Market Flash: Inflation slows down in the US

• Consumer prices rose less than expected in October, up 0.4% or +0.3% ex food and energy
• Weekly jobless claims rose by 5,000 to 225,000
• The third quarter earnings season drew to a close

After enjoying a sharp rebound in October, risk assets started November in a hesitant mood ahead of the consumer price index in the US. The actual CPI figure sent risk assets higher and bond yields lower. Consumer prices rose less than expected in October, up 0.4% or +0.3% ex food and energy. Over a year, inflation slowed to 7.7% compared to 8.2% in the previous month. Ex food and energy, prices rose 6.3%, down from 6.6% in September. Weekly jobless claims rose by 5,000 to 225,000, flying in the face of employment data in the previous week which was stronger than expected. However, the unemployment rate had risen from 3.6% to 3.7% and the participation rate fell, reducing the number of net job creations. In addition, hourly wages rose 4.7% over 12 months, or less than US inflation.

The US midterm elections were not the most important short term event. At the time of writing, the final results were still not yet in but the Republican wave had failed to materialise. Florida governor Ron DeSantis was easily reelected and will be a serious rival to Donald Trump for the 2024 Republican nomination.

In China, rumours of the zero-Covid policy being eased triggered a big rebound on markets at the end of the previous week but the trend failed to continue into this week. The likelihood of a change in policy is still highly uncertain as Covid cases are rising. At the end of the period, tech stocks across the globe were hit by cryptocurrency woes. Bitcoin suffered another big sell-off after Binance decided not to buy FTX. The cryptocurrency trading platform was confronted with a serious liquidity crisis after its users asked for massive redemptions. The FTX share price cratered by more than 80% in only 24 hours. Back in January of this year, the platform had a market cap of more than $30bn.  

As the third quarter earnings season drew to a close, the results were mixed. Although 70% of companies posted better than expected figures, albeit lower than the historic mean, expectations had been largely revised lower. In Europe, earnings were much better, mainly due to the falling euro and a very strong showing from the energy sector. Ex energy, results fell over a year in the US and sales, both there and in Europe, increased more than results, a sign of shrinking margins.

Following the CPI print, government bond yield curves steepened a little as short rates fell more than long rates on expectations of fewer rate hikes to come. Interest-rate volatility has fallen since mid-October, a tactically encouraging indicator for equities. Nevertheless we are sticking to our slight equity underweight as earnings trends are at risk and central banks are still tightening. In fixed income, we believe current levels are more reasonable, especially in the US.

European Equities

At the beginning of the week, markets were optimistic at the prospect of Republicans making sweeping gains at the midterm elections, enough to trigger sharp falls in Treasury yields thanks to a more balanced approach to the budget. Sentiment was also driven by persistent hopes for China reopening and relatively resilient economic data and earnings. Even so, markets are still fragile: central banks continue to tighten and much depend on the consumer inflation figures in the US.

In third-quarter earnings news, Marks & Spencer warned that the coming months would see persistent rises in costs and softening demand. Even so, giant retailer Ahold Delhaize raised its targets for this year after strong figures, especially in the US. The group however, failed to give any detailed numbers for 2023. Adidas once again revised down its objectives. As well as the impact from the group's cancellation of its contract with US rapper Kanye West, demand in China is weak and uncertainty hangs over other zones. Renault unveiled ambitious targets for 2025 at its Capital Market Day and confirmed that it wanted to list its Ampère electric vehicle division. The outcome of its ongoing talks with Nissan is still, however, uncertain. Deutsche Telekom once again raised its targets for this year thanks to its US exposure and big currency translation gains. Deutsche Post also raised guidance for 2022 after strong online shopping helped the group post record figures. Ryanair expects strong growth in airline traffic over the next three years at least. The Irish airline has just posted record earnings and raised guidance on passenger volumes for 2023 even if it expects travellers to be more price conscious.

US Equities

US indices lost ground over the last five trading sessions as investors waited for the midterm election results. Although the final count was not yet in at the time of writing, it looked as if the Republicans would gain control of the lower house. The Senate was still uncertain with the possibility that Democrats might hold on to their slim majority. The results are a setback for the Republican party which hoped for a strong wave, and even more so for Donald Trump as most candidates he sponsored failed to win. Moreover, Ron DeSantis, his biggest rival for the Republican nomination in 2024, won by a resounding 20 points in Florida. Historically, US equities have outperformed in the six months following 16 of the last 19 midterm elections.

Ahead of the consumer inflation figures, the Chicago Fed’s chairman, who is not voting this year, called for more moderate rate rises to avoid a recession. Fed Funds futures are now 57% betting the Fed will raise rates by 50bp in December with 43% going for a 75bp move.  

