Political risk returns

Market analysis - 2/10/2017

In spite of reassuring macro data on Germany’s industrial orders, surveys on French sentiment and US activity as well as rather solid company results, equity markets continued to hesitate over the elements in Donald Trump's programme relating to protectionism, fiscal stimulus and deregulation.

The initial moves towards protectionism- the cancellation of the Trans-Pacific Partnership and the possible hike on Mexican import levies- have fuelled concerns over US relations with its major trading partners and the US President’s intention of scrapping the Dodd-Frank regulatory framework also ended up worrying investors following the ECB’s outright criticism of the plan. In a blunt riposte at a parliamentary hearing in Brussels, the ECB chairman, Mario Draghi, said any retreat or cancellation of banking regulations would be very worrying. This knee-jerk reaction from the ECB is probably behind recent underperformance from bank stocks.

Investors have several doubts over US policy but they also have high expectations for infrastructure spending and fiscal stimulus. Donald Trump’s election is not the only reason the reflationary trade is now back in favour but it has certainly contributed.

In any case, the reflation theme is far from over judging from today's economic data, strong earnings momentum and the White House's determination to pursue sweeping fiscal reforms. Meanwhile, bond market yields fell back this week. Yields on France’s 10-year bonds moved back below 1% for the first time in two weeks while peripheral spreads also tightened overall.

We continue to focus on equities rather than bonds in our diversified portfolios. We moved to positive on the US dollar following its drop in recent weeks and because there is the possibility that the Fed could tighten faster than markets expect. In bonds, we have increased US curve-steepening positions. 

  European equities

For the second week in a row, European markets focused on widening government bond spreads as political risk rose in Greece, Italy and France. Telecom Italia's results in Italy and Brazil beat estimates but investors worried about the group's ambitious plans for fibre which are designed to thwart the arrival of Enel and Iliad on the Italian market. BNP Paribas disappointed the market with its 2020 strategy plan which expects 10% in RoE by that date and is cautious over margins due to cost inflation in a competitive pricing environment. Société Générale's results showed that its French and international retail banking operations had performed better than expected. Sanofi rose due to better-than-expected resilience in diabetes treatment sales at the end of 2016 and 2017 guidance that was higher than estimated by analysts. Vinci’s positive free cash flow was surprisingly good and investors were reassured by a turnaround in its construction business. Publicis continued to be hit by account losses and like-for-like growth fell for the first time since 2009 - difficulties over digital media integration are spurring worries over ad agency business models. Total reported robust earnings and cash flow, providing confirmation that current oil price levels ensured enough cash flow to cover, and in fact raise, the dividend. Visibility on future production growth remains high. The autos sector revisited the thorny emissions issue as Peugeot is now facing a court case. However, Renault posted solid operating figures and its medium term guidance is more than ambitious, especially at this stage in the cycle. Tarkett posted excellent results on a turnaround in emerging markets; margins have upside potential due to the recovery on the Russian market. 

  US equities

US markets advanced in relatively quiet trading. Replacing the Affordable Care Act will take longer than expected according to Donald Trump. And the executive order blocking the arrival of nationals from certain countries remained suspended. There were no major economic data over the period. 

Attention focused instead on fourth quarter results. Both General Motors and Gilead reported robust figures but they lost around 5% on the news. Amazon announced solid results with sales growth topping 20% due to its cloud computing infrastructure business. But the company disappointed investors by saying it intended to replough almost all its profits into a massive investment drive targeting on-demand videos, fresh food delivery services and expansion in India, etc. 

Over the last 5 trading sessions, financials and consumer staples led advances while materials and energy were the only sectors to lose ground. Overall, we are still in a reflationary phase with central banks determined to remain accommodating.  

  Japanese equities

The TOPIX edged 0.2% higher after hovering within a tight range. Investors took a wait-and-see stance ahead of a scheduled meeting between US President Donald Trump and Japan's Prime Minister Shinzo Abe on February 10. The yen surged against US dollar and euro mid-week and shares of export companies dipped on concerns over profits. However, equities rallied as the yen fell back towards 112. Higher-than-expected core machinery orders for December also underpinned sentiment.

Over the week, the best-performing sector was Fishery, Agriculture & Forestry (+4.5%) while Oil & Coal sank 3%.

Sumitomo Electric Industries soared 7.2%. Credit Suisse raised its target price on expectations that all four business segments would see operating income recover in the next quarter. The weaker yen and strong demand for wiring harnesses are also expected to contribute to earnings growth.

Elsewhere, Japan’s nuclear power generation giants, Mitsubishi Heavy Industries, Toshiba and Hitachi all tumbled over 5% due to mounting uncertainty over the industry’s future. 

  Emerging markets

The US dollar recovered and so did emerging market equities. Strong performance was seen in China, Chile and Peru. Several emerging market currencies managed to beat the USD rebound with the Indian Rupee up 0.7% WoW and both the Mexican and Argentinean pesos  0.4% higher.

The Mexican peso’s move was underpinned by the central bank’s 50bp hike on Thursday which should restore some confidence in the near term. Central banks in India and Thailand left interest rates unchanged, a positive stance amid a possible US hike as it will help prevent inflation rebounding too quickly and the risk of massive outflows. 

Official macro data out of China looked slightly worrying on the surface with FX reserves falling below USD 3,000bn in January and the PBoC tightening liquidity. But underlying data continued to point to solid momentum.

