A difficult week

Market analysis - 11/23/2018

It was another difficult week with mostly the same preoccupations.
  • doubts on the strength of the global economy
  • worries over company margins
  • looming monetary policy normalisation
  • threats to global trade
  • concerns over a no-deal Brexit
  • the stand-off between the European Commission and Rome over compliance with budget standards. 

Two new issues - mounting concerns over US tech stocks and highly leveraged companies - joined the party. The only positive development came from company valuations falling back to, and even a little below, their 10-year average. We are hoping for an equity market rebound as this sell-off strikes us as being both premature and excessive given the expected pace of global growth in 2019. 

  European equities

The week's headline event was the arrest of Carlos Ghosn, Renault’s CEO and Nissan's chairman. He was accused of (i) knowingly under-reporting his total remuneration in the official disclosure to Japan’s stock market authority, (ii) embezzlement, and (iii) fraudulent use of the group's investments. The arrest apparently coincided with his plans to merge the two groups and it inevitably raises questions over the future of their alliance, an arrangement which goes back to 1999 when Renault bought a stake in Nissan and sent Carlos Ghosn to turn around a company that was about to go under. The alliance will be difficult to unwind because of its operational nature: 80% of its activity will be on shared platforms up to 2022 and synergies are expected to increase to €10bn. For the moment, Carlos Ghosn has been dismissed with the unanimous approval of the Nissan board and Thierry Bolloré is to be Renault’s acting CEO and Philippe Lagayette its temporary chairman. It remains to sort out the tricky issue of the alliance’s shareholding structure which Nissan would like to be more balanced.  

Elsewhere, a few laggards reported third quarter figures. Compass posted results in line amid upbeat operational trends but cement maker CRH disappointed investors with its EBITDA forecasts for the year. Enel’s investors’ day reassured markets by raising 2019-21 objectives and reaffirming its 70% payout. Its 2019 yield should be at least close to 7% thanks to its strong presence in high visibility regulated businesses. Generali presented a 3-year plan to investors which includes raising its payout ratio.

Volkswagen is to call a board meeting before the end of 2018 to discuss spinning off its truck division and UniCredit is mulling the separation of its Italian activities from those in the rest of Europe.

Société Générale reached an agreement with the US Department of Justice and will pay a $1.3bn fine which is already provisioned in its accounts. 

  US equities

In a shortened Thanksgiving week, the S&P shed 3% in relatively thin trading and moved into negative territory for the year. In addition, macroeconomic data fell short of expectations. Housing starts rose 1.5% instead of the 2.2% pencilled in, durable goods orders fell 4.4% (-2.6%) and the University of Michigan’s consumer confidence gauge slipped to 97.5 from 98.3 in the previous month. In fact, markets were chiefly dragged down by the unwinding of consensus positions and tensions on bond markets.

US Vice-President Mike Pence toughened his stance towards China and warned that the US would not budge as long as Beijing stuck to its ways. His tone diminished hopes for an agreement at the forthcoming G20 summit in Argentina. Elsewhere, the Asia-Pacific Economic Cooperation summit ended with no joint declaration for the first time in 20 years.

In company news, Foot Locker jumped 15% after like-for-like sales rose 2.9% or above the 2% expected and GAP enjoyed a 5% bounce following news of the CEO's ambitious restructuring plan. Apple lost a further 5%, taking its month-to-day drop to 20%, as its suppliers said orders were falling.

Consumer discretionary and tech fell 4% and 5% respectively while defensives like property and utilities cushioned the slide by only losing 1%. 

  Japanese equities

Japanese stocks were dragged down by bearish sentiment on US tech stocks. The TOPIX edged 0.02% lower.

Earnings for the end-of-September quarter were mixed with some falling short of strong investor expectations of upward revisions. We saw both upward and downward revisions, but unlike last year, upward guidance had only a limited and fleeting effect on stock prices. However, note that gaps between valuations and earnings have expanded somewhat. The average Nikkei 225 PE fell to 12.13 times, or the low end of its historic range. 

Domestic demand-related Food, Land Transportation and Electric Power & Gas were relatively firm while Mining, Oil & Coal products and Insurance underperformed.

SPE producer Tokyo Electron rebounded 7.85%. On the other hand, global auto producer Nissan Motor fell 4.80% over the week (and by as much as 7% at one point) on the shocking news that its charismatic chairman Carlos Ghosn had been arrested for under reporting his earnings by JPY 5bn in his public disclosure statement. Mitsubishi Motors, which has a strategic alliance with Renault and Nissan, also lost 7.8%. 

  Emerging markets

The APEC (Asia-Pacific Economic Cooperation) meeting last weekend ended without a joint statement for the first time ever. Deep US-China divisions over trade and investment, as evidenced in speeches given by Xi Jinping and Mike Pence, stymied cooperation. The update from USTR on China’s practices accessing US technology in EV, Biotech and Semiconductors did not help ease tensions either days before the G20 meeting. During the local elections on November 24-25, Taiwanese voters will also decide whether to change the name of the island's Olympic team to "Taiwan" from "Chinese Taipei", a move that could bolster independence advocates and roil already fraught ties with China.

