A glimmer of hope

Market analysis - 11/2/2018

European and global indices turned higher after Donald Trump and Xi Jinping said trade talks were to resume.

Both leaders are due to meet at the G20 summit in Argentina at the end of the month. An improved outlook for Brexit talks also helped markets rally. An agreement before the end of November now looks possible with reports that a solution allowing UK financial firms to continue operating in Europe has been found. This is essential for the City as companies are already reorganising to avoid losing their financial passport.

Meanwhile, company earnings in Europe and the US were strong. As of November 2, 82% of US companies have seen earnings rise 23% on average, or 7% better than expected, with sales up 8% YoY. In Europe, 52% of Stoxx600 companies have seen profits rise 10% , or 3% above expectations, with sales 6% higher. Investors are, however, still worried about margin trends. Mixed messages from companies are still weighing on sentiment but the improvement in sales is reassuring.

With risk appetite reviving, European and US bonds reversed the flight to quality seen in the previous week and yields tightened. in the US, the movement was amplified by a rise in real rates with 10-year Treasury yields returning to 3.17%.

  European equities

A sharp rebound to end October and start November left investors feeling less aggrieved after a tricky month. Sentiment revived after Donald Trump tweeted that talks with China’s President Xi Jinping were going well. There were reports that he had asked his cabinet to draw up a draft agreement that might be signed at the G20 summit in late November. Hopes were also raised by better company results over the week. 55% of companies have released figures and 52% of them have beaten estimates with average earnings growth of 10% and sales up 6%.

The Bank of England left its rates unchanged but said it was ready to act after Brexit actually happened. Meanwhile, the Times said an agreement had been reached to leave UK financial firms with access to continental European markets. Sterling promptly gained 1.2% against the euro over the week.

Unsurprisingly for a sector awash with profit warnings, auto supplier Schaeffler said third quarter margins were 100bp less than it had expected in August. Management also cut margin guidance for the full year. But all was not doom and gloom in the car world: Volkswagen’s third quarter EBIT rose 10% more than consensus estimates and the group reiterated its full year guidance. Achieving it will now only require margins of 6.1% in the fourth quarter (vs. 6.4% in the third). 

Elsewhere, L’Oréal reported an impressive 7.5% jump in like-for-like sales after +6.5% in the first half. Good news, too, from Sanofi which has returned to growth with sales 3% higher than the consensus thanks to vaccine sales and EPS 8% better, half of which was due to improved operational performance. The group has raised the low end of its EPS guidance for this year from +3-5% to +4-5%. In similar vein, Airbus said EBIT was 12% above consensus estimates thanks to commercial aircraft sales that were 11% above expectations. In banks, ING's revenues and costs were both better than expected and a contrast with BNP where pre-tax profits came in 7% below consensus estimates.

  US equities

In a particularly choppy week, the S&P500 started off by shedding 2.5% before rebounding by 3.7% over three trading days. The Nasdaq was down 3.6% before jumping 5.4% over the same period. Such erratic market moves, including a fresh VIX record, are a strong sign of low investor confidence. In macro news, third quarter GDP grew 3.5% and ADP’s labour market figures showed 227,000 job creations, or much more than expected. Manufacturing ISM remained at a high 55.7 but was still sharply lower on the 59.8 seen in the previous month.

Market agitation was driven by earnings results but also by international political developments and fears that the US/China trade war would mean an economic slowdown. In company news, high-valuation FANG companies saw selling even if results still showed robust growth. In contrast, General Motors bounced 9% after its quarterly figures beat estimates. The group posted operating margins above 10% in the US thanks to a positive price effect from a new pickup launch and also made record profits in China.

In the S&P500, commodity stocks led gains with a 5.7% surge while financials rose 3% and industrials ended the period 1.8% higher. Utilities dropped 1.75% and property edged 0.3% lower.

  Japanese equities

After steadily moving lower in October, Japanese stocks rebounded over the last two trading days of the month. The TOPIX bounced 2.26% for the week.

Traders suddenly seemed to realise that stocks were oversold compared to solid corporate earnings and historic PE ranges and vs. global markets. SONY (+7.76%) attracted buyers after revising up guidance for the financial year ending March 2019.

Export sectors, which had been hit hard ,rebounded sharply. Electric Appliances (+6.37%), Chemicals (+4.83%) and Precision sectors delivered positive returns. Murata Manufacturing surged 20.93%, and SMC, FANUC, Shin-etsu Chemical, Mitsubishi Electric and Kyocera posted double-digit gains. Financials were also firm.

On the other hand, Information & Communication sank 7.05% after industry leader NTT DoCoMo said mobile phone service prices were trending lower due to Shinzo Abe’s efforts to help end users. NTT DoCoMo, NTT (the parent company) and KDDI all fell on concerns over the possible impact on earnings.

  Emerging markets

China rallied as sentiment turned more positive on  (i) US/China trade tensions easing with both Donald Trump and Xi Jinping expressing optimism after discussing trade issues, (ii) Xi Jinping promising a better environment for private sector firms. He assured more tax cuts and bailout funds were on the way, said private and public sectors would be treated in the same way and guaranteed protection of personal and property rights, (iii) incipient renminbi strength after flirting with 7 to the US dollar and (iv) Trump asking his cabinet to a draft trade deal. In results news, China Merchant Bank and ABC posted a rather robust rise in earnings with strong non-interest income growth. On the other hand, Moutai’s results disappointed as the company lacked the capacity to meet demand and made no price increases.

