Worrying developments

Market analysis - 11/16/2018

It was another dizzy week for fund managers.

Oil prices were extremely choppy after Saudi Arabia said it intended to cut production and Donald Trump immediately riposted by urging Riyadh to do no such thing. This had a mixed impact on markets: oil is a index heavyweight so any reduction in demand would be harmful but less inflationary pressure would be welcomed by investors worried about central banks going too far with tightening. US-China talks seem about to resume after the mid-terms. It is too early to cheer this development but a pause in hostilities would be welcome. 

Elsewhere, the EU has reached a pre-agreement with London over Brexit. This provides hope but any chances that the current administration, or what's left of it, can get it through the Commons are still slight. Sterling lost 2%. The stand-off between Rome and the EU continued. Germany’s GDP fell in the third quarter. Autos were a big drag on the figure but this does not augur well for European growth rates to clear 1.5% in 2019. 

We have maintained our slight European and US equity overweight. We remain cautious on government bonds. 

  European equities

Markets plunged again on the UK crisis over Brexit, and mounting worries that Theresa May could get her agreement with Brussels approved by Parliament. Italy’s decision to remain inflexible over its draft budget proposals was another downer. Sterling suffered its biggest intraday drop against the US dollar and the euro since 2016. UK domestic stocks fell sharply just as a strong fall in October retail sales was announced. UK tobacco companies BAT and Imperial Brands tumbled on rumours of stricter US legislation. The FDA is considering a ban on menthol cigarettes and could also tighten up regulation of e-cigarettes. Europe’s new car registrations fell 7.3% in October, the second down month in a row, due to WLTP standards coming into force. The sector was also hit by rumours that Chinese officials would not support cutting taxes on cars.

Technology was also lower. SAP fell on concerns that its acquisition of Qualtrics would entail earnings dilution. Infineon was also hit despite hitting expectations. Markets think its 2019 guidance is unrealistic, particularly in the autos sector, especially as US suppliers to Apple have been told to limit production. STM also suffered.

However, telecoms were in demand after Vodafone released upbeat figures and upped its free cash flow guidance. Iliad’s results were in line: subscriber numbers in France were flat, but the product mix suggested margins would rise. Bouygues subsidiary Bouygues Télécom saw sales rise 6.5% with an EBITDA margin at 29.4%, or 270bp better than the first nine months of the 2017 financial year.

Elior rose after maintaining guidance and on the prospect of its Areas concession catering business being sold. That would allow the group to focus investment on its own mass catering arm. 

  US equities

It was another down week with the S&P losing 1.8% and the Nasdaq ending 2% lower. CPI for October came in at +2.5% or in line with expectations. And there were good macro data with the Empire Manufacturing index rising from 21.1 to 23.3 and retail sales up 0.8% vs. 0.1%, or better than expected.

Equity market turbulence was in fact due to bond market moves as investment grade/high yield spreads widened.

At a QA session, Jerome Powell put recent market shifts into perspective and said equity market volatility was only one of a number of factors that the Fed considered. There have already been three rate hikes so far this year and a fourth looks likely in December.

In company news, Walmart’s same store sales rose 3.4% compared to expectations of 3.5% and its e-Commerce sales jumped 43%. However, the stock fell 2% on the news, dragging the entire sector lower due to falling margins, a reflection of persistently tough competition. In tech, Cisco released upbeat figures thanks to strong IT infrastructure spending. The group expects sales to rise by 5-7% in the current quarter and the stock gained 5.5%. There was, however, a disappointing showing from NVIDIA as previous strong demand led to an inventory build-up which weighed on the third quarter. Utilities and consumer staples posted the smallest declines while energy, tech and consumer cyclicals sold off. 

  Japanese equities

Following the sharp fall in US stocks after Apple tumbled, Japanese stocks followed suit as investor sentiment worsened. Electric part suppliers to Apple such as Murata Manufacturing and TDK were hit.

Oil and Coal Products also lost ground after WTI futures tanked while sectors which benefit from cheaper oil like Air Transportation and Electricity & Gas led outperformers. The TOPIX declined 2.03% over the week.

China-sensitive baby care goods producer Unicharm and Pigeon gained on reports that the country might relax birth control measures and pneumatic control equipment manufacturer SMC rebounded 5.35% from last week’s steep fall. 

Japan’s third-quarter GDP growth fell by an annualised 1.2% but mostly because a series of natural disasters weighed on consumer spending. GDP is forecast to get back to positive territory in this quarter. Meanwhile, there could be further economic slowing in China and Europe and that could weigh on exports in the future.  

  Emerging markets

US and Chinese economic teams are reportedly engaged in serious discussions, raising hopes of a deal during the Xi-Trump meeting at the G20 Summit at the end of the month.

China’s industrial production and fixed asset investment were marginally better than the previous month, but new renminbi loans for October only came to 697bn, falling well short of market expectations of 905bn. In response to the weak credit data, the central bank’s governor said that, given the financing difficulties facing corporates, banks should actively take responsibility to “appropriately plan the pace and magnitude of credit supply” to support private enterprises and SMEs.

Consumer sentiment remained positive. Singles Day shopping festival sales reached another record this year, up 27% YoY in GMV or $30bn in one day for Alibaba, an indication that consumer spending was still resilient despite a slowdown.

Tencent’s third quarter results provided temporary relief for tech names: revenues rose 24% and earnings 15% YoY with mobile games still 11% higher QoQ despite the game approval freeze. Netease also reported a 35% YoY increase in third quarter top line growth thanks to better-than-expected online game sales.

