A chaotic start to 2019

Market analysis - 1/21/2019

In the last 3 months, the prospect of less central bank liquidity, the risk of a hard Brexit, Italy's budget conflict and the ongoing trade war have all conspired to make markets lose their bearings.

The uncertainty has ended up weighing on company momentum and probably on global economic growth. Earnings estimates will definitely be revised lower even if we see no recession in 2019.

All these risks could materialise but we believe the market correction has gone too far. Inflation risk has evaporated due to sharply lower oil prices, a development that will also boost purchasing power.

As a result, we remain upbeat on equities but a short term rebound only seems possible if Theresa May succeeds in getting her Brexit plan approved by Westminster next week and if the US and China reach a trade agreement in the coming weeks. In the meantime, with Bund yields down to 0.17%, government bonds are acting as a temporary, and probably dangerous, safe haven. 

  European equities

After a very mediocre 2018 for European equities, the MSCI TR index ended the year 10.6% lower. Midcaps even lost 12.9% and 2019 kicked off with not very encouraging data. China’s Caixin/Markit manufacturing PMI for December fell to 49.7, or below the symbolic 50 mark which divides expansion from contraction, compared to expectations and a previous reading of 50.2. The survey, which polls purchasing managers, confirmed the data released by Beijing two days earlier.

Sentiment also took a knock when China’s president Xi Jinping issued warlike statements to the effect that China would react to any foreign interference in Taiwan. But the biggest downer came from Apple which slashed its first quarter revenue forecasts, essentially because of soft emerging markets, and continental China in particular. The news dragged the entire tech sector down, notably Apple's semiconductor suppliers, but also luxury names and companies likely to be hit by the US-China trade war.

However, at the end of the week, markets bucked up after China unveiled measures to stimulate the slowing economy by cutting banks’ required reserves to free up money for loans and lowering company taxes and charges.

The good news came from Airbus which announced 2 firm US orders worth a catalogue price of $11bn for 120 A220-300 planes, 60 for JetBlue and 60 for Moxy. The A220 is, in fact, Bombardier’s ex-C Series which comes in two versions, one with 110 seats and the other with 160. Both orders represent 30% of the programme’s total order book which had 402 orders from 19 airlines before it was taken over by Airbus last year. The A220-300 will be built in Airbus’s new Mobile Alabama factory where the group has installed an assembly line for its A320 family. Production is expected to start at the end of January.

In another reassuring news item -given complicated weather and falling consumer confidence - NEXT’s trading statement was generally in line with guidance even if the group slightly trimmed its pre-tax forecasts. Sales rose 1.5% in November and December, or more than the 0.5% expected by the consensus, largely due to online sales jumping 15.2%, or well ahead of expectations of +9.7%. Retail sales, however, fell 9.2% or more than the 7.3% drop expected. 

  US equities

The mood remained just as uncertain as at end 2018. The S&P 500 ended the period 0.8% lower and the Nasdaq fell 1.4%. December’s manufacturing ISM hit a 2-year low of 54.1, down from 59.3 in November. In contrast, the jobs market looked just as robust with the ADP survey saying 271,000 private sector positions had been created in December.

Apple’s profit warning depressed the tech sector. The group now sees revenues falling 5% in the fourth quarter of 2018 due to weak iPhone, iPad and Mac sales in China. The news stirred fears of a fresh fall in Chinese consumer spending and sent all China consumption stocks lower.

M&A continued in the healthcare sector. In a deal worth around $74bn, or a potential premium of 60%, Bristol Myers is to acquire US biotech Celgene. The energy sector recovered by 1.13% over the period thanks to a slight rebound in oil prices. 

  Japanese equities

Japanese equity markets were closed from Monday 31st December 2018 to Thursday 3rd January 2019. During the break, the JPY/USD surged on speculative trading, hitting 104 at one stage before returning to around 107 after Apple slashed its sales forecast citing worse-than-expected trading in China. Yen appreciation and sharp falls on Wall St meant trading in Tokyo began the new year in bearish mode on growing concerns over a possible global downturn.   

During 2018, the TOPIX (with dividends) fell 16.26% and the Nikkei 225 12.08%. Unlike the previous year, small and mid-cap stocks underperformed large caps. High PE growth stocks were especially hit by foreign selling. Domestic demand defensive sectors such as Electric Power & Gas, Consumer Goods and Land Transportation outperformed external demand-related sectors including semiconductors and machine tool manufacturers. The Nikkei China Related Stock 50 Index (-18.08%) underperformed due to China’s slowdown.

For 2019, Japan’s domestic economy remains robust but external political factors like the US-China trade dispute have started to have a real impact on global economies and Japan’s economic-sensitive, external demand-related sector earnings. Appropriate individual stock selection using bottom-up analysis to identify solid earnings is essential in such a situation.

At end 2018 year, the 1-year forward P/E ratio fell to 11.22 for the Nikkei 225 and 12.62 for the TOPIX. 

  Emerging markets

China and the US said they would be holding vice-ministerial level trade talks on January 7-8. After the market close on Friday, the PBoC cut its RRR by 1%, thereby making RMB 1.5 trillion available for seasonal loan demand before the Chinese New Year. Recent macroeconomic data pointed to a continued slowdown: November industrial profits fell 1.8% YoY, the first contraction in 3 years and NBS manufacturing PMI for December was 49.4, the first time it had fallen below 50 since July 2016.

