The tone mellows

Market analysis - 12/14/2018

Markets consolidated amid some easing in US-China tensions, but the focus shifted to concerns over the strength of global growth.

China has been stepping up concessions by gradually resuming commodity imports from the US and starting to consider a reduction in customs duties on cars. It has also abandoned its Made in China 2025 drive to help reinforce competition from non-Chinese companies.

Meanwhile in the White House, Donald Trump has been trying to reassure everyone that talks are making progress by easing his tone on Europe, Japan and even China.

However, this softer, and likely temporary, ambiance failed to help global markets stage a genuine rebound, probably because of a slew of data over the week.

Protectionism's negative effects have already hit the Chinese economy if the latest retail sales and industrial production figures are anything to go on. And in the eurozone, December PMI continued to weaken, especially in France, rather than pointing to an incipient recovery. Significantly, the ECB trimmed its growth forecasts for 2019 from 1.7% to 1.5% although it left 2020 and 2021 unchanged. Its inflation forecasts also dipped slightly to 1.6% in 2019, 1.7% in 2020 and 1.8% in 2021. However, it made no change to its forward guidance on monetary policy or its decision to stop asset purchases from January 1st 2019.

Investors will inevitably be watching the next FOMC meeting very closely. Most US data argue for more monetary tightening but soft inflation and commodity prices, particularly oil, should underpin the FED’s new approach. Rate hikes are no longer on autopilot as in 2018, with one each quarter. And the FED’s new creed of optionality over tightening could ease financial conditions, taking the US dollar and benchmark rates lower and providing support for emerging country economies. 

  European equities

European equity trading revolved around hopes for a US-China trade settlement, Brexit uncertainties, and measures in France to promote purchasing power, even at the risk of increasing the budget deficit.

In results news, there were fresh profit warnings in the chemicals sector. BASF now sees 2018 operating profits down 15-20%, citing demand softness in the Chinese auto sector and in upstream oil activities as well as the extremely low level of the Rhine river which is disrupting commodity deliveries to production sites. Germany’s Metro (cash and carry) also unveiled disappointing prospects due to persistent pricing pressure in Russia which will inevitably impact earnings. Spain’s Inditex, which has refused to jump on the discount bandwagon, fell after disappointing sales momentum. But its gross margin was strong, a sign that short production cycles help to avoid stock piling and thus offloading goods in difficult conditions.

In advertising, WPP’s new management tried to reassure the market at its investors’ day. The CEO gave a presentation on the group's potential transformation and updated current business trends. He also provided the group’s 2021 objectives which will include a cost-cutting programme. Dividend payout was maintained and the group said it had seen a number of parties interested in bidding for its majority stake in Kantar. 

It was a busy week for M&A deals, shareholder activism and other special situations. Rumours suggested that Berlin was orchestrating a merger between Deutsche Bank and Commerzbank so as to create a leading European bank that could assist German companies abroad. In contrast, Jean-Pierre Mustier, head of Italy’s UniCredit, ruled out any bank merger before 2021. Engie said it intended to keep its 32% stake in Suez Environnement.

Dassault Systèmes paid $425m for IQMS, a software publisher which designs solutions for small and medium manufacturing companies. In the railway sector, Alstom and Siemens said they had offered to sell 4% of their combined turnover, mainly in the signalling division, to meet EU competition requirements. The activist Elliott fund bought a stake in Pernod Ricard and criticised the group's closed governance, below-average profitability and disappointing track record in external growth. 

  US equities

US markets stabilised as US-China diplomatic relations appeared to ease with the S&P up 0.7% and the Nasdaq ending 1.4% higher. CPI inflation for November was up 2.2% YoY, or in line with expectations. But job creations came in at 155,000, or less than the 198,000 expected. Wage increases stabilised above the 3% mark.

Feelings that US and China relations had eased helped markets recover from last week's sharp sell-off. Beijing has reportedly agreed to cut import tariffs on US cars from 40% to 15% and to amend its Made in China 2025 plan which was designed to promote the emergence of purely Chinese groups in various sectors.

