Half of previously tariff-free Chinese imports will now be spared the proposed duties up to December 15. This concerns $150bn vs. a total of $300bn and the decision to delay implementation was taken to avoid hitting end-of-year festivities.
However, this new trade war truce was upstaged by worrying global economic data. German GDP fell 0.1% in the second quarter as domestic consumption failed to offset falling industrial investment across the globe and especially in China.
Argentina’s surprising primary election results stoked fears of a populist surge. The peso plunged 25% in 3 days and the country’s bond market plummeted by 40%.
China’s industrial production rose 4.8% over a year, or below expectations. Most importantly, the figures represented a 17-year low. Beijing also cut its growth forecasts to 6%.
And investors focused on further falls in US 10-year Treasury yields to 1.53%, or the lowest level since November 2018. On August 14, they even fell below 2-year Treasury yields during the session. Economists view this yield curve inversion as a possible sign that the US is entering recession territory.
The gloom was tempered on Thursday by a reassuring rise in retail sales in July. The ‘control group’, which is the best reflection of consumer spending in GDP, rose 5.1%, a growth rate that had not been seen in a year. Dynamic consumer spending accounts for around 70% of GDP in the US and is offsetting practically stagnant industry data.
The challenge for markets is to assess the US economy's chances of resisting a global slowdown and not following major economies like China and Germany lower.
In today's tricky macroeconomic climate, caution is still the watchword. Upbeat year-to-date returns led us to trim European equity exposure on August 2 so as to lock in profits. And this week we extended caution to the US by reducing equity holdings there.
First half results news dried up at the beginning of August and the week was the quietest for reports this year. Nevertheless, there was prevailing anxiety amid worrying economic developments. As well as concerns over a cyclical slowdown, markets also had to contend with political uncertainty in Italy. Matteo Salvini is pushing for fresh elections but so far other parties are dragging their heels as they have no desire to see the Lega winning complete control over government. Brexit remained a worry with no clear progress only 2 and a half months before the exit date. Meanwhile, the UK registered its first contraction in GDP in 7 years with a 0.2% drop in the second quarter vs. the first.
Elsewhere, Getlink/Eurotunnel reported a steep 7% drop in passenger shuttle traffic and a 10% retreat for lorries, reinforcing the view that the UK economy was slowing. Henkel issued a profit warning and reduced annual guidance, citing China and the autos sector. Schindler also warned on results and cut annual guidance to below consensus estimates while German telecom operator United Internet/Drillisch reduced its forecasts due to heavy investments in 5G. In contrast, RWE, which had already raised annual guidance in July, had a good quarter, particularly thanks to its trading division.
In M&A related news, Freenet, which is the largest shareholder in the Swiss telecom operator Sunrise, said it would vote against an increase in capital designed to fund Sunrise’s acquisition of UPC’s Swiss division.
Indices ended the week sharply lower with the S&P 500 and Nasdaq abandoning 2.4% and 2.1% as of last Thursday’s close. Market pessimism continued to reflect US-China trade war developments and investor concern over yield curve inversion, a possible harbinger of an imminent recession.
US 10-year Treasury yields fell by close to 15bp over the week to 1.55%, their lowest level since June 2016. And for the first time ever, the 2-10 year curve and 10-year real rates in the US were both in negative territory.
Markets are now discounting a 70bp cut in US rates by the end of 2019 but long-term rates suggest central bank action will have a very limited impact on growth and inflation expectations. Fund flows over the week appeared to come mainly from systematic investors with active asset managers remaining largely on the sidelines.
There was also extreme sector dispersion. Cyclicals like energy (-5%), basic materials (-3.7%) and financials (-4%) underperformed. Investors sought out defensives and/or sectors like consumer staples (+0.4%), utilities (+0.2%) and listed property (- 0.3%), all of which are sensitive to falling interest rates. Cisco tumbled by close to 12%. Quarterly results were in line but management sounded a more cautious note for the next 12 months and said sales in China had fallen by almost 25% over the last quarter. Ready-to-wear company Tapestry (which owns the Coach and Kate Spade brands) plummeted by 30% over the week after reporting disappointing results and cutting guidance for the rest of the year. Another casualty was Macy’s, down 16% on a steep drop in margins and a downward revision in its earnings outlook for the rest of 2019. General Electric also plunged last Thursday on rumors of accounting irregularities.
Japan’s preliminary GDP reading for the second quarter showed higher-than-expected annualized growth of 1.8％. This was down to strong domestic demand such as private consumption (+0.6%) and private capital investment (+1.5%) as well as better-than-expected net exports (-0.3%). Japan’s corporates saw net profits contract by 15% overall in the quarter with manufacturing down 45% and non-manufacturing up 38%. Electric appliances, autos and machinery suffered the biggest drops while information & communication led winners.
Following a sell-off on US markets over fears that the inverted yield curve might herald a recession, Japanese equities also tumbled. The TOPIX lost 1.33% for the week. Due to growing concerns of a global economic slowdown and falling interest rates, economy sensitive oil & coal and iron & steel as well as interest rate sensitive banks and insurance companies were among underperforming sectors. On the other hand, textile products sectors gained ground, led by carbon fiber producer TORAY which ended the period 4.11% higher.
