Markets consolidate

• In the US, the FOMC minutes showed a large majority in favour of slowing the pace of rate hikes while maintaining the upward move
• The COP 27 agreed to provide financial aid to developing countries which are suffering from global warming
• In China, stimulus measures are being undermined by sanitary restrictions amid an explosion in Covid cases

Falling government bond yields in the US and Europe helped equity markets consolidate recent gains. Even so, growth in Europe is falling back. PMI provided confirmation that activity had slowed significantly for the 5th month in a row. Budgetary stimulus measures and mild weather helped avoid even worse damage.

Following a wage agreement at IG Metall, Volkswagen’s agreement to  increase wages by 8.5% by 2024 illustrates the potential danger of knock-on inflation and the ECB’s concerns that inflation expectations might de-anchor. The bank is expected to keep monetary policy restrictive for several months so we can expect European government bond yields to go higher.

In the US, the FOMC minutes showed a large majority in favour of slowing the pace of rate hikes while maintaining the upward move. Government bond yields promptly retreated, pushing equity markets higher over the week and helping them consolidate gains made since November 11. 

In China, stimulus measures are being undermined by sanitary restrictions amid an explosion in Covid cases. Schools and shops have been closed in Beijing, Guangzhou has introduced lockdown measures and a campaign to test the population has been launched. Failing a large-scale vaccination programme, consumption and activity will remain under pressure over the winter.

The COP 27 agreed to provide financial aid to developing countries which are suffering from global warming. A €338m fund is to be set up. However, the conference essentially failed to produce a fresh international commitment to combat rising temperatures. The global energy crisis is one explanation: many countries have had to return to fossil fuels to ensure supplies and limit the short-term impact on their populations.

We are maintaining our neutral stance on equities while keeping a close eye on recession risk in developed countries. To benefit from monetary normalisation maturing and the probability that the dollar peaks, we prefer emerging country zones to Europe and Japan. In fixed income, we like carry strategies as they should provide protection now that volatility has plateaued. We also think improved visibility on the trajectory of short rates makes US duration more attractive.

European Equities

European equities continued in resilient mood as the Stoxx Europe 600 returned to levels not seen since the middle of August. The ECB followed the Fed in reassuring investors that they could expect a slowdown in rate hikes. As a result, government bond yields in Europe fell back sharply. November's PMI for the eurozone were rather encouraging thanks to government stimulus measures, falls in energy prices in recent months and the ongoing improvement in supply chains.

Despite signs in China of rising Covid cases and new restrictions, sector shifts benefited those which had been hammered the most recently, notably energy and basic resources. 
In company news, Volkswagen is to raise wages by 8.5% over the next two years for its German employees. The move follows a similar increase for metal workers. Soitec (high-performance electronic components) is struggling with soft demand, especially for smartphones, and margins have fallen due to rising input costs. For the moment, management is  sticking to its guidance for this year but has given no clear indications for 2023. In contrast, Interparfums raised 2022 guidance and said it was confident for next year. The premium perfume maker’s margins have been maintained thanks to strong US markets, reduced supply chain problems and strong pricing power. Others like Compass are not so lucky. The contract catering company warned on its margins for 2023. Like Tesco and other UK companies, the group is to give wage advances to its British staff to boost purchasing power.

US Equities

Markets were closed for Thanksgiving on Thursday and Black Friday meant trading would stop at 1pm. A Farm Bureau survey said the traditional Thanksgiving dinner would cost 20% more this year. The US, incidentally, is one of the few countries where shoppers are expected to spend 6% more on Black Friday deals. And yet, retailers are gearing up for a subdued Christmas season. Walmart, for example, has taken on significantly fewer temporary workers.

Elsewhere, Mary Daly at the San Francisco Fed said the FOMC should now take into account the lag between rate increases and the real impact on the economy. Loretta Mester (Cleveland Fed President) said she was open to slowing the pace for rate hikes. And the FOMC minutes showed a majority thought this approach would soon be in order. Most agreed that slower rate hikes would provide better indicators of how to reach full employment and stable inflation targets.

WTI oil prices slumped to $75 after the Wall Street Journal said OPEC might increase output by 500,000 b/d when it meets on December 4. But the price very soon recovered to $80 when Saudi Arabia quashed the rumours.

Disney jumped 6.3% when Bob Iger returned to replace Bob Chapek as CEO. Chapek had been pilloried after the Disney+ streaming service reported heavy losses. 

According to Bloomberg, the Federal Trade Commission (FTC) is to file an antitrust lawsuit to block Microsoft's acquisition of Activision Blizzard. 

After recalling 300,000 cars in the US for tail light problems, Tesla recalled 80,000 cars in China for software and safety belt malfunctions.

Japanese Equities

The NIKKEI 225 and TOPIX rose 1.62% and 2.67% for the period on (i) expectations the Fed might slow the pace of interest rate hikes and (ii) the stable yen.

All sectors ended higher. Electric Power & Gas gained 6.17% on news that electric power companies had started discussions with the government on raising prices. Insurance rose 5.90% on hopes for improved investment conditions amid robust equity markets. Wholesale Trade ended 5.72% higher after Berkshire Hathaway upped exposure to general trading companies. The news sent Marubeni (8002) 7.97% higher.

In pharma, Eisai jumped 10.25% on a joint research project with Shimadzu for the early detection of Alzheimer's disease. Ono Pharmaceutical gained 7.92% on attractive valuations backed by strong guidance for 2023. M3 and First Retailing fell 3.53% and 2.29% on profit taking. Sompo shed 3.48% after cutting guidance for 2023 on increasing natural disasters and Covid-19 infection numbers.

