European elections and trade war: markets retreat

Market analysis - 5/27/2019

The US trade dispute continued to worry markets and US and German companies.

At the end of the period, US PMI data remained in positive territory but showed confidence levels slipping. The Fed stayed in wait-and-see mode as the FOMC minutes said lower inflation was probably transitory. Recent hikes to tariffs on an extra $300bn-worth of Chinese imports are undermining inflation and growth scenarios, leaving all options open. The fact that no date has been set for another meeting between Donald Trump and Xi Jinping does not augur well for the period before the G20 summit at the end of June. And the trade war is starting to hit harder. Donald Trump announced a fresh $16bn aid package for farmers suffering from Chinese retaliation. He also softened his tone and is now considering leaving Huawei off the trade talks agenda.

Global trade reshuffling also hit Europe's PMI. Germany was still the hardest hit but France managed to rebound thanks to strong domestic consumption. The UK remained centre stage as another Brexit episode saw Theresa May setting her departure date for June 7. The withdrawal plan is still uncertain and the prime minister might also push for another referendum. Against this backdrop, the EU elections started.

Equity markets moved in line with trade war developments. US, emerging country and European indices shed more than 2% over the week. Bond markets continued to seek out quality and US 10-year Treasury yields fell by close to 10bp. The US dollar also made further gains. We believe that due to geopolitical uncertainty, markets will not rise on upbeat results as the earnings season continues but remain on the sidelines. Our asset allocation choices remained unchanged. We are still underweight risk assets. Caution is the watchword as risks are still asymmetrical. 

  European equities

Once again, developments in the ongoing US-China trade war took centre stage. US threats on Chinese giant Huawei's supply chain triggered fears that Beijing would riposte, heightening tension between the two countries. The mood darkened further when the UK's ARM, which has 99% of the global mobile chip design market, followed Infineon in interrupting supplies to Huawei. Quite logically, semiconductors fell the most, tracking sell-offs in stocks exposed to global trade. Banks, a barometer of current risk, declined further while defensives like utilities and healthcare outperformed. Oil stocks fell on news of higher US inventories and on worries over a global slowdown.

In Europe, there was no help from manufacturing PMI either which came in at a mediocre 44.3 while Germany’s IFO fell to 97.9. Concerns over Italy ahead of the European elections also led to more outflows from the zone.

Elsewhere, US regulatory authorities eventually agreed to the T-Mobile/Sprint merger but the Department of Justice still has to give its green light. Saint-Gobain sold its German building materials business. Vivendi fell on news that Private Equity firms found its price tag for UMG too high. The group is reportedly looking for a trade buyer. Casino’s parent company Rallye entered creditor protection to allow it to restructure its debt. 

  US equities

It was another down week on US markets. The S&P 500 lost 1.9% and the Nasdaq ended the period 3.6% lower. US-China tensions and increased pressure on Chinese telecom equipment giant Huawei made investors more nervous. US 10-year Treasury yields fell further due to rising concerns over global growth, losing 7bp to 2.32%, an 18-month low. Higher than expected oil inventories caused Brent crude to plunge 5% to $68 over the week. Energy (-4.5%) led losses. Tech fell 3.6% due to strong exposure to China via semiconductors (the SOX index plummeted 8%) and hardware (Apple shed 6% and Cisco 3%).

In company news, Target jumped 11% after like-for-like sales beat expectations but Kohl dived 20% after its sales missed by a significant margin, leading the company to revise annual guidance lower. Qualcomm and Broadcom tumbled 17.5% and 12.5% over the week due to broad semiconductor weakness but also specific legal action: both have been accused of anticompetitive practices by the Federal Trade Commission. 

  Japanese equities

Japan’s first quarter (Jan-Mar) GDP grew at a better-then-expected annualised 2.1% but the real economy was not as strong as lower imports made a key contribution.

Amid mounting concerns over US-China trade war escalation, the TOPIX lost 0.88% this week. This was mainly down to Washington’s prohibition of exports of essential electronic parts to China’s smartphone giant Huawei and reinforced by global firms subsequently cutting links with the company. This international supply chain interruption also hit Japan’s high-tech suppliers of semiconductors and electronic parts to Huawei. CMOS image sensor producer SONY tumbled 9.5% and motor producer Murata Manufacturing lost 7.65%. 

On the other hand, domestic demand stocks in sectors like Food & Beverage, Land transportation and Real Estate rose. They are seen as largely avoiding the effects of the US-China trade conflict. 

  Emerging markets

Emerging market equity funds last week reported one of their largest weekly outflows in 11 months. Around $5bn came out from active and passive funds, reflecting mounting tensions between China and the US.

Google’s announcement to stop providing its Android software to Huawei was another high-profile development of the back-stage trade war which has already taken place in the global tech sector. Whilst we recognize that the Android ban is an issue for Huawei outside China, with limited impact for its domestic market, this may have some long immediate implications, such as a slowdown of 5G deployment within China, and the revival of Korean competitors.

The trade war spillover added another potential victim. According to the New York Times, the US administration is considering limiting US company supplies to HIKVision, a Chinese video surveillance company. The impact on video chips will be limited as HIKVision sources most of its chips within China.

On the earnings front, Weibo’s first quarter results were as expected with revenues up 14% and earnings 12% higher. However, management’s 9% revenue guidance for the second quarter disappointed; the Chinese advertising industry may experience oversupply of ad inventories and advertisers’ budget decline in the coming quarter. Ctrip, the online travel agency, reported better-than expected first quarter results but guided for slower 16-21% YoY revenue growth for the current quarter as domestic travel appeared weak in March and April and outbound travel could be hurt by the renminbi’s depreciation.

