufacturing sector. New orders in the construction sector rose sharply, pointing to stepped-up government spending on infrastructure. On the corporate front, the announcement that China would bring forward the removal of foreign shareholding caps for insurance companies by one year from 2021 to 2020 was good news for insurance groups like AIA.

India’s manufacturing PMI fell to 52.1 in June (from 52.7 in May) and Goods and Services Tax revenues for June came in at a four-month low of Rs1.0tn (+4.5% YoY). Inflation, on the other hand, slowed to 3.28%. In its first budget meeting on July 5, the newly formed Modi government said it was lowering its fiscal deficit target to 3.3% from 3.4%. To fund that plan, it will raise around Rs1.05tn from asset sales -vs the Rs900bn targeted earlier- and will increase taxes on wealthy households. Additional taxes were also announced on petrol and gold. The finance minister signalled his intention to sell sovereign bonds overseas to fund the Rs20tn rupees needed every year for infrastructure investment. The government also agreed to inject Rs700bn into state-owned banks, a lower amount than in previous years, and a sign of its confidence in the health of the banking system. Indian auto sales continued to struggle, with Maruti Suzuki reporting a 15% YoY drop in June.

South Korea's exports fell for the seventh straight month in June, with the drop accelerating to 13.5% YoY from a revised 9.5%. Japan announced export restrictions on some tech items sent to South Korea. The move was in response to worsening relations between the countries after courts in Seoul demanded compensation from Tokyo for Korean citizens conscripted by Japan to work from 1910 to 1945. Samsung and LG Electronics logically underperformed on the news. Samsung Electronics announced its preliminary results for the second quarter. Revenue was down 4% YoY, but operating profits fell 56% from a year earlier.

Brazil’s industrial production in May showed a better-than-expected 0.2% drop MoM vs consensus expectations of minus 0.3%. On the corporate front, Brazil’s Commission recommended a series of environmental measures that could further undermine prospects for Vale, the Brazil’s largest mining company. 

  Commodities

The G20 summit ended with reduced US-China tensions and the OPEC meeting also concluded with a pleasant surprise. No surprise from OPEC and Russia deciding on an extension of the 1.2 million b/d output reduction but investors were expecting it to be prolonged for only 6 months and not to the end of the first quarter of 2020. The decision is actually quite logical as demand is subject to strong seasonal variations as this time of the year. It is also a strong sign of OPEC’s determination, led by Saudi Arabia, to keep a firm hand on oil stocks. However, the news was met with an equally surprising 5% sell-off on the day it broke (2 july 2019). This was partly due to traders taking profits, but also to fresh worries over demand prospects after manufacturing PMI in major zones fell once again in June, retreating to levels seen in the first half of 2016. OPEC is making the required efforts to cut stocks but is losing market share to US shale oil. Since the 1990s, OPEC has had between 37% and 41% of the global market. It is now at the bottom of that spread and could go lower.

Saudi Arabia also suggested using the 2010-14 period rather than 2013-17 as a gauge of average stock level targets. That would suggest a further160 millions barrel cut and therefore fresh efforts from member countries. Traders appeared to be sceptical that the cartel could sustain losing market share over such a long period. For the second half of 2019, current conditions suggest Brent crude could trade between $65-70. 

  Corporate debt

 

Credit

Markets were lifted by optimism over US-China trade talks and Christine Lagarde’s appointment as ECB chair. Investors expect her to stick with Mario Draghi’s accommodating monetary policies. Markets were also reassured by Rome’s decision to review its deficit targets so as to avoid disciplinary measures from the European Commission. The Xover tightened by around 18bp between Monday and Thursday and the Main by 4bp.

Picard’s bonds edged lower on disappointing results for the fourth quarter of 2019. Sales fell 4.5% and EBIDTA 9.1% while leverage moved to 7.5 times, up from 7 in March 2018. The company gave no firm targets but said it would remain cautious in today’s rather competitive market. Hema gained 2 points as sales rose 2.5% and EBIDTA remained stable, excluding exceptional items. The group sounded an optimistic note on growth prospects and said it would be expanding in the US and Canada. Casino finalised disposals worth €39m and said plans for other asset sales were going to schedule.

Deutsche Bank has still not unveiled restructuring plan details but press reports alluded to costs of between €3-5bn with 15,000-20,000 redundancies, notably in its investment banking division. The bank is reportedly talking to the regulatory authorities to reduce solvency ratios so as to be able to absorb restructuring costs.

It was a rather quiet week on the primary market. In financials, Commerzbank raised $1bn with its first AT1 to reinforce its capital base. The bond has a 7% coupon. Demand was very heavy and the issue subsequently gained a commendable 2.5 points. Italy’s UBI Banca issued a 10-year Tier 2 bond at 4.375% with a 5-year call. 

Convertibles 

In a much calmer week on the new issues market, Switzerland’s Cembra Money Bank raised CHF 250m over 7 years with a zero coupon bond and a 30% premium. Along with an equity placing, the issuance will fund the acquisition of Cashgate for CHF 277m. The company also intends to sell AT1 debt.

The secondary market was busier and rose on Christine Lagarde's appointment as ECB chair. Both Cellnex convertibles saw heavy trading on talk of the most recent issue joining the index.

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