Unflappable sentiment

Market analysis - 2/22/2019

Markets gained further ground despite mixed economic data, notably the Philly Fed index which indicated a slowdown in February, the first since May 2016.

Worse-than-expected durable goods orders and existing home sales were in the same vein. Only new jobless claims and preliminary services PMI for February, up from 54.3 to 56.2, provided some support for current investor perception.

In the eurozone, the IFO, the benchmark business climate index, fell even further. This was down to a combination of factors like tariff threats and Dieselgate, which have soured prospects for the auto industry, and reduced foreign demand due to Brexit concerns and China’s slowdown. The considerable gulf between current and future conditions also has to be factored in.

Even so, European growth seems to be stabilising, judging from the rise in February’s provisional indicators.  

The other big event over the week was the release of the FOMC minutes which reinforced recent comments made by committee members. The Fed considers that persistently tame inflation, worsening financial conditions and growth prospects all warrant a pause in rate hikes. But there is no agreement among FOMC members on what would be required to resume the rate hike programme.

As for our asset allocation choices, we have maintained equity hedges as markets have rebounded sharply since the beginning of the year and we are now at neutral weightings. 

  European equities

European industrial data for February was disappointing with Germany dropping to a 2012 low of 47.6 but markets mostly brushed off the news and continued to rise on optimism over a US-China trade deal. The eurozone was also bolstered by confirmation that the ECB was soon to discuss a new TLTRO. The autos sector rebounded despite risks that Washington might introduce tariffs on European imports and cautious guidance from SAF-Holland and Valeo. Faurecia stood out from the rest of the field after managing to maintain margins.

The UK market was hit by poor results at BAE and news that 3 MPs had quite the Conservative party, a development that will make Theresa May’s life even more difficult.

Bank stocks were hit after UBS was fined a record amount by a French court and also by HSBC’s lacklustre results. In addition, the chances of higher interest rates have been put back but investments still have to be made. Elsewhere, an enquiry into Swedbank was launched in connection with the Danske Bank scandal. Bouygues Telecom net profits rose sharply on a strong rise in subscribers. After acquiring Keyyo in December, the group’s offensive on the corporate market continued with the acquisition of Nerim. Orange’s fourth quarter sales and margins came in slightly above expectations and the group delivered reassuring operating FCF targets for 2019. But Iliad tumbled amid press reports in Italy that its arrival on the market there had triggered a mobile phone price war.

Fresenius Medical Care enjoyed a strong rebound after better-than-expected fourth quarter figures and upbeat prospects and Wirecard also rose after Germany’s BaFin regulator banned any future short selling of its shares.

Sainsbury fell after its proposed acquisition of ASDA was called into question. Total bought Synova, a company specialised in recycling polypropylene for car makers and suppliers. The group also said it had joined with Orsted and Belgium’s Elicio to make a consortium tender for a marine wind farm project, another sign of its diversification into green electricity. 

  US equities

US markets ended the week slightly lower due mainly to healthcare and energy. Macroeconomic data generally missed expectations. PMI underlined a slowdown in growth in the manufacturing sector. December’s durable orders revealed a modest slowing in capital spending growth.

In the ongoing US-China trade talks, Donald Trump was due to meet the Chinese representative on Friday, February 22 and the March 1st deadline was not expected to be pushed back.

John Williams, chairman of the New York Fed, said he saw no reason for a rate hike as long as economic growth or inflation failed to accelerate sharply. But he thought the Fed would continue to reduce its bond portfolio until next year.

As the results season approached its end, guidance from CVS (drugstores) for 2019 came in below expectations due to temporary problems. However, the company's long-term strategy of integration with Aetna (healthcare insurance) should create strong synergies and pave the way for solid growth. 

  Japanese equities

Japanese stocks gained 2.3% over the week despite deteriorating macroeconomic indicators and downward revisions in earnings estimates in manufacturing sectors.

As expected, China’s less vigorous growth is hitting Japan. The Japanese government cut expectations for exports, production and corporate earnings for February due to a slowdown in electronic part exports but remained upbeat on employment and earnings growth in non-manufacturing sectors. Fourth quarter machine orders in the private sector fell 4.2%, or more than expected by companies.

However, the stock market had mostly priced in earnings revision and rose on optimism over US-China trade talks. Economic sensitive sectors such as Non-Ferrous Metals and Machinery led gains. Sumitomo Metal & Mining soared 14.06%, chemicals producer Asahi Kasei gained 7.91% and China-related Komatsu added 5.84%. On the other hand, Fujitsu lost 2.98%. SoftBank Group, which had previously performed well after announcing a share buyback, saw slight profit taking. 

  Emerging markets

In China, domestic sentiment continued to improve with better-than-expected January lending data and stabilisation in P2P financing dynamics, benefiting private sector small-mid cap companies. Senior leadership in the government also gave timely attention to the risks of the low-quality bill financing that helped to drive the credit rebound and pleaded for more sustainable support for companies asking banks for loans.

In the property sector, more cities have been easing local-level policy since the Chinese New Year - with Nanjing, Xian and Haikou relaxing hukou eligibility as an indirect way to relax home purchase restrictions.

