Equity overweight halved

Marktanalyse - 18.05.2018

We decided to take some tactical profits and halved our equity overweight by reducing exposure to Europe and Japan. (English version)

We are confident good visibility on the economic and profit cycle will persist but acknowledge that the more pronounced rebound on European equities is essentially linked to that of the dollar. The greenback has finally reconnected with its traditional strengths, namely the relative dynamics of US rates. A stronger dollar initially looks beneficial. But this upward pressure on long-term rates and the dollar has been putting downward pressure on the emerging complex for several days. If it were to continue, there might be contagion effects on a broader set of assets. We do not have a pessimistic core scenario on US rates (we turned neutral on US bonds after 10 Treasury yields hit 3%), but we could see short-term overshooting. 

In addition, the recent deterioration of the political situation in Italy -we have been underweight on Italian bonds over the last few weeks- has not had a significant impact on other risky assets. We cannot rule out contagion, even if the risk seems to be contained as there has already been significant tension on Italian spreads. Geopolitical tensions and rising oil prices have not weighed on the equity market rebound. However, although higher oil prices are initially beneficial, further rises could lead to growth scenarios being revised downwards, particularly in Europe and Japan. And as for the deterioration in the Middle Eastern situation, we will need to see the full impact of Donald Trump's decisions. In the meantime, uncertainty will persist. 

  European equities

Equity markets pushed higher, choosing to downplay rising interest rates and oil prices and Italy’s political upheavals and focus instead on the US dollar gaining ground against the euro. Export sectors like luxury, pharma and autos logically gained ground while oil services like Vallourec, TechnipFMC, CGG, and Saipem were galvanised by strong oil prices and analyst sector upgrades. 

Milan nevertheless fell due to political developments and significant widening in long bond spreads.

Financials like BPM, UniCredit, Mediobanca, Unipol and Generali were particularly badly hit but utilities like Enel, Terna, and Italgas also suffered.

In results news, Alstom had an excellent fourth quarter with operational improvement running ahead of schedule. Lagardère’s quarterly sales were slightly better than expected due to publishing and travel retail. Europcar jumped after reporting a sharp rise in sales.

In disappointing news, Iliad‘s stock tumbled when results missed expectations due to subscriber losses and lower ARPU in land lines. The group said management was to be overhauled and announced new offers to better reflect market segments and boost ARPU. Bouygues also missed first quarter expectations due to Colas which suffered from bad weather. The other divisions reported in line and upbeat momentum in the telecoms divisions continued. Elior (restaurants) sold off sharply after issuing another profit warning. As well as non-recurrent items, margins came under pressure in France.

In company transformation news, Worldline’s acquisition of Switzerland’s Six Payments has reduced the Atos stake to 51%, diminishing Ingenico’s speculative appear and sending the share lower. FNAC-Darty unveiled a broad alliance with its main shareholder Ceconomy, a group which also announced good second quarter figures. UK online distribution specialist Ocado soared after announcing a partnership with UK supermarket company Kroger. Imerys said it was to sell its roofing division for €1bn. 

  US equities

The S&P edged 0.3% lower over the period. But small and mid-caps, which are less sensitive to the rising US dollar and fresh fears of a trade war, outperformed, with the Russell 2000 advancing 1.2%. The market appeared to be missing strong leadership and trading remained thin with volumes 20% below the previous month’s levels. 

Macroeconomic data, meanwhile, came in higher than expected. The Michigan consumer sentiment index rose to 98.8, or higher than the 98.3 expected while the Empire Manufacturing index jumped from 15.8 in April to 20.1. April retail sales rose 0.3% as expected and March data was revised higher to +0.8%. The strong economy helped 10-year Treasury yields stay above 3% and even hit 3.11%, their highest level since 2011.

Among late earnings reports, there was disappointing news from Agilent (due to China's changing regulatory environment), Cisco which posted good first-quarter figures but gave downbeat guidance, and Walmart where profitability was hit by the mix effect, price investments and rising freight costs. 

