A trying week

Market analysis - 6/1/2018

Equity, bond and currency markets had a trying week.

It is sometimes unclear what is behind a particular market move but this week we had a big choice:

  • ups and downs in Italy over attempts to form a new government and the consequences for the eurozone and therefore Italian bond spreads. The biggest shift was in Italy’s 2-year bond yields which jumped from -0.4% to more than 2.5% in only a few days.
  • the surprise collapse of the Spanish government which is to be replaced by a very mixed bag of a coalition.
  • Washington’s introduction of protectionist tariffs on steel and aluminium imports.
  • easing oil prices.
  • slightly disappointing European growth data.
  • inflation coming in slightly above expectations.

Despite all this, equity markets proved relatively resilient as investors preferred to focus on persistently favourable fundamentals. Earnings growth expectations have not been challenged and interest rates should remain low, particularly in the eurozone. We took advantage of market turmoil to invest in short term Italian debt. 

  European equities

Equity markets were in thrall to political turmoil in Spain and Italy and indices tumbled last Tuesday as Italian spreads widened sharply. The mood improved when the new M5S/Lega Conte government got approval from President Mattarella after proposing an economy minister who is not overtly in favour of quitting the euro. But then the US fanned worries over a trade war by approving customs duties on steel and aluminium imports, a negative development for Europe. 

Financials continued to fall along with auto stocks. Defensives like consumer staples and pharma gained and tech stocks continued to advance. 

Oil stocks rose on buoyant oil prices while companies with exposure to Brazil like Edenred, Sodexo and Casino were hit by the strikes there. 

Deutsche Bank tumbled on news that one year ago, its US affiliate had been added to a secret list of troubled banks that US regulators monitor. The bank had been forced to reduce its risk businesses. Iliad gained after launching a €5.99€/month easy-to-use mobile offer in Italy. Vivendi fell after Canal + lost its right to broadcast France’s top league football matches from 2020. Dialog was hit after Apple, (70% of its sales), said it was to use a second firm to provide power management integrated circuits (PMIC) for its iPhones. 

Elsewhere, Michelin completed its €1.48bn acquisition of Fenner. Ingenico is in exclusive talks with BS Payone over contributing its retail assets to a joint venture in Germany, Austria and Switzerland. Bayer received the green light from the US and Canadian authorities for its acquisition of Monsanto but on the condition that it would sell €7.5bn in assets to BASF. KWS has reportedly counterbid to acquire Nunhems’ vegetable seeds business from Bayer. Thailand’s Minor Hotels has offered to buy the 29.5% held by HNA in NH Hoteles and will have to launch a bid in compliance with Spanish law. FCA is considering divesting brands in China and the US. 

  US equities

In a short Memorial Day week, the S&P 500 slipped 0.8% and the Nasdaq was flat, accentuating the YTD performance gap in US dollars to +1% for the S&P vs. +8% for the Nasdaq. May’s consumer confidence index hit 128, stabilising at highs not seen since 1999/2000. Core PCE inflation, the Fed’s preferred gauge, for May came in at 1.8% or in line with expectations and the trend seen in the previous months. 

Donald Trump's decision to withdraw custom duty exemptions for the European Union, Canada and Mexico surprised markets. Paul Ryan had already publicly disapproved the move, so it was in no way a unanimous decision. Its immediate impact should be marginal, at least for the EU, but markets fear an escalation. 

Meanwhile, banking sector deregulation continued apace. After Congressional approval last week for a watering down of the Dodd-Frank Act, the Volcker rule is set to be unwound. The regulator has released a new text to give banks more freedom in market-making. 

Elsewhere, further declines in 10-year Treasury yields boosted long duration sectors. Over the week, utilities, property and tech posted the best returns while financials and commodity stocks lost ground. 

  Japanese equities

Japanese stocks continued to decline on worries over US trade protectionism, political confusion in Italy and Spain and the yen’s rapid rise against the US dollar and the euro. 

Bearish sentiment on global equity markets triggered by political uncertainty and concerns over Italy’s bonds had negative effects on Japan too. During the week, the TOPIX fell 1.37%, with the biggest fall on Wednesday although oversold companies rebounded on Thursday. 

Companies exposed to foreign demand or with a high percentage of sales in Europe like Isuzu and Mazda were weak. Major bank and insurance stocks were hit by worries over mounting capital losses from foreign bond investments. 

Almost all sectors except Other Products (+2.52%) and Food (+0.01%) ended lower. Nonferrous Metal (-4.49%), Pulp & Paper (-3.81%), Marine Transportation (-3.63%), Iron & Steel (-3.60%) and Oil & Coal Products were among the five worst performing sectors.  

On the other hand, game producer Nintendo jumped 5.96% while up-market cosmetics producers like Shiseido and Kao gained 3.17% and 1.70% respectively as tourism to Japan increased.  

  Emerging markets

The MSCI China index is including 226 Chinese A shares, representing 2.5% of the index and 1.5% in the MSCI Emerging markets index. Another share quota representing 2.5% of the index will be added in August. With A shares then representing 5% of the MSCI China, an estimated $18.4bn could flow in. Inflows are as yet not very strong as only 3% of the quota has been used. Elsewhere, China’s May PMI came in at 51.9, up from 51.4 in April, or the highest level since September 2017. 