The yen rallied further against the dollar, moving from 140.20 to 138.58 as US interest rates declined.

Speculation persisted that PM Fumio Kishida might call a snap election for the House of Representatives in January next year to reassert his control after three Cabinet members resigned. He then denied media reports about a possible reshuffle in the near future, saying he would concentrate on his political agenda, notably finalising new national security documents that the government is slated to approve by the end of the year.

Emerging Markets

The MSCI EM Index was up 0.4% as of Thursday’s close. China retreated by 2.2% after wider “restrictive measures” were applied in lower tier cities. India rose 0.7%, while Brazil (+3.1%= outperformed.

In China, the PBoC cut the RRR for the second time this year by 25bp, injecting the equivalent of $70bn into the economy. The bank also made a joint announcement with the CBIRC to support housing demand and to ease developer liquidity pressure. SOE banks are offering more than $30bn in new credit lines to support developers. Daily COVID infections rose to a record high, topping April’s peak. Restrictions were in place in several areas. On the geopolitical front, China’s Commerce Minister and the US Trade Representative had a constructive face-to-face dialogue and discussed bilateral economic and trade issues. Beijing lifted its six-year ban on Korean media content after the heads of the two countries met in Bali. Baidu’s third-quarter revenues were in line, but profits beat thanks to more disciplined opex spending. 

In Taiwan, export orders fell 6.3% in October, the worst pace in nearly three years as a global slowdown in demand worsened. TSMC reportedly received Tesla’s order for its next-gen Full Self-Driving chip on 5nm, replacing current foundry service provider Samsung. Tesla is expected to become one of TSMC’s top customers next year. 

In Korea, the central bank raised interest rates by 25bp to 3.25%, the highest level since 2012.

In India, Zomato’s co-founder resigned, the third senior management exit from the company in recent weeks. Nykaa said its CFO was stepping down. Adani Enterprises plans to raise £2.5bn by selling new shares to increase its free float and improve its balance sheet. At its analysts meeting, Axis Bank said it was targeting 18% in ROE in the medium term.

Indonesia announced a 10% cap on wage increases for 2023, or less than trade union demands.   

In Thailand, core net losses at AOT narrowed in the fourth quarter thanks to a sequential rebound in traffic. 

In Brazil, Congress could dilute the transitory government proposal to spend R$200bn but the outcome is still highly uncertain.  

In supply-chain-relocation news, LG Chem will invest more than $3bn by 2027 to build the largest cathode factory in the US. Construction is to start in the first quarter of 2023. TSMC confirmed it was to build a 3nm foundry capacity in Phase 2 in Arizona.

Corporate Debt

Credit

Indices ended another week higher as inflows resumed and inflation worries abated. Between Monday and Thursday, the Xover and Main tightened by 9bp and 2bp, sending weekly returns on the high yield and investment grade indices 1.25% and 0.98% higher.

On a busy new issues market, auto equipment maker Valeo raised €750m at 5.375% with a Sustainability-Linked Bond due May 2027.

Contract caterer Elior was the big news this week. Third quarter results were down due to inflation and the company is having difficulty renegotiating its public sector contracts. For FY 2021-22, sales rose 15.4% thanks to economies reopening but losses worsened to €427m from €100m in the previous financial year. After three loss-making years, the group is mulling a closer tie-up with its main shareholder Derichebourg which could transfer assets to Elior and in return take its 19.6% stake to 24%.

Third-quarter sales at seamless steel tube maker Vallourec jumped 54% to €1.3bn and the group made a €6m profit. Analysts had been expecting €1.4bn in sales and €94m in profits. Free cash flow was still negative (-€81m). Even so, S&P upgraded the group to B+, citing strong demand from Permian basin oil exploration companies and the reopening of a tin mine in Brazil. The group is also pressing on with its restructuring programme to reduce fixed costs and improve profitability.

Over the week, subordinated bonds enjoyed a vigorous rebound. Euro CoCo premiums fell from 870bp to 800bp. They were at 1,200bp only a month ago. It was the same story for senior financial debt: average premiums have fallen by 250bp to 199bp over a month.

In new issuance, Bank of Ireland sold a T2 bond in euros and Commerzbank a Tier 2 in sterling. As generally expected, BCP extended its Tier 2 bond callable end 2022 by offering to exchange it for a new bond. 

The troubled Credit Suisse saga continued with a fourth-quarter profit warning and a third-quarter loss that was larger than expected. Although an increase of capital was approved at a shareholders’ meeting over the week, the bank's bonds still lost 2 to 3 points on the figures.

Convertibles

It was another good week for convertibles thanks to favourable bond moves and upbeat news. In thin trading due to Thanksgiving and Black Friday, the Bruxelles Lambert group, no stranger to the asset class, still managed to raise €500m at 2.125% with a bond exchangeable into Pernod Ricard shares. The group’s broad portfolio helped it refinance at attractive rates.

Elsewhere M&A news underpinned the convertibles market. In the US, private equity firm Vista Equity Partners made a bid to take Coupa Software private by offering a 29% premium. Another PE firm, Hellman & Friedman, bid $10.2bn for software company Zendesk. Note that this sort of deal is particularly advantageous for convertible holders as convertibles have anti-dilution clauses (Ratchet and Poison Put) which allow them to benefit fully from takeover premiums.

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.

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This is a marketing communication.
25/11/2022
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