Energy, commodities and healthcare led gains while defensives lost ground. 

  Japanese equities

With oil prices up, US Treasury yields above 3% and the Yen weakening to 110 against the dollar, Japanese stocks gained ground. The TOPIX rose 0.75%. Most company earnings for 2017 have now been reported and excessive concern over guidance risk for this year has receded. 

Traders shrugged off a contraction in Japan’s real GDP in the first quarter (-0.2% QoQ, an annualised drop of 0.6%). On the other hand, first quarter machinery orders (except shipments and electric power), a leading indicator of future CAPEX investment, came in at a better-than-expected +3.3% due to strong demand for SPEs and IT equipment. And they are seen rising 7.1% in the next quarter. 

In sectors, Oil & Coal (+2.90%), Iron & Steel (+2.68%), and Insurance (+2.61%) gained from higher oil prices and US Treasury yields. Daiichi Life Holdings and T&D rose 6.62% and 4.96% respectively. Pharmaceutical sectors were also strong. Shiseido jumped 10.68%, and Daiichi Sankyo, Ono Pharmaceutical and Eisai climbed more than 5%. 

But there was weakness in Mining (-2.44%), Pulp& Paper (-1.71%), and Construction (-1.09%). Sumitomo Real Estate sank 4.12% on worries over higher personnel and material costs. 

  Emerging markets

Emerging markets fell 1.7%, as US 10-year Treasury yields broke above the psychological 3% mark to hit levels not seen since July 2011. China’s industrial production increased to 7% in April, or more than expected. The Chinese delegation, led by vice Prime Minister Liu He, made a second visit to Washington to continue talks despite sanctions on ZTE and Qualcomm getting the green light to acquire NXP. Tencent first-quarter revenues jumped 48% and profits rose 36%, or more than expected, due primarily to strong performance from smartphone games. Advertising revenues were up 55% thanks to Wechat’s popularity. Other services, notably payments; soared 111%. Despite delays, management is confident that the Fortnite and Pibg games can be monetised. Baozun, which provides e-commerce solutions in China to international brands, saw first quarter gross merchandise volume (GMV) jump 66% while earnings rose 36% as increased operating efficiency helped improve margins. In contrast, Netease’s first quarter operating margin fell by a disappointing 15% QoQ due to the cost of marketing its new e-Commerce segment.

Despite higher oil prices, India’s trade deficit stabilised at $13.7bn in April thanks to exports rising by a better-than-expected 5.2% and imports only rising 4.6% compared to +7.1% in March. However, inflation rose 0.3% to 4.6% despite food prices stabilising at +3%. Narendra Modi’s BJP party narrowly won the Karnataka elections, a result which domestic investors took badly. 

Brazil’s central Bank surprised the market by keeping interest rates unchanged. In Mexico, the end to the NAFTA talks has once again been put back. Bancolombia reported weak results due to a worse-than-expected cost of risk. In Argentina, the primary fiscal deficit came in at a better-than-expected 0.3% of GDP. We are waiting for more details on the talks with the IMF. 

  Commodities

We expected it to happen and traders duly obliged. For the first time since November 2014, Brent crude futures popped over the $80 mark for a few hours. Spot prices remained slightly below that level. 

The more interesting statistic is that Brent crude has rebounded by close to 80% since its June 2017 lows. It rose by almost 3% over the week due to geopolitical tensions and steadily improving fundamentals. The IEA in its monthly report said that at the end of March, the latest available data, inventories had fallen back below their 5-year mean. This was the stated aim of OPEC and its allies. Commercial inventories fell by 27,000 barrels in March, a counter seasonal development. The agency also marginally reduced its demand growth forecasts for 2018 by 38,000 b/d to +1.33 million b/d and raised non-OPEC output growth by 84,000 b/d to +1.87 million b/d. 

