Evergrande und die Fed schüren Nervosität

• Risk assets came under pressure
• The risk of the Evergrande affair spreading abated
• The Fed confirmed that it would gradually reduce its asset purchases

Risk assets came under pressure as the crisis at Hong Kong property group Evergrande worsened, rekindling worries over China’s growth slowing. Nervousness also increased ahead of the FOMC.

Midweek, however, the risk of the Evergrande affair spreading abated as the group said it would pay interest due on September 23 and China’s central bank injected fresh liquidity. Even so, it looks as if Beijing will have to intervene to neutralise contagion risk and fully restore confidence.

Equity markets now look capable of digesting the Fed’s tapering project. The bank confirmed that it would gradually reduce its asset purchases but only if the economy continued to improve. We expect it to start tapering before the end of this year, but so gradually that rises in bond yields will remain under control and valuations will stay above average 2015-17 levels. 

We believe any subsequent benchmark rate rise will be carefully managed so as to avoid disruption to equity markets. Nevertheless, there is still no certainty on whether the current spike in inflation following the easing of Covid restrictions will turn out to be fleeting or persistent. That said, US inflation surprisingly fell last month.

In the UK, there is a question mark over the economy’s ability to absorb the 1.9 million workers who until this month were benefiting from partial unemployment measures. Given labour shortages from the epidemic and Brexit, this means upward pressure on wages. As a result, the Bank of England is in favour of a rate hike.

PMI data for September in the US, France and Germany showed their economies were still strong but markedly less so than in August. The slowdown is due to persistent supply chain problems and labour shortages in services.

We are still neutral overall on equities but have been rebalancing exposure. We remain upbeat on Japan but are now neutral on the US and Europe. This move is to take account of regular post-pandemic growth amid cautious monetary policy normalisation. In fixed income, we are still negative on eurozone government debt and have stayed neutral on US Treasuries.

EUROPEAN EQUITIES

Trading was choppy due to fears China’s giant property company Evergrande might go bust. Initially, this led to European cyclicals getting hammered but they rapidly clawed back losses as the likelihood of this episode turning into a Lehman Brothers mark 2 disaster evaporated. At the same time, several sectors managed to perform well, notably in the tourism and leisure sectors due to the US and UK reopening travel possibilities.

Airlines benefited the most: Air-France KLM jumped 11% over the week as the group said it was betting on air traffic returning to normal by 2025-27. The other big development over the week was the sharp rise in energy. Shell and Total Energies gained 4% on average over the period. The European Commission reacted by saying it was ready to approve temporary measures to help consumers deal with surging gas, oil and electricity prices. The inflation outlook was revised higher on the heels of the energy price surge. Bank stocks ended the period in positive territory as yields edged higher
In company news, Valneva extended clinical trials for its COVID-19 vaccine and pursued talks with the European Commission on a potential supply contract. LVMH said it would be hiring 25,000 people under 30 before the end of 2022. The news suggests the group is expecting to see strong growth. Shell sold its Permian basin assets to CONOCO for $9.5bn. The proceeds will go on funding a share buyback and bolstering its balance sheet. In the autos sector, Faurecia and Traton said semiconductor shortages had forced them to reduce output. The market largely brushed off the news as the situation had been well flagged; many estimates already see no return to normal conditions before 2023.

US EQUITIES

Markets kicked off the week worrying that Evergrande, the liquidity-strapped Chinese property group, might turn into another Lehman Brothers. But the group later promised to pay overdue bond coupons thanks to talks with its clearing house.

At the much-anticipated post-FOMC press conference, Jerome Powell surprised markets by implying that the Fed might start to raise rates as early as next year. Half of the 18 committee members are now in favour of a hike. Consensus expectations had previously been for a first rate hike in 2023. However, Jerome Powell’s statement was tempered with the now traditional reminder that the rise in inflation was only temporary. He also added that China’s property crisis and the delta variant could put the economic recovery at risk.

All in all, it was one of the Fed chair’s least accommodating press conferences since he took office. Tapering is now almost certain to start this November unless a really bad jobs figure comes in this month.

Elsewhere, President Biden met progressive and moderate Democrats in the Oval Office in an effort to solve disagreements over his stimulus package and speed up Congressional approval. The President also appointed Saule Omaraova, a law professor who is a fierce critic of cryptocurrencies, to head up the Office of the Comptroller of the Currency (OCC), the banking supervisor for the country’s leading banks. 