Baidu’s 4Q18 revenue was 4% above consensus but it was a low-quality beat. There was like-for-like growth in search traffic and news feeds. Investments will continue to focus on DuerOS, autonomous driving and video. Lenovo reported better-than-expected quarterly results thanks to market share gains in the data center hardware market, strengthening leadership in the PC space and good execution of smartphone business transition.

In India, Yes Bank was cleared in the NPA divergence issue. The government announced a Rs 482bn recap for state-owned banks to improve their capital bases and ease asset and capital stress tensions in the financial system.

In Korea, SK Hynix plans to spend KRW 20tn on new semi clusters beyond 2022. Samsung unveiled its new Galaxy and the surprise was the official announcement of the Galaxy Fold (GF) - its first foldable phone.

In Brazil, pension reform went before Congress. We expect it to be voted through before the third quarter of 2019 and achieve savings of R $800bn in the next 10 years. Ultrapar’s fourth quarter earnings showed signs of recovery in its core fuel distribution business, although net profit disappointed due to weaker results from Oxiteno. The highlight was strong cash flow generation which will cut leverage. Localiza reported upbeat results with the top line up 25%, Ebitda 16% higher and EPS 5% better. Its car rental division’s EBITDA margin expanded 310bp due to operational leverage.

In South Africa, the government’s 2019 budget will extend the deficit to 4.5%. This includes R23bn in annual financial support to Eskom (half of its cash flow needs) but is conditional on tighter management. To offset some of this rescue money, the government cut spending (mainly options on early retirement) and increased taxes on alcohol, tobacco and higher earners. 

  Commodities

Brent crude only gained 1% over the week but, at close to $67, it is gradually approaching the $70 level which it last saw in mid-November. Supply side tensions remained significant and Saudi Arabia’s Safaniya site, the world's largest with 1.2 million b/d capacity, ran into a problem which has so far reduced output by 300,000 b/d. Nigeria put back its elections by a week to February 23 but its oil facilities are still at risk. India was the largest buyer of Venezuelan crude in the first half of this month after increasing imports by 66% to 620,000 b/d. This offset lower imports of Iranian crude and shows India talking advantage of Venezuela’s current difficulties in selling its oil due to US sanctions and mounting threats from Donald Trump on the humanitarian aid that Caracas is currently blocking.

Growth in US oil production has only slowed a little amid indications from most companies that they will be careful over investments in 2019. Aggregate data from 60 companies showed a 10% drop in investments as companies prefer to focus on free cash flow generation instead. But production is still growing and expected to rise 8%. US oil exports also hit a record high of close to 3.6 million b/d over the week. This compares to an average of 500,000/1 million b/d between 2014 and 2018. 

Gold made solid gains to reach a high of $1,346/oz, a level not seen since April 2018, but fell back after the FOMC minutes sent the US dollar and 10-year Treasury yields higher. 

  Corporate debt

 

Credit

Markets pushed higher, boosted as in previous weeks by accommodating central bank stances and optimism over the US-China trade talks. However, Thursday’s poor macroeconomic data put some pressure on the party at the end of the week. Overall, the Xover tightened by 8bp and the Main by 3bp.

A Paris court fined UBS €3.7bn and ordered it to pay €800m in interest and damages for unlawful prospecting and aggravated money laundering and tax fraud. The bank is to appeal. Its shares tumbled but its bonds proved rather resilient.

Elsewhere, Tereos is to redeem half of its 2020 4.25% bond. The €250m needed will come from 3 and half year bank loans. Bank support for the deal sent the price of the 2020 bond higher but its 2023 maturity fell on uncertainty over the new loan’s subordination ranking and the company’s disappointing results which showed a 4.5% rise in net debt.

Talks between Dia and LetterOne turned complicated. Spanish press sources say LetterOne’s funding plan to ensure the group's short-term viability had been rejected by the group’s top four banks which are opposed to any moratorium on Dia’s bank loans up to 2022.

In other news, Senvion issued a profits warning and reduced guidance on revenues and its EBITDA margin.

Several companies reported upbeat figures. But (B2/B) said quarterly sales had risen 7.1% with EBITDA soaring 40.2% despite “yellow vest” disruption. Bombardier reassured investors with solid sales growth and a 25% rise in EBITDA over the full year. Faurecia’s bonds gained after results beat expectations. Vallourec’s equity and debt jumped after a sharp improvement in the group’s 2018 results. Management is to introduce a new cost-savings plan and will dispose of its power generation division.

In new issues, Thyssenkrupp raised €1.5bn over 5 years at 2.875%. Snam (natural gas storage and transport) raised €500m over 6 years. In financial debt, ING and Crédit Agricole both raised $1.25bn with AT1 bonds at 6.75% and 6.875%. 

Convertibles 

There were only 2 new issues but Fortive’s first convertible deal was much in demand. It raised $1.25bn over 3 years at 0.875% and with a 32.5% premium to fund some of the cash needed to acquire ASP. The issue's interest was that it came from an investment grade company in a sector which is under-represented in the US convertible bond universe.

Malaysia’s Top Glove (rubber products) raised $200m over 5 years at 2% and with a 20% premium to refinance current borrowings.

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