Waiting for the Fed

Market analysis - 9/15/2017

Since the beginning of September, the balance has clearly shifted in favour of equities and away from government bonds.

In just two weeks, European markets have clawed back close to half of the drawdown since May's high. This has been made possible by (i) de-escalation in North Korea and reinforced sanctions adopted by the UN Security Council, (ii) core UK inflation at 2.7% YoY, or more than the 2.5% expected and (iii) a spate of new bond issues, including an Austrian 100-year bond for €3.5bn. Additionally, US underlying inflation came in slightly higher than expected at a monthly 0.2% (+1.7% YoY) compared to +0.1% over the previous 5 months. The figure should not in itself close the debate on persistently low inflation, but it has maintained pressure on fixed income markets and helped the bank sector perform both in the US and in Europe. And a promise from Treasury Secretary Steven Mnuchin to get fiscal reform passed by the end of 2017, and what’s more with retroactive tax cuts, helped reinforce the relative attraction of US equities compared to bonds.

Nevertheless, after months of preparation, the September 20 FOMC will start to reduce the Fed’s balance sheet. The two questions nagging investors, and which are like to create uncertainty, are by how much and what the consequences on interest rates will be. After all, it would be quite logical for investors to assume that this “Reverse QE” might have the opposite effects than a long period of easing. For the medium to long term, the real question facing markets is assessing the influence and relative size of central bank balance sheets and the flow impact of changing net purchases on major asset classes.

In the current situation, we are sticking with our asset allocation decision to be reasonably in favour of equities with a focus on the eurozone and to a lesser extent on Japan. Recent long bond and US dollar movements look overdone to us but we have not yet changed our asset allocation breakdown apart from some tactical shifts in certain portfolios.

  European equities

European markets edged higher on a US dollar rally against the euro. At the same time, the consensus view among investors has, in recent days, moved back to expectations that the Fed, ECB and BoE will finally be less accommodating.

The Oil & Gas sector gained on rising oil prices and retail was boosted by Next’s half-year results which came in higher than expected, leading the management to speak of encouraging prospects. Autos gained on news that new EU car registrations had risen 5.6% in August, an improvement on the +4.5% notched up in July. Financials advanced on expectations that the ECB would soon tighten monetary policy.

In M&A news, Ryanair’s CEO said a bid on ailing Alitalia was being finalised. Valeo said it had renewed its request to the European Commission to acquire FTE and Nestlé did the same for its projected purchase of 68% of the Blue Bottle Coffee cafe chain. Sweden’s Autoliv, which is a specialist in car safety solutions, wishes to conduct a strategic review ahead of a possible spin-off of its passive safety and electronics businesses. The Dutch government said it had reduced its stake in ABN Amro from 63% to 56% after placing 65 million shares with institutionals.

  US equities

It was a good week on Wall Street with the S&P rising 1.2% and both the Dow Jones and Nasdaq hitting fresh highs. Damage from Hurricane Irma was eventually less than feared - $50bn rather than 200bn- and optimism returned. CPI inflation reassured investors as it rose 1.9% YoY in August and 1.7% ex food and energy. 10-year Treasury bond yields rose to flirt with 2.2%, up from 2% last week.

As expected, Apple’s new iPhone X comes with an OLED screen and 3D sensors to power augmented reality apps. It can also recharge without being plugged in. The presentation held no surprises and the stock slipped 2% over the period following a 37% surge so far this year. The big question mark hovers over consumers’ willingness to spend more than $1,000 on an iPhone.

Financials this week led gains with a 3.6% rise while long duration sectors lost ground in absolute and relative terms. Consumer staples and property ended the period lower.

  Japanese equities

The TOPIX gained 2.4% over the week after rising for three days in a row due to the weaker Yen. Financials and export stocks were buoyant. However, the market went into reverse on Thursday, battered by profit taking and fresh concerns over geopolitical risk after North Korea threatened the US after UN sanctions were imposed. But downside was limited thanks to upbeat performance on Wall Street.

By sector, the best performers for the week were Securities & Commodity Futures (+4.6%) and Insurance (+4.3%). Panasonic jumped 9.7%, rising for four days in a row, led by high expectations for its EV business. Nidec (+9.5%) was also strong.

There were no negative sectors this week. Construction (+0.05%) and Information & Communication (+0.6%) were relatively weaker than others, but still chalked up gains. Toshiba tumbled 3.4% on the news that it favours Bain Capital Group’s bid for its microchip business. Rakuten, an internet service company, also declined 3.1%. 