But these figures are misleading. To match supply with demand, OPEC would have to produce 32.2 million b/d, but current output is 31.65 million. If it stays that way, inventories will fall further in the second half of 2018. Venezuelan production fell by a further 50,000 b/d to 1.44 million b/d in April but the rest of the OPEC cartel, with the exception of Iraq, is still very largely respecting production quotas. What’s more, these estimations do not factor in the probable impact from reduced Iranian exports in the second half of the year. 

Elsewhere, Tesla, despite model 3 production difficulties, is still upbeat on future output capacity. But worries over securing critical materials to help it hit its goals have led it to sign an agreement with Australia’s Kidman Resources on supplying lithium, a key element in electric car batteries. Kidman has a joint venture with Chile's SQM which has a project that is scheduled to come on stream in 2021.  

  Corporate debt

 

Credit

The market edged lower, notably for long-dated maturities due to rising US and core European yields. The Xover widened by 4bp over the week. Financials came under particular pressure due to weakness after political uncertainties in Italy caused Italian bank spreads to widen. 

BFCM raised €500m with a 10-year Tier 2 bond at 2.50%. Kraton (B, chemicals), raised €290m with an 8-year maturity at 5.25%. In telecoms, Iliad’s bonds were badly hit after the group posted disappointing first quarter results which reflected a sharp slowdown in growth. Altice (B1/B) reported slightly better than expected figures. Altice Europe saw sales fall 1.2% and EBITDA down 2.3% but gained more French subscribers. Telecom Italia’s results were in line: sales fell 1.6% and EBITDA 8.7% due to a hefty Italian government fine. Wind Tre (B1/BB-) released disappointing figures with sales down 8.9% and EBITDA 1.5% lower due to underperformance in its mobile phone division. Hapag-Lloyd (B2/B+, container shipping) saw EBITDA jump 62% thanks to the merger with UASC which was completed in 2017. Sales in US dollars were 42% higher. But translated into euros, the group posted a net loss due to US dollar strength and higher oil prices. 

Wind turbine producers Senvion (B2/B+) and Nordex (B3/B) saw sales tumble by 34.8% and 24.8% respectively while EBITDA fell to €800,000 and €20m. However, both groups said their order books had expanded and both reaffirmed their full-year forecasts. Swedish security group Verisure (B1/B) unveiled satisfactory first-quarter results with sales and EBITDA up 16.4% and 9.2% and a 13.1% rise in new clients over a year. 

Convertibles 

It was a busy week on the convertibles primary market with seven new deals. In Europe, Swiss construction company Sika came to market with a jumbo CHF 1.65bn 7Y 0.25% coupon convertible to fund the acquisition of its own shares from Saint-Gobain. Norway’s Borr Drilling (oil & gas services) raised $350m with a 5Y 3.875% coupon convertible to finance acquisitions of high spec new build jack-ups. 

In the US, content delivery network services company Akamai issued a jumbo 1$bn 7Y 0.125% convertible to repay its outstanding 2019 convertible and buy back shares. Twilio, a cloud communications platform company, raised £475m with a 5Y 0.25% coupon convertible for working capital and general corporate purposes.  

Software company Alteryx raised $200m with a 0.5% convertible for general corporate purposes. Cloud company New Relic raised €435m with a 5Y 0.5% coupon convertible for working capital financing. Communications solutions company Vocera issued a $125m 5Y 1.50% coupon convertible for working capital and general corporate purposes. And Ligand Pharmaceuticals announced a $650m 5Y 0.75% coupon convertible to fund a share buyback and potential M&A. 

In the rest of the news, Ubisoft posted very strong FY 17/18 results with 19% growth in sales YoY to €1.73bn on solid performance from Assassin’s Creed Origins and Far Cry 5 but also robust back catalogue sales (more than 50% of sales). The company confirmed its FY guidance for EBIT despite cutting its sales forecast and a delay in Skull & Bones.

In Thailand, Bangkok Dusit Medical Services reported a 48% YoY increase in earnings (+44% QoQ) driven by a 16% increase in Thai patients and 12% growth in foreign patients (China, Kuwait and Cambodia). 

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