Risk aversion resurfaces

Market analysis - 8/3/2018

Markets retreated over the week following a 3.1% rise in the MSCI World index in July.

On the plus side:

  • company results, especially in the US where close to 80% have beaten analysts’ expectations.
  • US jobs data, with the ADP survey reporting 219,000 new hires, a 6-month high and better than the 175,000 expected.
  • US growth of 4.11% in the second quarter.
  • Europe is expected to have grown more than in the first quarter, especially in France. Corporate investment is already one of the biggest drivers.On the down side:
  •  
  • concerns over inflation which have weighed on interest rates even if higher oil prices are mainly to blame and have since stabilised.
  • persistent worries over Donald Trump’s protectionist rhetoric which is undermining market valuations and could eventually throw company profitability and global growth off course.
  • As a result, we are maintaining our equity market exposure with a preference for US and eurozone equities rather than the rest of the world. We have nevertheless used options to partially hedge positions despite today's attractive valuations.

  • We remain cautious on bonds, notably core eurozone government debt. 

  European equities

Risk aversion resurfaced in Europe at the end of the week as a US-China trade war looked increasingly imminent. Autos and commodities fell sharply, and Germany's DAX continued to underperform due to Siemens’ profit warning. 

Milan was also hit as Italian government bond spreads widened on a tricky first budget meeting between the Lega and M5S. Utilities and heavily geared companies came under attack.

Enel tumbled after disappointing first half sales and a downgrade to neutral by a US bank. This week's second quarter results showed like-for-like growth accelerating to above the 5% seen in the previous quarter, particularly in cyclical industries, while the upbeat trend was confirmed in aerospace and technology. Operational leverage remained limited, however, due to currency effects and higher costs and commodity prices, notably in traditional cyclicals.

Financials reported mixed results. Société Générale's retail banking outlook (25% of operating results) disappointed investors. However Crédit Agricole announced robust figures and looks set to revise 2019 prospects higher and it was the same story at Natixis. In Italy, Intesa Sanpaolo fell on what were seen as disappointing first half revenues and the impact of widening spreads on its CET1. Other Italian banks fell in sympathy. Axa saw operating profits rise 4% and confirmed that cutting its debt was a priority. This week’s falls included Heineken after warning on margins, Altice Europe where sales drives to win back subscribers hit ARPU hard and Ferrari where the new CEO described the late Sergio Marchionne’s strategy as ambitious. 

But investors cheered results from Leonardo because its results suggested its helicopter division had touched the bottom thanks to a €3n contract with Qatar. Rexel reaffirmed its guidance and posted better-than-expected results. Lufthansa said it was optimistic over second half unit revenues. Vivendi said it would soon be launching a big share buyback. 

  US equities

US indices lost ground over the last 5 trading sessions with energy and technology leading the way. Only defensives like healthcare, telecoms and consumer staples remained in positive territory. 

As expected, the Fed left its benchmark rates unchanged and said US growth was strong. Second quarter GDP grew by an annualised 4.1% and consumer spending remained brisk.

In earnings news, Apple gained 2.9% as higher iPhone prices buoyed results. The group became the first to move above a trillion dollars in market cap. However, other tech stocks like Twitter, TripAdvisor and Akamai had a very bad week, tumbling 22%, 15% and 8% respectively. Healthcare rose on upbeat results from Pfizer, Regeneron (Biotech) and gene sequencing specialist Illumina

  Japanese equities

At its July 31 Monetary Policy Committee, the Bank of Japan decided to maintain current monetary easing while introducing guidance to maintain its 2% CPI target. To enhance policy sustainability, the bank is to be more flexible. Governor Haruhiko Kuroda suggested allowing long bond rates to fluctuate up to 0.2% maximum and increasing TOPIX tracker ETF weightings from 75% to 87% and reducing Nikkei 225 Index trackers from 23% to 12% in its JPY 6 trillion ETF purchase programme. 

Before the meeting, markets participants were in cautious mood ahead of a possible shift but there were no significant changes. Japanese stocks rebounded but declined again when Donald Trump hinted at further escalation in US-China trade conflicts. The TOPIX ended 1.33% lower for the week. 

By sector, Pulp & Paper (+4.03%), Iron and Steel (+2.77%) outperformed. Steel producer JFE Holdings gained 10.23% on strong earnings following price increases. Banks and Insurance also outperformed as yields rose. On the other hand, Air Transportation (-5.14%) was weak on rising oil prices and the Other Financing sector (-5.01%) underperformed due to ORIX tumbling 7.70%. Food producer Ajinomoto declined 10.57% on poor earnings. 

Currently, investors are focusing on April-June earnings which remain generally upbeat but not enough to justify upward revisions for FY2018 as a whole due to uncertainty around the US-China trade war.

  Emerging markets

The escalating US-China trade conflict weighed on emerging markets. Donald Trump suggested taxing €200bn in Chinese goods at 25% rather than the 10% initially aired. Washington also made the ban on government agencies using high-tech Chinese products official, including surveillance cameras made by Hikvision and Dahua.

The renminbi lost a further 88bp against the US dollar this week as Beijing sat on the sidelines. July’s manufacturing PMI came in at 51.2, down from 51.5 in June and slightly lower than the 51.3 expected. China's politburo reaffirmed its determination to stabilise the economy through more deleveraging and help in funding existing infrastructure projects. Chinese company results remained encouraging with Baidu reporting a 31% rise and guiding on a 23-30% increase in the third quarter. But the stock was hit by the (improbable) rumour that Google was to move into China and launch a research engine. iQiyi (streaming) reduced its operating losses thanks to a 75% jump in subscribers and a 51% surge in sales. Moutai announced a 41% increase in first half earnings. 