Chinese auto sales for January fell 9.8% YoY to 2.12 million units but Chinese domestic brands are gaining market share in mid-segment vehicles, i.e. private cars priced between RMB 100,000 to 200,000 CNY (EUR 13,600-27,300). Companies like Geely, Great Wall Motors and Guangzhou Automobile Group all enjoyed volume growth YoY. There is an historical correlation in China between the state of the property market and demand for cars. The property market, despite lots of negative expectations and worries, continues to be healthy. True, there are pockets of excessive pricing but demand is genuine, migration to the cities from rural areas continues unabated and property developers now have a more rational approach to the market. The lack of inventory is a support factor:  over the past two years, the pace of new permit issuances has fallen below sales thus creating a scarcity effect.

Other positives in China were: 1) wage increases in the SME segment which accelerated for the first time since 2014, rising 4% on average, 2) some stabilisation, and even a slight reduction, in total non-performing loans. Outstanding loan volume still remained very high and worrying but some stability seems achievable and 3) excavator sales which jumped 54% YoY in January and heavy duty truck sales which soared 122% YoY on robust infrastructure spending.  


Bejing marked the return from China’s New Year holidays by slightly tightening liquidity in an attempt to stabilise growth and provide support for the renminbi. The move sent commodity prices slightly lower at the beginning of the week on fears demand would slow. But then January’s trade figures pointed to a strong economy - iron ore and coal imports rose 12% and 64% respectively over a year- and prices rebounded. Copper imports, however, slipped 14% but compared to a high basis of comparison.

Copper market traders are currently focused on possible production stoppages. Workers in Chile’s Escondida mine have just gone on strike for higher wages. Past strikes lasted between a few days and a month. The situation is more worrying in Indonesia where Freeport's lack of an export licence is likely to force it to close the Grasberg mine. Escondida and Grasberg together represent 8-9% of global production. 

Oil prices continued to trade in a narrow range with Brent crude moving between USD 54 and 56. US drilling activity continued to rise with an additional 17 rigs, taking the overall count to 583. This compares to the low point of 316 at the end of May 2016 and an October 2014 high of 1,609. The trend is beginning to worry the market. But the IEA’s monthly report said demand for oil was still strong. It rose by 1.6 million b/d in 2016 and for 2017 is seen rising by 1.4 million b/d, an increase of 0.1 million b/d on last month's forecasts. Citing 90% compliance with production quotas, the IEA expects the market to balance out by the first quarter of this year. 

Iran’s missile launches had no impact on oil markets but, along with European election worries and American migrant policy, they pushed geopolitical risk higher. As a result, gold rose and ETF outstandings are now up 3% YTD to 66.9m ounces. 

The gold ounce hit USD 1,240 for the first time since Donald Trump's election but fell back at the end of the period following the US President's promises to cut taxes massively. 

  Corporate debt



Uncertainty over the outcome of France’s presidential election maintained pressure on the OAT/Bund spread which jumped 10bp on Monday. But it then eased, dipping by 2bp on Tuesday, 5bp on Wednesday and 4bp on Thursday. The high yield market was untouched by rising government bond spreads and the iTraxx Main and Over indices were unchanged. 

In the run-up to the next Eurogroup meeting on February 20, Greece’s debt came under pressure. 

On the new issues market, Hapag-Lloyd (B2/B+) raised EUR 200m with a tap on its 2022 bond -the proceeds will go on redeeming some of its 2018 bond issue. Verallia (B1/B) raised EUR 350m with a 5-year NC2 senior secured toggle bond, of which EUR 280m will serve to repay equity contributions. The issue will take the company’s pro forma leverage from 4.5 to 5.1 times. 

Elsewhere, Alain Afflelou decided to postpone its IPO, citing difficult equity markets but saying the main reason was the recent Essilor-Luxottica merger which will radically change the sector’s configuration. This is bad news for holders of the company’s debt as the IPO was expected to reduce leverage below 3 times by July 2017. Shareholder meetings at Areva and Newco approved capital increase plans for EUR 2 and 3bn respectively. The French state will contribute EUR 4.5bn overall. 


Microchip Tech issued the first jumbo deal of 2017, a double tranche of convertible bonds (USD 1.8bn of 10Y senior subordinated and USD 500m of 20Y junior subordinated CBs). The money raised will be used to refinance a portion of the existing convertible bond due 2037 but also to repay borrowings under the revolving credit facility. On the previous day, the company reported Q3 numbers above expectations (strong sales especially in MCUs and Analog) and released Q4 guidance well above estimates.

Severstal issued another convertible bond, this time as an officially investment grade-rated company.  The 5Y USD 250m bond was priced with a zero coupon and a 35% premium but also full dividend protection. French construction and concessions company, Vinci, came to market with a USD 450bn equity neutral bond at 0.375%. Ubisoft confirmed once again its transformation with higher margins, efficient cost control and an on-going digitalisation of its sales (ahead of schedule), despite Q3 sales being slightly disappointing (they fell 6% due to the slow start of WatchDog 2). In valuation terms, it remains attractive versus peers like EA or Activision/Blizzard. Aperam posted very good Q4 numbers, beating on profitability with adjusted EBITDA at USD 144m. The company also increased its dividend and announced a USD 100mbuyback with a total cash return of 5.6% of its market cap.

In Asia, Advanced Semiconductor Engineering reported strong Q4 results with revenues up 6% QoQ and gross s up 50bp driven by its EMS business; the ASE and SPIL merger should be completed later this year.

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