In the first big profits warning, Fedex revised its annual forecasts lower, citing higher costs from wage increases due to labour shortages and an unexpected drop in trading. We can expect other companies to suffer from the same difficulties.

Disney lost 4.1% after announcing that the Delta variant was slowing new film production.

Uber jumped 11.5% after saying it could move into the black this quarter for the first time ever. It sees results falling in the $-25m/+25m range. Passenger traffic has recovered while demand for home food deliveries has remained strong.

Bitcoin fell back below $40,000 for the first time since August after Gary Gensler, SEC chairman, said he was in favour of it being more tightly supervised.

JAPANESE EQUITIES

During the period, the Japanese stock market finished weak, NIKKEI 225 and TOPIX dropped -2.26% and -2.23%. The market initially rose with large trading volume as the upcoming election is catching investors’ attention towards possible economic measures. However Evergrande’s troubles especially dragged down the companies with revenues in China.

Air Transportation and Land Transportation gained 4.07% and 1.07% expecting activities reopening. Marine Transportation slightly rose 0.95%. On the other hand, Iron & Steel, Machinery and Wholesale Trade sank -8.30%, -4.70% and -4.63% due to concerns over Chinese economy.

Daiichi Sankyo gained sharply by 11.38% favoring the clinical trial of an anticancer drug. ANA Holdings rose 3.65% with expectation for travel recovery as well as Central Japan Railway that rose 3.15%. Nippon Steel dropped -11.29% from the positive reaction for possible upside of earnings, due to troubles in China. Daikin Industries declined -8.63% with large Chinese revenue exposure.

The current state of emergency was extended several times but is expected to be lifted as scheduled on 30 September with the progressing vaccination and decline in Covid-19 new infection cases. The inpatients currently declined by half from the peak, and the number of infection cases per day is around 10% of the peak.

EMERGING MARKET

The MSCI Emerging Market index was down 0.53% as of Thursday’s close. China was down 1.41%, on worries over possible contagion from Evergrande. Both Brazil and India closed higher, up 1.15% and 1.03% respectively. Pressure on emerging market currencies eased after the Fed’s comments on the outlook for tapering.

In China, Evergrande reached agreement with debt holders on the onshore part of its coupon payment but its offshore coupon is yet to be paid. The PBoC injected short-term liquidity multiple times this week to avoid an immediate liquidity squeeze. China also said it was stopping funding for the construction of coal-fired power plants for overseas markets as a sign of its commitment to carbon neutrality. Jiangsu, among more than 10 other provinces, is urging power rationing and forced cuts to factory production to meet environmental targets and ensure blue skies ahead of the Winter Olympics. According to NBS data, tourist trips during the Mid-Autumn Festival holiday amounted to 78% of 2019 levels by revenue and 87% by trips. Ant Group started to share detailed consumer credit data with the central bank as the regulatory overhaul continued. Tencent continued its share buyback: HKD 2.2bn worth has been bought back since the beginning of the year, of which 1.4 bn in September. 

Senior Macau casino and junket executives met with authorities, seeking details on proposed regulatory changes but have so far only received limited clarification.

In Taiwan, TSMC said it would achieve flat emissions growth by 2025 and reach net-zero carbon by 2050. MediaTek is to hire 2,000 workers by the end of the year to meet strong demand. 

In Korea, LG Chem and General Motors said they had found a fix to avoid battery fires in the Chevrolet Bolt EV.

India, the world’s biggest vaccine maker, will resume exports of COVID-19 vaccines in the next quarter, thanks to increased production and the inoculation of more than half of the population with at least one dose. Prime Minister Modi is visiting the US to attend a Quad meeting and strengthen India’s global strategic partnership with the US, Japan and Australia. Sony India will buy local rival Zee to become the largest broadcaster in the country.

In Brazil, the number of monthly Covid vaccine doses hit 50 million, or more than forecast. In October, 90% of adults above 20 are expected to have received one dose. As expected, the central bank raised interest rates for the fifth consecutive time this year by 100bp to 6.25% as it battles to contain inflation. Another adjustment of the same magnitude is planned during the October meeting. Minister Paulo Guedes said a solution for court-ordered payments would come earlier than expected. US private equity firm Bain is to sell half of its remaining stake in Grupo Notredame Intermedica (healthcare).

CORPORATE DEBT

CREDIT

Major indices buckled last Monday due to worries over Chinese property company Evergrande’s woes. Concerns over China’s growth slowing also played a part.

