The week got off to a good start

Análisis de mercado - 31/08/2018

The week got off to a good start but profit taking returned on rumours that another $200bn in Chinese imports were to be hit by higher US duties and by a relapse in emerging country currencies led by the Argentine peso and the Turkish lira. (English version)

Unfortunately, these developments took the shine off upbeat IFO figures in Germany and the US Conference Board consumer confidence index which hit 133.4, its highest level since 2000. 

Elsewhere, Fed chairman Jerome Powell delivered a reassuring Jackson Hole address in which he reaffirmed robust growth in the US (currently growing at 4.2%), his independence with regard to presidential tweets and his determination to press on with monetary tightening but at a moderate pace. 

Nevertheless, risks like Italy’s budget and Brexit continue to weigh on eurozone equity valuations. Without these clouds, the zone would warrant more interest from international investors. We continue to favour US equities -their gains are simply a reflection of expected earnings increases- as well as eurozone equities which look over-discounted. 

  European equities

Risk sentiment improved at the beginning of the week after hopes for a US-Mexico agreement on NAFTA helped cyclicals like autos, construction and chemicals to rally after underperformance in previous weeks. Banks, utilities and telecoms, however, underperformed. Aerospace (Safran, Thales, MTU) and technology (SAP) continued to perform well due to their sought-after structural growth/quality profiles. But from Thursday, persistent concerns over a trade war, Italy and certain emerging market economies caused risk aversion to resurface on Europe's equity markets. The euro retreated while Italian spreads widened. 

Pernod Ricard reported rather satisfactory figures and the outlook for higher margins helped the group revise guidance higher. 

But the stock fell after management said they could cut prices to retain market share if required. Unibail fell even if its results were expected: occupancy rates slipped 140bp and there was no lift to guidance. In telecoms, Iliad fell sharply, unlike Bouygues whose half-yearly results beat expectations with construction stabilising in the second quarter and further improvements in its telecom division which gained 161,000 subscribers. Ingenico was hit by fears that competition from Amazon in Japanese mobile payments might threaten its hardware. 

In retail, Metro rallied sharply on news that a Czech-Slovak tandem had acquired 7.5% of the shares. Ceconomy might now sell its 10% stake. Spain’s DIA (hard discount) signed an agreement to join central buying unit Horizon International Services with Casino, Auchan and Metro.

Following the resignation of DIA’s CEO, press reports suggested Letter One which owns a 25% stake might launch a bid with Goldman Sachs. 

Tarkett reinforced its North American exposure by buying Lexmark, the leading manufacturer of carpeting for hotels. The UK’s Whitbread is selling its Costa café chain to Coca-Cola for an enterprise value of £3.9bn. 

  US equities

It was another week of records for equities with the S&P500 gaining 1.6% and closing for the first time above 2,900 and the Nasdaq up 2.6%. US consumer confidence beat expectations, coming in at 133.4, its best level since October 2000! The second reading of second-quarter GDP growth came in at 4.2% while PCE inflation rose 2% in July, or at the same pace as in the first quarter. 

Donald Trump persisted with his tough strategy towards China. Civil servant sources in Washington claimed that he wanted to slap duties on another $200bn of imports. So far, extra duties concern $50bn in goods. The President also made waves this week by accusing Google of only channelling bad news about him. 

In company news, Yoga apparel specialist Lululemon gained close to 5% after reporting a 19% jump in like-for-like sales. However, Best Buy (electronic goods retailer) plunged 6% after disappointing second-half guidance. Electronic Arts (video games) also disappointed investors and tumbled by 10% after revising 2019 prospects lower. 

Technology and cyclicals led gains while defensives like telecoms and consumer staples lost ground, both in relative and absolute terms. 

  Japanese equities

Higher hopes for a US-Mexico agreement on NAFTA renegotiations and gains on the NASDAQ helped Japanese equities rebound.