Markets traded sharply lower this week, echoing investor concerns on the global economy, but they received some respite. Donald Trump adopted a more conciliatory tone in the trade war and there was a possibility that China might introduce more economic stimulus following weak macro indicators.
China had its weakest industrial output growth since 2002 and retail sales growth slumped in July as a cyclical slowdown and trade tensions reinforced the argument for more stimulus. Industrial output rose 4.8% from a year earlier, its lowest level since 2002, while retail sales advanced by 7.6% over the first seven months and fixed-asset investment growth slowed to 5.7%. Seasonal effects probably compressed the data, but they were lower than forecast by economists. China’s PPI slipped to minus 0.3% in July vs. 0% in June, its first YoY decline since September 2016 and an indication that the industrial sector might be slipping back into deflation. July retail sales rose 7.6% YoY, or below estimates of +8.6% and June’s +9.8%. Political headlines continued to take centre stage as Hong Kong protesters stepped up action and swarmed into the airport, causing all flights to be cancelled.
Meanwhile, Donald Trump decided to delay tariff hikes on certain Chinese imports until mid-December, and both countries confirmed plans to talk by phone in the next two weeks.
On the corporate front, Chinese companies Sunny Optical, JD.com and Alibaba posted better- than- expected earnings. Sunny Optical saw strong demand for smartphones, while margins rose at JD.com and Alibaba along with strong revenue growth. Tencent disappointed on top-line growth on lighter online advertising and fintech and business services, but thanks to effective OPEX control profits were better than expected. Moutai reassured investors after announcing an annual cap on its parent company‘s related-party deals.
India’s June industrial production growth slowed to 2% YoY, down from +4.6% in May. This confirmed the economy was slowing and auto sales were also down for a 9th consecutive month. Reliance Industries announced during its AGM it will sell a 20% stake in its refining and chemical business to Saudi Aramco for 15bn$, as part of an effort to bring down the leverage.
Argentina’s equity markets dived 50% in US dollars last Monday and its currency tumbled by 15% after Mauricio Macri lost the primary election vs. opposition candidate Alberto Fernandez by a higher-than-expected margin of 15% compared to expectations of 5% consensus. Markets feared the return of left-wing protectionist policies. After the results, Macri launched a package to incentivize consumers, increasing the minimum wage and freezing fuel prices. The presidential election is scheduled for October 27.
Brazil’s government approved the economic freedom bill in the Lower House in an effort to cut business bureaucracy. On the corporate front, Natura posted strong results on domestic top line growth and BodyShop’s solid recovery. PagSeguro reported a robust 45% surge in net revenues with stronger net adds and net profits up 42% YoY. Stone had disappointing results due to fiercer competition in the SME segment, but net revenues were still up 68% YoY and net profit 33% better. Hospital group Hapvida reported a stronger-than-expected 15% rise in net revenues and a 28% jump in EBITDA on a lower medical loss ratio. Net profits soared 51% on lower financial expenses.
The market fell on recession fears and mounting political risk, especially in Italy and Argentina. US-China trade tensions continued to exert pressure and Tuesday’s decision by Washington to postpone the application of customs duties on certain Chinese imports to December 15 only provided temporary relief. The Xover widened by 6bp between Monday and Thursday and the Main by 1bp.
Political risk in Argentina knocked up to 10 points off Codere's bonds. In financials, BBVA and Santander got off lightly as their Argentine exposure does not contribute much to their bottom line.
Thomas Cook said it had made significant progress with its largest shareholder Fosun as well as with creditors over restructuring talks. Another £150m could be injected, mainly by bond holders, to reinforce liquidity. Thomas Cook’s bonds lost up to 3 points after the news broke. Lecta replied to recent claims that French government aid to avoid closing its Condat factory was in doubt. The group said it was looking at various alternative plans for the factory and any unfavorable fair-trading ruling from Brussels would only be an indication. S&P nevertheless said it thought Lecta could be faced with liquidity problems in the next 12 months and downgraded the group from B- to CCC with its negative outlook unchanged, Teva remained under pressure after Moody’s downgraded its outlook from stable to negative, citing high leverage.
Nordex unveiled reasonable quarterly results with a 3.5% rise in sales although EBIDTA fell 56%. However, management confirmed expectations of an EBITDA margin between 3-5% this year.
In new issues, Credit Suisse raised $1.75bn with an AT1 at 6.375%. Demand was heavy and the bond performed well when it started trading.
Mid-August is usually quiet, but markets were very volatile over the week due to concerns that the ongoing trade war might trigger a recession and mounting geopolitical risks. The convertible bond market suffered this week from tensions in Hong Kong, disappointing primary election results in Argentina and a significant flattening in US yield curves.
Even so, several US companies issued convertibles bonds, including a Jumbo deal. Akamai Technologies (infrastructure software for the world’s leading enterprises) raised $1bn over 8 years at 0.375% and with a 30% premium. The proceeds will be used to fund a $100m share buyback, working capital and other general corporate purposes, but also to finance possible acquisitions.
Wayfair (e-commerce home goods) raised $825m over 7 years at 1.7% with a 32.5% premium for general corporate purposes.
Insight Enterprises (IT services) raised $300m over 6 years at 0.75% and with a 32.5% premium to buy back shares and cover general corporate purposes.