In India, HDFC reported upbeat results with 17% loan growth and good asset quality. According to a media report, the government intends to invoke powers under section 7  of the RBI Act which allows it to give specific directions to the central bank in the public interest. The discussion faded away after the RBI’s governing board threatened to resign. The board defended the need to protect central bank independence.

In Brazil, Jair Bolsonaro from the right-wing PSL party was, as expected, elected president with 55.5% of valid votes cast versus 45% for Fernando Haddad, leader of the Workers’ Party. Bolsonaro’s first speech was business friendly, emphasising Social Security reform; reduction of the fiscal deficit; lower government spending and debt stabilisation. He also talked about respecting the constitution, increasing liberties, reducing bureaucracy, zero tolerance in the fight against corruption and a more entrepreneur-friendly state, etc.

In Brazilian results news, Bradesco had a better-than-expected third quarter thanks to higher net interest margins, better asset quality and cost controls. Localiza also reported a strong 33% YoY increase in revenue and better rental margins, partially offset by higher depreciation in the used car segment. MercadoLibre  posted mixed third quarter results on decelerating gross merchandise volume but Fintech and logistic improvements accelerated.

Mexican markets were hit by President-elect AMLO’s surprise decision to cancel the new Mexico City airport project, citing a 4-day referendum result in which only 1 million people voted. We believe the next important factor to monitor is December’s budget proposal.

Although we remain prudent on emerging markets on global growth concerns, we welcome China’s initiatives to stabilise growth and the possible de-escalation of US/China trade tensions.

  Commodities

Since its October 3 high of $86, Brent crude has lost 16% or close to $14. Admittedly, this peak was perhaps overdoing it and fuelled by NYMEX traders going heavily long. The subsequent correction was due in part to risk aversion on concerns over economic growth in 2019. The correction in the last few days mirrors the rise at the end of September and looks just as excessive. It does, however, reflect some confusion over OPEC production data and the actual impact of falling Iranian exports. Bloomberg expects OPEC output to have risen in October by 430,000 b/d, mainly thanks to Saudi Arabia and Libya. Meanwhile, the US is handing out dispensations on Iranian imports to 8 countries, including India, China, South Korea and Japan which alone account for around 60% of Iran's exports. There are still no details on dispensation volumes and how long they might last but it would appear that India could import 300,000 b/d up to March 2018 or half of its average year-to-date imports. In our view, the US decision is not a position reversal but merely a sign that Washington is facing up to reality. Saudi Arabia and other countries simply cannot make up for Iran’s exports falling to zero. The result would be a steep rise in oil prices, an eventuality that markets had started to anticipate at the end of September.

Elsewhere LME-listed metals like copper and aluminium rebounded at the end of the week after Donald Trump and Xi Jingpin sounded optimistic notes on trade tensions being resolved.

World Gold Council data showed that central banks accelerated buying of gold in the third quarter to 148 tonnes, a rise of 22% and the highest monthly amount since 2015.

  Corporate debt

Credit

Markets turned positive after S&P decided only to downgrade Italy’s outlook from stable, Donald Trump said there might be a trade agreement with China, and UK press reports suggested Brexit discussions had made progress with a deal on financial services imminent. Xover spreads tightened by around 14bp between Monday and Thursday. But somewhat mixed European macro data and some disappointing company results weighed on overall sentiment, especially at the start to the week.

Financials led outperformers with CoCos and insurance debt enjoying a rally. Autos also saw sustained buying at the beginning of the week on reports that China was considering halving taxes on new cars. FCA (Ba2/BB+) posted an upbeat 9% rise in third quarter sales and +13% in EBIT while reiterating its full year guidance. However, auto supplier Schaeffler (Baa3/BBB-) cut its 2018 targets on reduced Chinese demand. Spain’s Dia released disappointing third-quarter results with sales and EBITDA sharply lower but its bonds managed to rise. Management said it was optimistic leverage could be reduced and bond holders are betting on a recapitalisation plan. Nyrstar (Caa1/CCC, metals) saw its bonds lose ground on unsatisfactory third-quarter results with sales up 11% over 9 months but EBITDA down 17%. Investors were worried when management gave no information on debt refinancing. Senvion (B2/B) issued a profit warning and cut sales guidance for 2018. CMC di Ravenna came under pressure on rumours of a restructuring but investors were reassured over short-term liquidity risks after the Italian motorway authority paid out €50.6m. SMCP (B1/B+) and Recordati posted robust figures.

In financials, Santander beat consensus estimates with CET1 coming in above 11%, its end-of-year target.

Convertibles 

Markets rebounded on the last trading day of October thanks in part to fund and strategy adjustments. The trend was reinforced by Beijing’s stronger accent on stimulus and rumours of an import tax cut on cars, accommodating statements from the Bank of Japan's governor and Donald Trump’s tweet suggesting that his recent conversation with Xi Jinping had gone well.

In another bumper week for company results, Sony’s half-yearly figures beat sales and earnings estimates but the group sounded a cautious note on its hardware divisions like TVs. SBI Holding (a Fintech venture capital fund) posted upbeat results, especially in asset management and financial services.

Safran took advantage of market conditions to issue a buy-in offer for its 2020 zero coupon bond at a €0.9 premium to the volume-weighted average price, or VWAP. The offer ran from October 30 to November 2 2018.

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