Taiwan's GDP rose 3.29% in the second quarter, but its central bank retained a cautious forecast of +2.3% for the second half. Chroma ATE released very strong results with sales up 89% and earnings 98% higher due to its MAS modular assembly automation subsidiary. Thanks to a 25% jump in memory sales, Samsung Electronics reported a 6% rise in operating results despite a 4% drop in sales, with smartphones down 9%. Samsung SDI’s gross operating result soared 153%. Unfortunately, the group's screen division dragged net earnings down. 

Hankook Tire’s results were flat and fell short of expectations. Mediatek saw operating results rise 74%, or better than expected, but reduced sales guidance due to lower smartphone sales. The Reserve Bank of India raised its benchmark rate by 25bp to 6.5% in an effort to curb inflation which it expects to see rising 4.8%. India’s consumer staple companies continued to post strong results with Dabur up 25%, Emami 41% and Avenue Supermarts 43% better.

ICICI Bank, however, reported heavy losses with net NPLs running at an alarming 8.8%. Tata Motors’s EBITDA rose 10%, or less than expected, due to weakness at Jaguar Land Rover. In Indonesia, Matahari and Unilever both reported flat annual figures. In the Philippines, Banco de Oro’s fell 1.5% or worse than expected. 

Brazil’s industrial production rebounded by 3.5% over 12 months. Central banks in Brazil and Mexico left rates unchanged. Brazil's Ultrapar reported a poor 6.4% drop in results. Excluding the KC 390 prototype incident, Embraer’s EBIT was better than expected but still fell 34%. Investors were disappointed by Bancolombia’s 9% drop in results and timid growth in lending. Mexico’s Femsa reported zero annual growth. 

  Commodities

The LME non-ferrous metal index had bounced in the preceding week on the Chinese government’s stimulus plans to limit the impact of higher customs duties by increasing spending on infrastructure and easing monetary conditions. But the index gave it all back over the week to return to a July 2017 low. The about-turn was prompted by Washington's threat to increase taxes on $200bn of Chinese imports by 25% rather than the 10% initially mooted. This is not a healthy climate for commodities and July global manufacturing PMI dropped, albeit modestly, from June’s 54.1 to 53.4, another July 2017 low. China's official manufacturing PMI edged lower from 51.5 to 51.2.

Oil prices also slipped, due partly to higher weekly crude inventories in the US. As promised in its end June meeting, OPEC increased production to return to levels close to official quotas. Bloomberg estimates its July output at 32.6 million b/d, or an extra 300,000 b/d, mainly from Saudi Arabia which has increased production by 230,000 b/d to 10.65 million, a record level. Increased output from Iraq and Nigeria has also helped offset drops in Venezuela, Libya and Iran. Quota compliance is now running at 104%.

Meanwhile, Russia’s output of 11.21 million b/d represents a monthly increase of 140,000 b/d. The big question mark remains to what extent Iran's exports will fall after November 1st, not least because of Donald Trump's erratic behaviour, one week threatening Tehran and the next suggesting a meeting with its president Hassan Rohani with no strings attached. Iran, in any case, rejected the proposal. US oil output fell by 30,000 b/d to 10.44 million in May due to maintenance in the Gulf of Mexico. These operations are temporary but data in coming months could well be impacted by restrictions in the Permian pipeline which have led some oil services companies like Halliburton to cut guidance. 

  Corporate debt

 

Credit

After starting the week lower, the market bounced on Tuesday on hopes the US and China would start trade talks. But Washington’s announcement on Wednesday that it would slap 25%, rather than 10%, on Chinese imports sent markets into reverse and the Xover widened by 10bp between Wednesday and Thursday. The decline picked up speed on Thursday on fresh worries over Italy’s political troubles. 

In a batch of quarterly results, metals company Nyrstar (B3/B-) reported a 7% rise in sales and +8% in EBITDA. Its 2019 bonds jumped by 5 points when the company said it planned to buy them in early. Similarly, chemicals company Huntsman (Ba1/BB+) said sales had risen 17% and EBITDA 38.8% over a year. Belgium’s Telenet (Ba3/BB-) reported a 2% rise in sales, or more than expected, won over more clients than expected and is to pay put a bonus dividend. Results at Altice (B1/B) fell (-4.8% for Altice Europe's sales) but in line with expectations while Wind Tre fell short with sales down 10.1% and EBITDA 4.3% lower. Portugal’s energy company EDP announced a satisfactory 3% rise in EBITDA and travel agency Thomas Cook (B1/B+) saw sales rise 10% but gross margins fall 3%.  

In new issues, cable company Nexans (BB) raised €325m over 5 years at 3.75%. Online financial services company Wizink (B+) raised €515m with 5-year PIK Toggle Notes at 6.5%. 

Convertibles 

In Europe, Qiagen posted strong second quarter earnings with an EBIT margin improvement of 160bp with Quantiferon sales up by more than 20%. Inmarsat reported second quarter revenue of $339m, up 6% YoY with government revenues higher while maritime segment growth stalled vs. the previous quarter. Fresenius had a solid quarter driven by Kabi (IV generic drugs) with a 7% beat and increased full-year EBIT guidance increase by 4%. 

In the US, Illumina jumped 12% after raising full year revenue guidance by 20% thanks to stronger NovaSeq demand. Tesla posted a better-than-expected quarter with gross margins at 21% and cash burn at $739m or lower than feared; the stock gained 16%. Biomarin posted second-quarter revenues of €373m and announced a long term sales target of $2bn by 2020; the company gave quite reassuring comments on the recently approved Palynziq drug (genetic disorder) rollout. 

In Japan, Sony surprised on the upside, raising full year guidance by 4% to JPY 8.6 trillion. PlayStation related business saw operating profits increase fivefold.

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