Financials fell by a significant 2.5% with banks targeted after an inversion in the 2-5-year Treasury yield curve. Energy stocks were also weak. Integrated groups offered the best resilience but services tumbled 5% on fears of investment in 2019 being reduced. 

  Japanese equities

Japanese equities remained volatile, swayed by fickle investor sentiment over the US-China trade conflict, notably the arrest of Huawei’s CFO. Market volatility was fuelled by short-term investors trading in NK225 index futures. China-related names such as Komatsu, Kubota and Nissan Motor underperformed on worries over a US-China trade war escalation. The TOPIX fell 0.23% over the week after ups-and-downs.

Small caps were also relatively weak as market liquidity, mainly dominated by domestic retail investors, was absorbed by SoftBank’s IPO. This should be resolved after the stock is actually listed on December 19.

By sector, Precision Instruments, Construction and Pharmaceuticals outperformed. Daiwa House rose 4% and Takeda rebounded 2.34%, In contrast, market sensitive sectors such as Oil & Coal Products, Banks and Insurance underperformed due to declining oil prices and bond yields.

Leading brokers were reported to have slightly revised down earnings estimates for Japanese companies for the year ending March 2019 from double digit growth to around 9-10% in recurring profits, a reflection of the slowing Chinese economy. 

  Emerging markets

Beijing’s pro-private sector tone and its promise “to promote opening-up on all fronts” also helped lift domestic sentiment. However, November’s macroeconomic data was mixed. On the positive side, Total Aggregate Financing was RMB 1,519bn, or higher than estimates and the previous month: slower local government financing and shadow bank credit was offset by marginally better corporate bond issuance. Fixed-asset investment continued to improve for the third month to +5.9% thanks to a pick-up in manufacturing and property.

On the other hand, industrial production slowed further to +5.4%, down from 5.9% in October while retail sales growth also slowed to +8.1% YoY (+8.6%), mainly due to persistent weakness in auto sales.

China’s pharmaceutical sector was still under pressure this week ahead of more scrutiny on adjuvant drugs. The National Health Commission continued its move to control unreasonable medical charges at public hospitals.

In India, the new central bank governor’s appointment raised concerns over the bank’s independence. But the market welcomed the change as it could favour a shift to a more dovish liquidity stance. Narendra Modi’s BJP lost local elections in some high-population states such as Rajasthan and Madhya Pradesh, making a win-with-alliance a more likely situation for the general election next April/May. CPI inflation undershot in November, coming in at 2.3% YoY, the lowest print in the past 17 months. Industrial production improved to 8.1% YoY in October thanks to a favourable base and festive demand.

In Thailand, PTTEP won two concessions for gas fields in Bongkot and Erawan, but with a much lower-than-expected price and profit-sharing scheme.

Brazil’s October retail sales declined 0.4% MoM, or more than the market expected, on weaker auto and auto part sales. September’s figures had also been disappointing. The cyclical retail sector recovery is fading. Not surprisingly, the central bank kept rates unchanged at 6.5% and struck a much less hawkish tone. B3, Brazil’s stock exchange, reported strong November data with equity trading volumes up 47% YoY. Elsewhere, Ultrapar said 2019 capex would be below expectations.

In Mexico, October’s industrial production decelerated. The President is expected to submit the 2019 federal budget to Congress.

In Argentina, November inflation came in above consensus expectations. 

  Commodities

In the end, OPEC and its allies agreed on a 1.2 million b/d cut, with OPEC accounting for 800,000 b/d and non-OPEC countries 400,000 b/d. Oil prices rebounded on the news as the overall reduction was higher than expected, but the fact that it appeared to take 2 days of complicated discussions to reach an agreement spoilt its impact on markets. Saudi Arabia represents around 50% of the OPEC effort with Russia providing 50% of the non-OPEC cut. Venezuela, Libya and Iran are not concerned but Nigeria will be involved for the first time. The agreement will apply from January 2019 and be based on October 2018 output of 32.8 million b/d. However, the next OPEC/Non-OPEC meeting will be in April, allowing the organisation to take stock of the effects of Iranian export exemptions.