Although upside was still limited, the TOPIX gained 1.75% with investors gradually adopting a risk-on stance ahead of the US mid-term elections and Japan’s governing party president elections. Prime Minister Shinzo Abe is seen as the winner in September. 

There was strength from economic sensitive sectors like Marine Transportation (+4.85%), Nonferrous Metals (+4.17%), Oil & Coal Products (3.59%), Machinery (+3.43%) and Electric Appliances (+3.25%). As in the US, high-tech names such as Nidec (+5.11%), Nitto Denko (+4.84%), Sony (+4.77%) and Murata Manufacturing (+4.62%) were among top performers. There was also strong performance from Rakuten (+7.57%), Komatsu (+6.44%) and Nintendo (+5.60%). 

On the other hand, Electric Power & Gas (-0.21%), Retail Trade (-0.13%) and Construction (-0.09%) failed to rebound. 

Small & mid-cap stocks, which saw heavy selling last week, rebounded and outperformed large caps. 

  Emerging markets

Donald Trump suggested China could be hit by 25% duties on another $200bn of imports, thereby aggravating trade tensions, but there was good news from Mexico where a new trade deal looks as if it might soon be signed. The agreement stipulates that US-manufactured car parts in an imported car should rise from 62.5% to 75% and that 40% of cars must be made in factories where employees earn at least $16 an hour. The deal will require US Congressional approval within 3 months. The draft agreement was a relief but it failed to help Mexico’s equity index rise over the week, partly because lower oil production caused the current account deficit to worsen to $2.9bn instead of the 1.5bn expected. 

Brazil’s current account deficit also continued to worsen, rising to $4.4bn in July, or higher than the 3.6bn expected. The Real slipped on the news and has now lost 25% against the US dollar year to date. 

But the Argentine peso has done even worse, with a 53% decline against the US dollar. This week, the central bank was forced to raise rates by 15% to 60% and hike minimum reserve requirements from 31% to 36%. 

Even the renminbi continued lower, though to a lesser extent. It is now down 5% against the US dollar so far this year. China’s manufacturing PMI came in at 51.3 in August, or better than the 51 expected, mainly because of construction. July’s industrial profit growth remained at an upbeat 17.1%. To underpin economic growth and minimise the impact from trade conflicts, China’s tax authorities want to raise income tax entry levels on monthly earnings from 3,500 to 5,000 renminbi. The change will probably be effective in October. And to address short-sightedness among young video game addicts, Beijing has appealed to parents to reduce the time their children spend playing and standardise character size and game brightness levels. The news triggered heavy selling of Tencent and NetEase. In autos, Guangzhou Automobile's results rose 10% as expected and Brilliance beat consensus expectations for a 38% rise by actually posting a 54% increase. China Construction Bank and Agricultural Bank both reported results in line, +6.3% and +7% respectively. Tsingtao’s recurrent operating profits, however, only rose by a disappointing 1%. In India, a court in Allahabad ruled against giving failing electrical power companies any extra time to find solutions with their creditor banks. In Brazil, PagSeguro reported a superb 125% increase in results. 

Most emerging countries are having more and more trouble in funding their external accounts. And any aggravation in the US-China trade conflict would only make the problem worse. That is why we remain cautious over the short term even if most companies have reported upbeat quarterly figures. 

  Commodities

Oil prices continued on their rebound, gaining 2% over the week. Brent crude traded at $77, or close to levels seen in early July, but WTI lagged even if it moved above the symbolic $70 mark.