Another important emerging market headline was the victory of the Bharatiya Janata Party (BJP) party and the reelection of Modi. India continues to benefit from positive tailwinds with dynamic growth, a positive reform agenda initiated by the Modi government, the emergence of an affluent middle class, high single-digit economic and infrastructure demand growth as well as strong urbanization. India is one of the fastest growing emerging markets in terms of earnings and is also trading at attractive valuations.

In Brazil, Randon one of the largest commercial vehicle equipment manufacturers, had a positive earnings release with 15% YoY topline growth, a sign of strength in the commercial segment.

The Casino share trading suspension was negative news for CBD. It could speed up a restructuring of Casino’s assets in LatAm, and not necessarily with a positive outcome for CBD minorities. Despite good operating momentum, we see turbulent times ahead for CBD’s shares at least until a conclusion is reached on corporate restructuring in LatAm.

In Argentina, Cristina Fernandez de Kirchner surprised the market with her decision to step down from the presidential race and instead to run for vice-president. Alberto Fernandez will be the presidential candidate. Elsewhere, April CPI inflation showed some improvement, up 3.4% versus expectations of +4%. 

  Commodities

Oil prices tumbled. Brent crude fell by close to 7% or $5 before stabilising at $68, leaving it 8% lower over the week. WTI was down $5 to $58 and Thursday May 23 saw the biggest daily drop in a year. The sell-off was due mostly to a sharp rise in US inventories which revisited July 2017 highs. Petrol stocks also rose more than expected even though refineries were running at seasonal lows.

OPEC countries are closely watching developments. Last week’s meeting showed they were determined to cut output in the second half after weighing up contrary factors like slackening demand on the one hand, and supply risks from countries like Iran and Venezuela on the other. All OPEC countries are mindful of the price collapse in the fourth quarter of 2018. Saudi Arabia said it had not seen any increased demand from countries which had previously imported Iranian oil. It is likely that Iran is still exporting but cutting tanker communications to hide the fact.

The price drop comes as markets fall on fresh US-China tensions, particularly the Huawei issue, and has been aggravated by what looks like a weakening in the Russia-Saudi alliance. Russia’s energy minister seems to be in favour of easing production cuts which suggests that they have had a negative impact on the Russian economy. Saudi Arabia, meanwhile, seems to have withdrawn from funding the Arctic LNG project which is sponsored by Russia with Novatek, Total and CNOOC as partners. 

  Corporate debt

 

Credit

It was a risk-off, choppy week as the US-China trade war escalated over technology issues and US and German manufacturing PMI proved disappointing. US and German 10-year yields fell sharply to lows of 2.32% and minus 0.11% respectively. The Xover fell 9bp to 288 and the Main by 3bp to 68.

Flows into investment grade bonds remained at a healthy €580m over the week, taking the year-to-date gain to €6bn. However, the high yield segment suffered outflows of €520m, taking YTD inflows down to €3.6bn.

On a dynamic new issues market, Holland’s LeasPlan (Baa1/BBB-, vehicle hire) which also has a banking division, sold its first AT1 PNC5 (Ba3/B+), raising €500m at 7.375%. Shaeffler (auto parts) refinanced its PIK debt for €2.05bn, with two euro-denominated tranches (BB+) over 6 and 8 years at 3.625% and 3.875%. In investment grade, Telenor (A3/A-) raised €2.5bn in three maturities, one of which for €500m over 15 years at 1.75%.

Individual company risk also returned to the limelight. Rallye, the Casino group’s ultimate holding company, as well as parent companies Foncière Euris, Finatis and Euris, filed for 6-month creditor protection to freeze debt payments and avoid bankruptcy. The group pointed out that this procedure did not concern Casino and had no impact on its strategic plan execution, its debt or its funding costs. Rallye also said it was to maintain control of Casino. The Rallye share plummeted by 50% while its 2021 bond lost 40 points to 23. Casino shares and bonds fell sharply on Thursday before staging a strong rally the day after.

Elsewhere, S&P, Fitch and Moody’s cut UK tour operator Thomas Cook to CCC+/Caa2, citing a persistently tough trading environment as well as a deterioration in the group's liquidity. Its 2022 and 2023 maturities shed 20 points over the week to 36 and 35. 

Convertibles 

There were two new deals in the US. Veoneer Inc. (auto parts) is raising $180m over 5 years at between 3.75% and 4.25%. The issue is part of a $600m capital raising with $420m to come from new shares. The proceeds will go on working capital requirements, general corporate purposes and additional investment in capacity or R&D.

IAC/InterAvtiveCorp (media and internet with more than 150 brands including Citysearch, Match.com and Vimeo) sold two convertibles for $500m each. The 2026 maturity is at 0.875% and has a 32.5% conversion premium while the 2030 is at 2% and has a 27.5% premium. Each will go on financing a call spread as well as general corporate purposes.

Elsewhere, Google’s decision to shut off Android access to Huawei phones was a big blow for phone and semi-conductor suppliers. Lite (optical fibre) reduced sales guidance from $405/425m to $375/$390m and cut margin forecasts from 18%/20% to 15.5%/17%. The news aggravated the recent sell-off in the stock. On the other hand, II-VI (semiconductors) said its sales would not suffer much and left guidance unchanged. Even so, the stock fell further due to trade war concerns and because of its cyclical profile.

Indian markets rose sharply after Narendra Modi’s BJP party increased its majority in the lower house elections. The news is good for infrastructure plays and Larsen & Toubro convertibles gained, all the more so as the group had released upbeat results and confirmed that its 2020 objectives were within easy reach.

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