Nevertheless, markets ended the period more or less unchanged as indices recovered losses during the Tuesday and Thursday trading sessions amid the Fed’s confidence in the economic recovery. Credit spreads benefited from the rally but higher bond yields weighed on credit indices and long-term bonds. Last Thursday, 10-year US Treasury yields saw their biggest rise since March and ended up at 1.44%. Both investment grade and high yield returned a negative 0.13% over the period. Travel and leisure stocks performed in line after the US government said it was reopening borders to vaccinated people from November 1st. Autos, however, continued to underperform due to increased component shortages, and especially semiconductors.

The news issues market maintained the same pace as in the previous week. Goodyear Europe raised €300m at 2.75% with an August 2028 maturity. The proceeds will go on refinancing debt, notably the 2023 3.75% maturity. Europcar sold a €500m green bond due 2026 to refinance its 2022 maturity. The company has undertaken to reduce its fleet’s carbon emissions to 93g of CO2/km for cars and 144g for trucks by end 2024.

The group also wants to increase the number of green vehicles -those emitting less than 50g of CO2/km- to 20% of its car/truck fleet over the same period. Incidentally, Moody's raised its Europcar Mobility Group rating by one notch to Caa1 from Caa2, citing the group’s faster-than-expected recovery this year. The agency raised its earnings estimate for the group after car rentals performed well over the summer due to restrictions being eased and an increase in vehicle shortages. 

The biggest catalyst for Europcar is still Volkswagen’s bid, a move that should reinforce the car rental company’s profile. The week’s biggest deal came from telecom holding company Altice France which raised $3bn in a euro/US dollar tranches. The proceeds will help optimise the group's financial structure and fund acquisitions like the €415m purchase of virtual mobile operator Coriolis Telecom.

Elsewhere, Fitch Ratings upgraded BNP Paribas from negative to stable, citing reduced risks to earnings and asset quality thanks to the improved macroeconomic outlook on the bank’s main markets. Fitch also raised Deutsche Bank from BBB to BBB+ thanks to upbeat markets and the progress made since the group launched a restructuring in 2019.

After upgrading Portugal to Baa2, Moody's also raised senior non-preferred debt at Caixa Geral de Depositos from Ba1 and Baa3 and its T2 from Ba2 to Ba1. Moody’s also upgraded Greece’s Eurobank, Alpha and NBG from Caa1 to B3. T2 at NBG and Alpha were raised from Caa2 to Caa1 and at Piraeus Bank from Caa3 to Caa2.

On the new issues market, La Banque Postale raised €750m with an AT1 at 3%. Commerzbank raised €500m with a Tier 2 bond.

CONVERTIBLES

Convertible bond indices were relatively resilient during the week’s surge in volatility. Convertible convexity helped cushion the sharp fall on Monday while tapping into the strong rebound on the following three days. At the end of the period, European convertibles had returned 0.6% compared to +0.19% for the global index.
In new convertible issues, Bill.com Holdings returned to raise $500m due April 2027. This followed a $1.15bn issue last November which was also earmarked to fund growth. The company offers cloud-based billing and payment software for companies.

GLOSSARY

• Investment Grade: bonds rated as high quality by rating agencies.
• High Yield: corporate bonds with a higher default risk than investment grade bonds but which pay out higher coupons.
• Senior debt benefits from specific guarantees. Its repayment takes priority over other debts, known as subordinated debt.
• Debt is considered to be subordinated when its redemption depends on the earlier payment of other creditors. To offset the higher risk, subordinated Senior debt has priority over other debt instruments.
• Tier 2 / Tier 3 : subordinated debt segment.
• Duration: the average life of a bond discounted for all interest and capital flows.
• The spread is the difference between the actuarial rate of return on a bond and the rate of return on a risk-free loan with the same maturity.
• The so-called "Value" stocks are considered to be undervalued.
• Markit publishes the Main iTraxx index (125 leading European stocks), the HiVol (30 highly volatile stocks), and the Xover (CrossOver, 40 liquid and speculative stocks), as well as indices for Asia and the Pacific.
• EBITDA: Earnings before Interest, Taxes, Depreciation, and Amortization.
• Quantitative easing describes unorthodox monetary policy from a central bank in exceptional economic conditions.
• Stress Test: a process which simulates extreme but possible economic and financial conditions so as to assess any impact on banks and measure their resilience to these events.
• The PMI, for "Purchasing Manager's Index", is an indicator of the economic state of a sector.

DISCLAIMER

24/09/2021

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