OPEC, the EIA and the IEA released their monthly reports over the week. Despite fears of a global slowdown, they have all left demand growth expectations unchanged at 1.4 million b/d for 2018 and 2019. On the supply side, they all see non-OPEC production increasing by 2.5 million b/d in 2018 with most of this (2.15 million b/d) coming from the US. Opinions on the trend in 2019 however differ. The IEA sees supply rising by 1.5 million b/d after cutting Russia by 400,000 b/d, while the other two have pencilled in a 2.3 million b/d rise.

The decision to shave 1.2 million b/d off production is enough to keep oil prices relatively stable in 2019 provided the agreement sticks. If so, Brent could return to the $70 level. But markets will wait to see hard evidence of OPEC/Non-OPEC discipline and whether it actually translates into lower exports and inventories. In the meantime, the encouraging news is that Saudi Arabia has told clients that its exports in January will fall significantly from 8 to 7 million b/d. Exports to the US should even fall below 600,000 b/d, a 30-year low. Russia’s production cuts will be more spread out with a drop of 30-40,000 b/d in January and 200,000 b/d eventually. 

  Corporate debt

 

Credit

Markets fell on Monday over Brexit fears after the key parliamentary vote in the UK was postponed. But the trend reversed on some easing in US-China trade tensions, Theresa May’s success in the no-confidence vote triggered by elements in her own party and Rome’s decision to revise its deficit target down to between 2% and 2.2%. Spreads tightened sharply with the Xover down 30bp and the Main 8bp lower. The unsurprising message after last Thursday’s ECB meeting had little impact on spreads.

In company news, CMC di Ravenna’s request for creditor protection was accepted. The group now has 60 days to come up with a restructuring plan. Altice's bonds saw heavy selling after the group was cut from B1 to B2 on expectations of tougher competition in France. Bonds issued by Paprec (B2/B+) also fell after Moody’s and S&P downgraded its credit rating by one notch. Eramet was also in the dog house after an internal quality review in its alloys division proved inconclusive, suggesting that earnings would be hit.

Spain's Dia (supermarkets) had a very volatile week, first coming under serious attack. The group has issued 3 profit warnings in the last 12 months alone and, according to press reports, was unable to repay its €1.8bn debt. LetterOne, its main shareholder with 29%, is said to have suggested it will only invest more if Dia’s bank debt undergoes a haircut. But the bonds rebounded on Wednesday after Dia denied a haircut was being discussed, claimed a €200m line of credit could be signed before the end of this month and said it might launch an increase of capital with Morgan Stanley ready to commit €600m.

Elsewhere, Tereos saw EBITDA slump by 54% in the first half due to lower earnings in its European sugar division. In contrast, Selecta (B3/B) unveiled a sharp increase in revenues and EBITDA. 

Convertibles 

Markets regained a little confidence as China passed its first big order for US soybeans and Huawei’s CFO was released on bail in Canada. Mario Draghi reaffirmed the ECB’s decision to stop its asset purchasing but revised growth in the eurozone in 2019 down from 1.8% to 1.7%, adding that risks to growth had been balanced out but were now on the downside.

The new issues market was quiet with only a regular issuer, Medicines Company, raising $150m with a convertible due 2024 at an issue premium of 27.5%. The proceeds will go on developing Inclisiran, a promising new agent in managing Hypercholesterolemia, as well as on general purposes.

Elsewhere, Sacyr’s shares lost more than 15% after the International Chamber of Commerce in Miami decided that the $584m advance received by GUPC, in which Sacyr holds 41.6%, should in fact be paid to the Panama Canal Authority. Yields on the Sacyr 2019 convertible’s edged higher even if the group said it had already secured its repayment with a $225m syndicated loan.

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