Waiting for new catalysts

Market analysis - 6/23/2017

It was another week of market stabilisation amid low rates and favourable economic momentum. In particular, France’s business climate hit a record level not seen since November 2011 with a sharp upturn in construction and retail trends.

This flat line consolidation follows a period of broad advances for equity and bond markets, and especially corporate debt, since the beginning of 2017. Emerging market equities, bonds and currencies have risen significantly while growth and defensive plays in developed countries are currently managing to perform well. Pharmaceuticals have recently stood out thanks to the US Senate presenting a revised version of Obamacare reform which extends the transition period and is less draconian than the first draft.

The economy is still on an upswing but we would make several observations. First, the sharp fall back in economic surprises, especially in the US, and a cap in real activity indicators are a reminder that peak activity conditions were recorded a few months ago. Second, inflation is slowing both in the US and Europe. German producer prices have peaked or are generally slipping back in line with base product prices while inflation in the US continues to slow. It is currently running at 1.7%, so below the Fed’s 2% target. Third, a change in tone, led by the Bank of Canada and the Bank of England, has triggered fresh short-term rate volatility in these zones.

Equity markets had already weakened on low oil prices and are now looking for new catalysts. Disinflation is the dominant force currently but we are keeping a very close eye on interest rate levels. We have reinforced our Bund shorts and are now once again neutral on 2-year German bonds. We have reinforced overall equity portfolio hedging via options or by buying volatility. We remain upbeat on European and Japanese equities and underweight US and emerging country equities.  

  European equities

European markets remained in wait-and-see mode in a week that saw Brexit talks begin and, more importantly, a further leg down in oil prices. 

The Bourget air show allowed manufacturers and equipment providers to confirm healthy sector trends. Airbus is expecting 35,000 new planes to be needed over the next 20 years and unveiled an improved version of its giant A380 to revive sales. Safran won a batch of new orders for its new generation LEAP engine. 

In banks, Italy’s Intesa Sanpaolo said it would pay a symbolic euro to save Veneto and Vicenza, 2 Venetian banks, from going under provided their toxic assets could be housed in a defeasance structure financed by the capital and subordinated debt of both banks as well as the Italian government. The plan would protect Intese Sanpaolo and, if accepted, help reduce the current risk premium on the Italian banking sector. In contrast, Belgium’s KBC disappointed shareholders as its plan to return cash to them was not considered ambitious enough from such a well-capitalised bank. 

M&A deals continued apace with Europcar acquiring low-cost operator Goldcar and Gecina buying Eurosic. Future projects could involve a tie-up between Engie and Innogey, a RWE subsidiary which houses its renewable energy and infrastructure businesses, and between Vinci and ADP

The biggest media draw was Diageo's USD 1bn acquisition of the high-end Tequila brand Casamigos. The price tag breaks down into a USD 700m payment and a performance-linked USD 300m over 10 years and represents 20 times sales, a lofty ratio but Casamigos has grown sales by 54% over the last 2 years. Elsewhere, Altice listed its US affiliate on the NYSE. 

  US equities

The S&P ended the week flat, still solidly positioned above 2,400 but the Nasdaq added another 1%, taking year- to-date performance to +16%. In a thin week for macroeconomic news, existing home sales rose 1%, or more than expected. 

The Republican Party released its healthcare reform draft which is relatively more favourable for private sector players. Presented by the senators, the plan is still open to discussion and suggests a slower reduction of Federal government grants to Medicaid than initially mooted. The previous plan came from House of Representatives republicans and worried healthcare companies as it argued for much quicker cuts in social aid. Press reports this week suggested the Trump administration was also taking a more favourable line on drug prices. This all resulted in the entire healthcare sector jumping 4% over the week. And biotech surged 8% on some good clinical progress for some companies and fresh M&A speculation.

Elsewhere, Oracle reported excellent figures with licence sales coming in 15% above expectations. Cloud business sales also swept past expectations by soaring 64%. 

The food retail sector was buffeted by two major developments:

1/ Amazon bought Whole Foods for USD 13.7bn, the first acquisition of a chain of stores by the online giant and

2/ Lidl entered the US market by opening 10 stores. It eventually aims to have 600 outlets. Both developments will radically change the sector and could have a big impact on the prices and margins of existing companies. 

  Japanese equities

The TOPIX gained 0.9% over the week. The market advanced in the first half of the week and the Nikkei 225 hit a year high on Tuesday as the yen weakened against the US dollar on expectations of higher US interest rates. The US tech stock rally caused some external demand-oriented stocks (electric appliances and rubber products) to rise. The market softened in the second half of the week weighed down by energy stocks as crude oil prices declined although downside was limited by strong buying of small and mid-caps.

The best performing sectors were Rubber Products (+3.8%), Other products (+2.9%) and Electric Appliances (+2.3%). Leading electronic components manufacturer Murata Manufacturing jumped 9.6% and major electronic company Fujitsu advanced 4.6%.

In contrast, Insurance (-2.5%) and Oil & Coal Products (-2.4%) were weak. Lower US long-term yields pushed down insurance companies Sompo Holdings (-3.7%) and Tokio Marine Holdings (-2.8%). Oil refining company JXTG Holdings dropped 2.7% due to lower crude oil prices.  