Online gaming approval resumed before the year-end with a first group of 80 games, although the key games developed by Tencent and Netease were not included in the first batch. Kweichou Moutai announced planned volume growth of 10.7% in 2019, and a preliminary 23% rise in 2018 revenue growth. Ping An Bank reported preliminary 2018 profit growth of 6.9%. Apple guided down sales for the December quarter, highlighting weakness in Chinese iPhone demand. The news hit all Apple’s Asian supply chain.

India’s passenger vehicle industry saw medium & heavy commercial vehicle volumes fall 20%-22% YoY in December, a second consecutive month of double-digit declines. The headline fiscal deficit narrowed to 3.8% of GDP in November from 4% in October, the first decline in the past seven months.

In Brazil, the highlight was Jair Bolsonaro’s inauguration speech, which reinforced his liberal agenda. Finance minister Paolo Guedes put the emphasis on reduced pension spending, state-owned asset sales and tax system simplification. Nevertheless, there were some positive surprises: Jair Bolsonaro’s PSL party supported Rodrigo Maia as Lower House speaker, increasing the probability of reform approval in the first half of 2019 and Eletrobras is to be recapitalised which could mean privatisation later on. The new president also announced a minimum salary increase that was lower than expected, translating into a R$ 2.4bn fiscal gain. The Government also confirmed the end of the fuel subsidy program. Petrobras raised diesel prices by 2.5%. The Brazilian economy also gave clear signs of recovery. Retail sales rose 7.7% in the weeks before Christmas, the best performance since 2015. Fenabrave (Brazilian Association of Vehicle Distribution) reported a strong 10% YoY increase in auto sales in December and forecast an 11% increase for 2019.

In Mexico, PMI and business confidence continued to deteriorate in December.

Russia’s central bank announced another rate hike for unsecured consumer loans, the second tightening since the beginning of 2018, as unsecured retail lending was up 2.3% MoM as of November 2018. 

  Commodities

Brent crude dipped below $50 during the Christmas holidays to an August 2017 low but then rallied at the beginning of 2019 to over $56.

December’s big sell-off was due to the combined effect of the worsening macroeconomic environment and doubts that OPEC would be capable of stabilising the market with enough production cuts. Global manufacturing PMI for December hit a 2-year low, not exactly a reassuring sign of industrial production and demand trends. However, the recent oil rebound reflects a more reassuring demand picture. Reuters says OPEC cut output by 460,000 b/d in December compared to the previous month, largely because of efforts from Saudi Arabia, Libya and the UAE. Remember that the OPEC/non OPEC December 7 agreement said OPEC would cut by 800,000 b/d from January and non-OPEC countries by more than 400,000 b/d so the data would suggest that OPEC has moved early. Recent tanker data confirmed a drop in oil exports and that should mean further inventory declines in the US of the sort seen over the week. Traders slashed positions in December and are probably back on the market but with more positive bets.

Meanwhile, gold benefited from the uncertain environment in 2018 and expectations that Fed hikes might not be as big as previously thought. The gold ounce is now trading at $1,295, its highest level since June 2018. 

  Corporate debt

Credit

The New Year started lower and the trend continued throughout the week. Concerns over a global slowdown amplified after disappointing Chinese manufacturing data and Apple’s profit warning. The Xover widened by around 20bp between Wednesday and Friday and the Main tightened by 5bp.

After Banca Carige’s failed rights issue attempt in December, the ECB put it in special administration. The bank had to increase its capital or find a buyer before the end of 2018. The Consob, Italy's market regulator, suspended trading in the ailing bank's shares and bonds.

Dia rose this week after losing ground in recent months. The group unveiled a bank funding agreement which included a short term €125m credit line and said it intended to press on with selling Clarel and Max Descuento. The funding will ensure business continuity over the short term but investors are particularly worried that the increase of capital might not succeed.

Grifols sold two recently acquired subsidiaries, Biotest USA and Haema for $537m. This will reduce leverage by 0.3 times and the group will retain a call option on both companies allowing it to buy them back after a year.

The new issues market revived this week. Toyota Motor Finance (Aa3/AA-) raised €500m over 3 years at 0.25%. BNP Paribas issued Senior Non-Preferred bonds over 6 and 11 years, raising $1.7bn and $900m at 4.705% and 5.198%. But their rather large issue premium subsequently weighed on French bank spreads. 

Convertibles 

Markets started 2019 as they finished 2018. In the US, December’s manufacturing ISM hit a 2-year low of 54.1, dragged down by Richmond for transport and Kansas City for production. And China’s Caixin manufacturing PMI moved below 50 for the first time since May 2017. All this weighed on markets and especially mines and metals which underperformed. Energy managed to do a little better thanks to the oil price rebound following OPEC’s December decision to reduce quotas. 

The entire tech sector tumbled after Apple issued its first profit warning in 16 years. Stocks like AMS (-23%), STMicroelectronics (-11%) and Microchip Technology (-7%) were particularly hard hit. Apple itself plunged 10%.

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