In India, industrial production growth remained stable in September at 4.5% thanks to a low base. Headline CPI for October was 3.3% YoY vs. 3.8% in September as food inflation fell more than expected. while the trade deficit widened again, mainly led by higher oil imports. Sun Pharma missed second quarter results for FY 2019 given the upfront costs for building a US specialty pipeline while the pickup in US generic business was slower than expected.

Bank Indonesia raised its policy rate by a further 25bp to 6% to defend the currency given the widening trade deficit in October with a 2.9% current account deficit in the third quarter.

Brazil’s retail sales fell 1.3% MoM or much lower than the 0.5% drop expected, mainly due to lower consumer confidence. According to local press reports, the Brazilian Senate could vote a law next week that provides for important changes to rules related to the Transfer of Rights (ToR). If the ToR is approved, it could generate a receivable of $7bn-9bn for Petrobras (or 7% of its market cap).

Mexico’s central bank increased interest rates by 25bp, or in line with expectations. The surprise came from its hawkish comment. In Argentina, the Senate approved a budget aimed at achieving a primary balance in 2019. 

  Commodities

Last week, we discussed Brent crude’s descent from $85 to 70 in barely a month. Now the price has gone from $70 to 65 in only a few days...

Last weekend, the Joint OPEC-non-OPEC Ministerial Monitoring Committee (JMMC), examined supply and demand fundamentals and noted that 2019 could see supply outpacing global requirements given today’s uncertainties. That made a production cut likely at the end of this year and Saudi Arabia even said it was planning to cut exports by 500,000 b/d in December. This shows that OPEC and allies are ready to act if required but at the same time that the situation is not as good as expected. Donald Trump then fired up his preferred means of communication to advise Saudi Arabia and OPEC against any cuts. The Khashoggi affair seems to have given the US President more sway over the kingdom.

In this uncertain, and even negative, environment, technical factors came into play to create a snowball effect. Hedge fund Andurand Commodity Fund, (AUM $1bn) wound up a significant long oil/short natural gas position, causing the option market rout to worsen (with a negative gamma, you sell an asset whose price is falling). This part of the correction ($5 a barrel) is nothing to do with fundamentals and should in the short term be made up. Nevertheless, the fundamentals are now less upbeat. The AIE, EIA and OPEC agencies have just cut estimated production needs in 2019 to 31.5 million b/d, down from 32.9m in October. Traders will now be scrutinising OPEC’s reaction. In our view, Saudi Arabia will try to stop inventories rising significantly and aim at getting Brent crude to stabilise between $70 and 80. 

  Corporate debt

 

Credit

The Xover widened by 33bp amid a strong surge in political risk as Rome refused to change its draft budget Brexit uncertainties rose. Rome is now facing action from Brussels for overstepping deficit limits and possible financial sanctions. Later in the week, the agreement between Theresa May and EU negotiators caused four of her cabinet ministers to resign and risked plunging the UK into a serious political crisis.

Financial debt underperformed over the week amid strong pressure on UK financials due to the worsening political climate in the country.

Telecom Italia (Ba1/BB+) sacked its CEO Amos Genish who is close to Vivendi, the group's largest shareholder. Bayer (Baa1 neg./BBB) beat third-quarter estimates. The results included Monsanto for the first time.  AP Moller-Maersk (Baa2/BBB ) posted upbeat third-quarter results with sales up 31% and EBITDA 13% higher over a year. S&P upgraded  Barry Callebaut from BB+ to BBB-,to reflect improved results. Moody’s had already raised its rating to Baa3 in September. Senvion (B2/B+) posted poor third-quarter results and revised its full-year objectives lower due to a drop in its third-quarter order book and delayed projects. 

CMC di Ravenna (B3 /CC) said it would pass on the half-yearly November 15 coupon for its 2023 maturity, leaving it with a 30-day grace period before default status becomes official. S&P cut the group from B- to CC.

Restructuring concerns continued to weigh on Nyrstar's bonds but they recovered at the end of the week.

In new issues, Japanese pharma Takeda raised €5bn with 4 maturities, and International Design Group (B2/B), €720m over 7 years in 2 tranches, one floating and the other at 6.5%. BNP raised €500m with a Tier 2 issue. 

Convertibles 

In a busy week for new issues after the end of the earnings blackout periods, German real estate company ADO Properties raised €165m with a 2023 maturity at a 27.5 premium and a 0.875%-1.625% coupon pricing range.

In the US, Wayfair, a household goods e- commerce company, raised $500m at 1.125% and a 32.5% premium, due 2024. KBR, a global infrastructure and construction company, priced a $350m convertible at 2.5%, and a 27.5% premium due 2023. Gogo, in-flight connectivity provider, announced a $200m convertible with an indicative pricing of 5.5-6% coupon, 20-25% premium, due 2022.

In earnings news, Apple supply chain companies announced profit warnings due to cuts in shipment orders, presumably for new iPhones. Lumentum in the US was the first to cut its revenue target for the quarter by 17% and the stock plunged 33% on the day. Several days later, it was the turn of Austria’s AMS to reduce its revenue guidance by 16%. Both companies are exposed to 3D sensing content in Apple products.

In Europe, Vallourec posted third quarter revenues of €96m, missing estimates, and negative free cash flow of €153m due to worsening working capital requirements. The stock initially tanked 23%.

In Japan, Aeon Financial Services saw first half revenues rise 9.7% YoY, or in line with expectations. However, domestic business credit costs rose due to promotions and additional advertising.

In other US corporate news, On Semiconductors announced a $1.5bn share buyback.

 

Elément complémentaire