  Emerging markets

After 4 years of talks, the MSCI finally announced a partial 5% inclusion of China’s A-shares (222 stocks) into its major indices, with a 0.73% weighting in the MSCI EM Index. The move should generate inflows of USD 14.1bn into the A-share market, which is not very significant considered the market has daily trading volume of RMB 400bn. However, the inclusion reflects China’s efforts to catch up with international regulatory standards and will help create better corporate governance. Argentina was not reclassified as an emerging market this year but the MSCI will be keeping it under review for 2018.

EM interest rates are stabilizing. Taiwan’s CBC kept its policy rate at 1.375% for the 4th quarterly meeting in a row. In Mexico, following a 400bp hike over the last 19 months, the central bank delivered what should be the last interest rate hike, +25bp to take its benchmark rate to 7%. Banxico believes that inflation which as running at 6.30% in the six months up to June, is near its peak. The economy continues to perform well: consumption is strong and YTD volumes at Cemex (cement) have come in above guidance. Real GDP growth accelerated to 2.8% in the first quarter, up from 2.3% in the last quarter of 2016. We expect upbeat second quarter results. In India, Nasscom lowered its guidance for IT industry export growth from 10/12% to 7/8% for FY17.

In Brazil, the Special Senate commission rejected the Labour Reform, which will be voted on in two weeks’ time. The government defeat increased concerns about its ability to pass reforms, especially the Pension Reform.  

Stabilising monetary policy, deeper Chinese markets and good earnings growth prospects should continue to support emerging markets in the medium term.  


Oil prices suffered from even more market anxiety. Brent crude fell below USD 45 while WTI traded lower at around USD 42.5, or levels seen before the November 30 OPEC agreement on production cuts. Investors are still sceptical on the chances the cartel and non-OPEC signatories will manage to get inventories down to their 5-year median.

There was nothing new about the reasons behind the price fall. US drill count growth is still of concern even if the pace has slackened, and, with oil trading below USD 50, counts should logically decline in coming weeks. The other big issue was a smaller-than-expected fall in weekly US crude inventories. And yet, inventory shrinkage has been the trend since the end of March with 11 down weeks and only one up week. OECD inventories are at much healthier levels today than before the OPEC agreement and yet prices are low.

The third issue is higher Libyan and Nigerian output. Libya has reportedly increased production to 900,000 b/d and should gradually take this to 1.1million by August. This level cannot, however, be taken for granted as it will depend on Libyan transport capacity. Any extra output will require hefty investments, for example USD 18bn to get back to 2.3 million b/d.

Lastly, OPEC exports, not to be confused with production quotas, have remained high for longer than expected. However, we are entering a high consumption season in the Persian Gulf due to oil-based electricity generation so exports should gradually fall in coming months. OECD demand will also benefit from the driving season surge. Even so, recent price weakness at a time of political tension over the Qatar crisis could undermine the OPEC agreement. 

  Corporate debt



The high yield market started the week on the front foot with the Xover tightening by 5bp between Monday and Tuesday. The mood changed radically on Wednesday as cash underperformed credit indices on profit taking on previously bid-only high yield bonds like Burger King, Loxam and Chemours. Concerns over falling oil prices also played a part. 

The new issues markets remained buoyant with 3 new deals. Manutencoop (B2/B) raised EUR 420m with Senior Secured Notes 5NC2. The proceeds will go on refinancing debt and buying in minorities (32.2% of the capital). Federal Mogul (B1/B-) raised EUR 300m over 7 years NC3 to repay part of a bank loan. N&W (B/B2) issued another EUR 40m tap on its 2023 7% maturity. 

In acquisitions by HY companies, Goldcar which is strong in Spain and Portugal, was acquired by Europcar (B1/B+) which will now be a major player in Europe's low-cost segment. Goldcar made EUR 240m in sales in 2016 with EUR 50m in EBITDA. The group will now have leverage of 3x vs. 1x as of end 2016. Elsewhere, SFR Benelux was bought by Telenet (Ba3/BB-) for EUR 400m in enterprise value. Post-acquisition, Telenet’s leverage will be 4.4 times up from 0.3x. 


Convertibles had another active week on the primary market. In Europe a well-known repeat issuer STMicroelectronics came to market with a double tranche USD 1.5bn deal. The semiconductor manufacturer issued 2 zero coupon convertibles, raising USD 750m over 5 years and 750m over 7 years. Some of the proceeds will be used to call the existing 2019 CB and to buy back shares. In the US, Synaptics, a developer of user interface solutions like touch pads, issued a USD 500m 5Y 0.5% coupon convertible for refinancing and M&A funding. Teledoc (healthcare services via phone or video consultations) issued a USD 240m 5Y 3% coupon CB in order to finance an acquisition.

In Europe, Grand City properties raised EUR 198m of new capital this week to finance potential acquisitions. In the US, biotech companies were back in favour with investors with convert names like Biomarin, Intercept, Pacira Pharma, Jazz Pharma outperforming this week. US software company Red Hat posted very strong first quarter earnings as billings grew 27% YoY sending the stock about10% higher.

In Asia, China decided to impose a 7% cap on investment returns for natural gas distributors. This limit will help reduce the cost for end-users and promote gas distribution in China. ENN Energy, which jumped 6% on Friday following the news, was also raised earlier in the week from Baa3 to Baa2 by Moody’s.


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