Pipeline infrastructure constraints in the Permian basin are starting to feed through. Texan output in July fell 2% for the first time in 16 months and was down 4% over a month, resulting in a $18 gap between local Midland reference oil and WTI. New pipelines are planned but will only be effective from the second half of 2019. International tensions resurfaced. Iran is threatening to block the Strait of Hormuz, which sees 30% of global tanker volume, if it is prevented from exporting its oil. Available data suggest Iran's exports are set to fall sharply to 1.5 million b/d in September, down from 2.3 million in June, or before sanctions actually come into force. At the same time, Chinese oil demand is once again rising steeply and rose by 1.2 million b/d over a year in July to 12 million. China’s manufacturing PMI for August rose to 51.3 which suggests demand will continue to rise. Donald Trump plans to release 11 million barrels from the Strategic Petroleum Reserve between October and November, probably to limit any increase in petrol prices before the mid-term elections. That would represent 183,000 b/d over 2 months, in other words not very much. OPEC/non-OPEC countries which are currently committed to production cuts have started to formalise a longer-term cooperation agreement. The goal is to improve coordination on price stabilisation moves in the best interest of producers and consumers. A charter is scheduled for the end of 2018. 

The gold ounce moved back above $1,200 on US dollar weakness even though COMEX shorts remained extremely high. Pressure is expected to continue at least until the next FOMC meeting in September. If the Fed gives no sign of another rate hike in December, the message will be very positive for gold. 

  Corporate debt

 

Credit

The market fell with the Xover widening by about 9bp. Trade fears persisted despite the US and Mexico moving towards a reformed version of NAFTA and a resumption in talks with Canada. Political risk also continued to weigh with concerns over Italy’s budget and delays in Brexit talks which have heightened the risk of a hard exit.

Casino/Rallye securities suffered further selling after a Swiss bank cut its target price, citing the group's high leverage and its complex structure. Astaldi's bonds also shed around 15 points on press reports that its bank creditors had asked the group to launch a restructuring plan to deal with uncertainties over the sale of its Turkish assets which are key to the increase of capital.  

Bonds issued by Douglas (B/B2) fell on like-for-like sales falling in most regions and a 20.8% plunge in EBITDA. On a more satisfactory note, Selecta Group (B3/B, vending services), saw sales edge 0.4% higher and confirmed guidance while Salt (B2/B+, telecoms) reported some stabilisation in sales but lower EBITDA. More encouraging figures came from clothing retailer CBR Fashion (B2/B), which saw sales rise 3% and EBITDA 14% higher over the quarter. In construction, sales at Loxam (BB-) rose 4.8% over a year thanks to a rebound in France and Algeco (B2/B-) reported a 17.8% jump in second-quarter sales. 

In new issues, RBS, HSBC, Sabadell sold senior preferred debt in an active market. Svenska Handelsbanken raised €750m with Tier 2 maturity of around 10 years at 1.625%. The investment grade market resumed with issues from Total, Unilever and Siemens.  

Convertibles 

It was a rather active week for new issuance in Asia but there were no new deals in the US and Europe. Next week should be busier in Europe. 

On Tuesday, Bunka Shutter (producer of light and heavy-weight shutters) raised JPY 10bn over 5 years with a convertible (16% conversion premium) to finance its recent acquisition of ArcPac Garage Door Pty and Roote’s. SBI Hondings, a venture capital fund mainly invested in internet related companies, raised JPY 50bn with a 2023 maturity at a 20% premium to repay loans and fund a share buyback and investments in FinTech, AI, and blockchain and digital asset-related businesses. 

On Wednesday, a third Japanese company Digital Garage (web solutions and business incubator) issued a JPY 25bn 5-year convertible at a 40% premium with the proceeds earmarked for a share buyback and growth investments. 

China Conch raised $400m over 5 years with a zero-coupon convertible to fund future project development. The company acts as an investment holding company providing energy preservation and environmental protection solutions but 80% of profits come from the Anhui Conch Cement Company. 

On the secondary market, Illumina 2023 continued to trade very actively, and Wright Medical Group N.V. (surgical solutions for the upper and lower extremities and the biologics market) paid $435m in equity to buy Cartiva. Elsewhere, Ciena convertibles traded higher on the back of a strong earnings surprise from the company due to market share gains and strong sales in its data center business.

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