After being accused of falsifying its accounts by Blue Orca, Samsonite answered each of the accusations and decided to change its CEO. The group's convincing explanations helped the stock rally 9.85%. In healthcare, CSPC’s results surged 43% or better than expected. In Indonesia, the central bank unsurprisingly raised its base rates by 25bp for the second time in two weeks in an attempt to counter the Rupiah's fall. India’s first quarter GDP rose 7.7%, or more than expected but the figure warrants caution as company results might mean it is not that accurate a reading. South Korea also released an encouraging 3.4% rise in April’s industrial production thanks to strong semiconductor and auto sales. 

Brazil’s truck strike ended after the government agreed concessions that will increase government spending by 6.8%. Diesel subsidies will only stay in place until December. We expect overall second quarter results will be hit by the strike and the knock-on impact on company and consumer confidence levels. Petrobras raised petrol prices in a sign that price parities were in place. As management pointed out last week, its diesel subsidies were only for a period of 2 weeks. First quarter GDP rose 0.4% (+1.2% YoY), or more than expected thanks to consumption and investment. In Argentina, President Macri vetoed a Senate-approved bill to limit water, natural gas and electricity price rises by scrapping subsidies. He also said talks with the IMF would be announced soon. 

The translation of upbeat economic indicators into strong emerging market performance will depend on (i) the extent of US rate rises and (ii) the level of protectionism that the Trump administration wants to impose on the rest of the world. 

  Commodities

OPEC/non-OPEC intervention in November 2016 set a new floor for Brent crude at $40. Oil then traded in a $40-60 spread amid excessive inventories. Rapid destocking following production cuts, as well as the steep decline in Venezuela’s output, resulted in the floor being raised to $60 but with a question mark on the new price ceiling.

Last week Saudi Arabia and Russia said they were in talks to increase production, thereby establishing a de facto ceiling for Brent at $80. The news sent prices down to $75 as traders unwound positions. 

The looming June 22 OPEC summit will decide on the extent and timing of production increases. An increase of 500,000 b/d minimum looks likely as that would offset the drop in Venezuelan production since September 2017. The maximum of 1 million b/d will probably depend on how Iran's exports fare in the second half amid US sanctions. 

Meanwhile, India's Reliance Industries, which owns the world's largest refinery at Jamnagar (1.2 million b/d) said it would halt imports of Iranian crude from October/November so as to avoid being hit by US sanctions, a decision that could increase oil market price tensions. India imports 18% of Iran’s output and is second only to China (24%). And yet India’s foreign affairs minister had just declared that the country would only respect UN approved sanctions and not those imposed unilaterally. We expect that production increases in Saudi Arabia and Russia will limit the fall in inventories over the second half but will not reverse the trend. 

China’s upbeat 51.9 in manufacturing PMI for May, the highest level since September 2017 contrasts favourable with February’s low point of 50.3 and shows that Chinese demand is still strong and even more so than expected. This is good news for commodity demand just when international trade is being buffeted by uncertainties due to Trump administration threats.

  Corporate debt

 

Credit

The Xover widened by a significant 20bp at the beginning of the week on political turmoil in Italy and Spain. Peripheral issues suffered the biggest falls. Financials were particularly hard hit with Intesa, UniCredit and Generali subordinated bonds losing as much as 4 points last Tuesday.

Investors were then reassured when talks to form an acceptable Italian government finally succeeded and markets rallied.  

In a busy week for results, CMA-CGM (B1/B+, shipping) reported a 17.1% rise in sales over a year due to strong volumes but EBITDA slumped 43% on much higher oil prices and steeper logistic costs. Salt (B2/B+, telecoms) saw sales stabilise at CHF 249m with a slight 1.8% rise in customers while EBIDTA rose by an upbeat 12.8% thanks to cost discipline. Fives (B2/B+, industrial group) reported a 3% rise in quarterly sales but EBITDA plunged 44% due to additional costs. Due to sanctions against Rusal and Iran, the group has downgraded its 2018 objectives. Spain’s Aldesa (B2/B2, construction) reported a satisfactory 28.2% rise in sales and EBITDA over a year as Spain improved but cash consumption remained high. Loxam (BB-, building equipment hire) saw sales rise 15.6% over a year and EBIDTA 18.2% higher thanks to a rebound in construction in France. Paprec (B1/B+, recycling) saw sales up 33% and EBITDA 35% higher thanks to its acquisition of Coved (+157% in volumes). But FCF and debt ratios worsened due to refinancing and acquisitions. 

Convertibles 

On Japan’s primary market, payments services provider GMO Payment Gateway raised JPY 17bn with a 5Y zero coupon convertible to finance working capital. Another deal came from China GDS Holdings, a NASDAQ-listed developer and operator of data centers, which raised $250m in 7Y convertibles at 2% for the development and acquisitions of new data centers and debt repayment. 

In Asia, Malaysian healthcare provider IHH Healthcare was down close to 5% due to the negative impact from FX TRL and SGD over first quarter sales and EBITDA which came in 7% and 11% below estimations. It also confirmed plans to acquire a controlling interest in North India-based Medanta Hospitals and said it also wanted to acquire 34-35% in India Fortis Healthcare

In Europe, Glencore (commodity trading and mining) was upgraded by S&P to BBB+ vs. BBB (amid decreasing leverage versus 2015 levels). Pierre & Vacances (tourism) reported a 2017/2018 results miss at €654.8m (+6.5% YoY); the €94.9m operating loss was due to higher charges and the renovation of center parcs, notably in Vielsalm in Belgium. Nexity (Real Estate) upped its stake in Aegide (senior homes) from 45.15% to 63.15%.

Elément complémentaire