  Emerging markets

In China, the PBoC reduced the reserve requirement on FX derivative sales to zero, slashing the cost of FX hedging. The measure indicates that the Government is less concerned about possible outflows. August activity slowed from July. Industrial production, electricity production and Fixed Asset Investment (“FAI”) all decelerated, but remained at high levels (IP at 6% YoY, retail sales up 10% YoY and FAI at 8% YoY). Property sector data was healthy with new starts up 5% and sales of floor space reaccelerated. In addition August loans increased 13.2% or more than expected.

Brazil’s economy continued to show signs of a cyclical recovery: according to central bank data, activity expanded 1.4% in July, after slipping 0.43% in June. July retail sales increased 5.7% or above consensus expectations of 3.1%). At the MS LatAm conference in London, Brazilian companies confirmed that they were seeing a much better environment, driven by lower inflation, higher lending to individuals, rising consumer confidence and upbeat job creations.


Oil prices extended their end August rally and Brent crude moved back above $55 for the first time since May. WTI rose above $50 but the spread between it and Brent crude remains high. The rebound at the beginning of July was triggered by US dollar weakness but the recent rally owes more to improving fundamentals.

For example, this week’s monthly reports from OPEC, the IEA and the US Department of Energy all revised their demand forecasts higher. Demand is expected to be driven by China but what is less expected is that Europe and the US will also play a part in both 2017 and 2018. All three agencies have also revised down growth in US output, partly because of Hurricane Harvey which caused production stoppages, but also due to drilling stagnating and even slipping. Expectations had previously been for a further rise in the oil rig count. Elsewhere, compliance with production quotas improved to 86% in August, up from 75% in July with non-OPEC countries standing out. All this is helping inventories to continue falling.

The market also reacted positively to Saudi Aramco's IPO possibly being put back to 2019. The postponement is seen as encouraging Saudi Arabia to make bigger efforts to reduce inventories, thereby favouring a rise in oil prices.

The energy environment is improving but not the mining sector. China’s industrial production, fixed asset investment and electricity production for August came in below market expectations. Metals had been rising sharply for the last 2 months but logically fell victim to profit taking on the news with copper down 6% and nickel 8% lower. However, steel production and demand is still upbeat as apparent demand for steel in August jumped 14% over a year.

  Corporate debt



Spreads tightened at the beginning of the week after North Korean concerns abated (temporarily) and Hurricane Irma was downgraded to a category 1 tropical storm. The Xover index fell by 6bp between Monday and Tuesday amid rising government bond yields. But the bullish trend remained intact with insurance debt rallying on lower estimates of Irma’s damage. The market subsequently went calm with narrow spread shifts and a rather neutral mood.

On a busy new issues market, Intralot (B1/B), a Greek lottery and sports betting company, sold a 7-year senior bond. Belden (Ba2/BB), an electronics goods manufacturer, issued an 8-year subordinated senior bond. IMS Quintiles (Ba2/BBB-), which specialises in health information technologies and clinical research, sold an 8-year senior bond. Softbank (Ba1/BB+), a Japanese telecoms company, issued senior bonds in four USD and EUR tranches across various maturities. The euro-denominated tranches were for €1.5bn over 8 years and 750m over 12 years. Viridian (Ba1), which is active in renewable energy, issued a senior 8-year bond in two tranches, one in euro and the other in sterling.

In results, BMI Group (Ba2/BB) posted fairly satisfactory figures with revenues up 1.4% over the year. But EBITDA fell due to higher variable costs and negative foreign exchange effects. And once again, net debt was on the increase. CMC di Ravenna (B2/B) released upbeat second quarter results with sales up 9.5% and EBITDA 1% higher. The increase stemmed from improved trading thanks to new projects. 


This week we had three new deals in the US. Cloud-based software provider for HR and finance management Workday raised $1bn with a 5Y 0.25% convertible for potential repurchase of its outstanding convertibles. Wayfair, an online furniture retailer, came to market with a $375m 5Y 0.375% convertible to fund working capital. Real estate investment company iStar Inc that issued a $250m 5Y 3.125% convertible with a concurrent offering of $800m in high yield bonds for refinancing purposes.

Intercept Pharma shares lost 30% this week after the company issued a letter warning of liver injury/failure and death if its Ocaliva drug is prescribed more frequently than recommended. In Europe, Bayer continued to sell its stake in Covestro, placing another €1.2bn in shares and reducing its stake to 31.5%. The stock and the exchangeable bond reacted positively. In Asia, Nanya Tech continued its impressive YTD performance, adding 17% this week on the back of rally in Micron shares. 

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