The latest high frequency data from China continued to show growth moderating, even in consumer staples. Baozun, China’s e-commerce solution provider, reported better-than-expected third quarter results with GMV up 55% YoY and operating margins 49% higher but with slightly reduced guidance of +40-45% for GMV in the fourth quarter. Meituan (food delivery services in China) reported 97% YoY sales growth in the third quarter but the swing into profitability is being pushed out another 6-12 months given the macro slowdown and tougher competition from Alibaba’s Ele.me. Foxconn, Apple’s biggest phone assembler, is said in an internal memo to be cutting $3bn in investment next year to tackle a difficult and competitive environment.

In Thailand, the cabinet approved a stimulus package amounting to around 0.5% of 2017 GDP to help low-income households and revive growth after weak third quarter GDP, a drop in Chinese tourists and rising political noise. Airport of Thailand said total passenger volume MTD in November rose by only 1.2% vs. 3.2% in October. Plans to build the second terminal at its main Suvarnabhumi Airport have been delayed for approval.

In India, Reliance Industrial traded higher on reports it was looking to spin off its 'Reliance Retail' arm.

Brazil’s central bank issued 2 norms to simplify and reduce reserve requirements for the country’s banks. Rubem Novaes was appointed as new CEO of Banco do Brasil

  Commodities

Within the same week, oil prices had their two most volatile days ever, losing close to 6% on November 13 and almost 7% on November 20. These falls were not down to fundamentals even if they are not as rosy as a few weeks ago, what with Iranian sanction exemptions, Libya’s recent increase in output to 1.2 million b/d, the highest level since 2013 (compared to 1.5m in 2010 and only 400,000 in 2016) and doubts over growth demand in 2019. The main reasons were the technical factors discussed last week such as CTA/Momentum strategy shorts, unwinding of long positions and negative gamma on options markets (the WTI $50, 55 and 60 strikes saw particularly heavy trading). And all this is occurring as market liquidity contracts ahead of the year end.

This situation could well last until the next OPEC summit on December 6. We also have to factor in Donald Trump’s tweets calling for low prices plus the fact that the Khashoggi incident has given him extra clout over Saudi Arabia. And yet Saudi Arabia is clearly intent on cutting exports. It has already dipped into its inventories to satisfy the market. The question is whether the cut will be enough to assuage market concerns. 

  Corporate debt

 

Credit

Credit spreads tightened by 13bp on the Xover and 3bp on the Main between Monday morning and Tuesday's close. Finalising Brexit withdrawal agreements looked complicated with Theresa May meeting opposition from some Conservative MPs while Italy refused to amend its budget proposals. The European Commission said the excessive deficit procedure would be rolled out for Italy.

But the market rebounded on Wednesday when progress on Brexit was announced and Rome suggested there might after all be room to manoeuvre on budget talks.

Financials fell at the beginning of the week but then rebounded sharply. Deutsche Bank came under attack on reports that it might be involved in the Danske Bank money laundering scandal.

Packaging group Klöckner Pentaplast’s bonds fell on a disappointing drop in EBITDA, worsening liquidity and a downward revision in its 2018 targets. Vallourec’s bonds followed suit after poor results which highlighted strong free cash flow consumption. Altice Europe (B1/B) missed expectations but reaffirmed its 2018 objectives. Aldesa (B2) reported a fall in results on reduced business in Mexico which resulted in overall sales dropping 19% over a year.

BUT (B2/B), however, surprised markets with a 4.6% rise in sales with EBIDTA 6.6% higher and despite a sharp fall in the furniture market. After recent weakness, there was strong buying of plane and train manufacturer Bombardier on news that the government might work with the group if necessary.

Renault fell after its CEO Carlos Ghosn was taken into custody in Japan on charges of flouting financial regulations. The arrest of the Nissan/Renault head casts doubts on the future of their alliance and could result in serious additional costs.

Nyrstar (Caa1/CCC), which has liquidity problems, should benefit from another WCR facility for $650m from Trafigura. The facility should be available on November 30 and will replace the current $250m arrangement. 

Convertibles 

Wall Street’s falls at the beginning of the week sent markets into risk-off mode while in Europe, Brexit and Italy’s draft budget continued to worry investors. Technology, financials and materials led declines.

The week was rather active for new issuances with a jumbo deal in China. In Japan, the primary market re-opened after the earnings season with two new deals.

Takashimaya (department stores) raised ¥60bn with a 10-year convertible at a 15% premium. ¥40bn will go on repaying the 2018 convertibles with ¥20b for capital expenditure and IT infrastructure. Cosmo Energy Holdings (oil refiner and distributor) raised ¥60bn with a 4-year convertible at a 13% premium to invest in its petrochemical arm and other businesses like renewable energy. Country Garden Holdings, a Chinese real estate developer, issued a HK$ 7.83bn 4.5% convertible due 2023 to fund the partial repurchase of its 2019 convertibles.

On the secondary market, Covestro issued a profit warning due to tougher competition. Ence Energia Y Celulose announced a new strategic plan to diversify its business and strengthen new product lines. The plan was well received by the market and resulted in a couple of upgrades. SBI Holding lost several percent due to its exposure to the crypto-currency business.

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