With 85% of S&P500 third quarter results now in, the period is in line with the historic trend on an equal weightings basis. However, results in leading sectors have been particularly disappointing. The Communication Services sector saw a 26% YoY decline in EPS with net margins down more than 500bp to 12.7%. Overall, the S&P posted its first fall in margins since the beginning of the pandemic.

In company news, Meta rose 5% on Wednesday after slashing its workforce by 13%, or 11,000 jobs, its first redundancy plan ever. Elsewhere, data analytics group Palantir tumbled 11% on extra hours trading after revising down its growth targets.

Ride-hailing company Lyft plunged 13% as investors reckoned that a decline in its user base might mean a loss of market share to Uber.

Walt Disney plummeted 13.2% after a revenue miss. The group has decided to slash costs. Management nevertheless maintained 2024 profitability targets for its Disney+ streaming service thanks to higher prices and a version with advertisements although growth is expected to slow.

Cryptocurrency stocks tanked after Bitcoin sank 24% over two days.

Japanese Equities

The NIKKEI 225 and TOPIX ended the period 0.19% and 0.47% higher after a weak start following hawkish comments from the Fed’s Jerome Powell. Sentiment then revived after signs the US employment market was not too strong, stable earnings in Japan and resilient Chinese equity markets. 

Marine Transportation, Iron & Steel and Wholesale Trade rose 4.18%, 3.96% and 3.37%, respectively, as major companies announced strong results mainly due to high commodity prices. Air Transportation and Land Transportation fell 2.65% and 2.32% on profit taking after recent strength.

Unicharm and Sumitomo jumped 10.37% and 10.16% after revising guidance higher. Nitori Holdings gained 8.61% as October same-store sales rose 11.4% YoY. Z Holdings, Eisai and M3 fell 10.52%, 7.27% and 5.12% after double digit falls in third-quarter earnings compared to the same period in 2021.

The yen strengthened to 146.41 from 147.90 yen against the dollar as US interest rates appeared to have peaked and some US economic data turned soft.

Chief Cabinet Secretary Matsuno acknowledged that coronavirus cases were on an uptrend. However, he added that the government had no intention of enforcing new restrictions if a new outbreak was due to a similar variant to Omicron. He said the basic stance of the government was to preserve economic activity while maintaining anti-infection measures.

Emerging Markets

In USD, the MSCI EM Index was up 1.7% as of Wednesday’s close. Korea (+7%) and Taiwan (+7%) led the rebound. India (+1%) slightly underperformed, while China (-0.9%) saw some profit taking after last week’s sharp rebound. Brazil (-6%) lagged most markets due to uncertainties around Lula’s finance minister and higher government spending.

In China, October exports fell 0.3% YoY vs. estimates of a 4.5% increase. Imports dipped 0.7%, vs. flattish expectations. CPI grew by 2.1% YoY in October, or slightly below the 2.4% forecast, while PPI fell 1.3%, or in line with expectations, mainly driven by declining global commodity prices. Beijing announced a new programme to support RMB 250bn in bond issuance for private companies, including property developers. The Zero-Covid policy was reaffirmed by the government at the latest public conference. Goertek is to suspend the production of a smart acoustic product for a key customer.

In Taiwan, TSMC is preparing for another multibillion-dollar factory investment in the US to build a cutting-edge plant.

In India, the foreign minister reiterated India’s commitment to buy oil from Russia. Both Reliance Industries and HCL Tech are each looking at taking a 30% stake in ISMC Analog, a semiconductor wafer fab applicant; this is another signal of India’s strong interest in developing its semiconductor industry. The investment could amount to around Rs 40bn ($488m) for each company. 

Thailand’s hotel occupancy rate crossed the 50% mark for the first time since the pandemic.

In Brazil, retail sales for September rose 3.2%, or well above the expected 0.2% MoM rise. Bradesco reported disappointing, below-consensus results due to treasury losses and higher provisions. In contrast, Banco do Brasil had an impressive third quarter, well above expectations, with decade-high ROE and stable asset quality.

In Chile, October consumer prices rose 12.8% over a year, a surprising slowdown after the 13.7% increase seen in September.

Corporate Debt

Credit

Attention remained focused on central banks. Their overall message is “slower rate rises but for longer.” In Australia and Norway, rate hikes have been slowed to 25bp moves. And after the Fed increased rates by 75bp, Jerome Powell stressed how much rates had already risen and said the future schedule was uncertain and would depend on the impact on the economy. He nevertheless indicated that the terminal rate would be higher than previously suggested and reaffirmed his determination to be restrictive enough to tame inflation. Credit indices held up well with the Main and Xover stable at 108bp and 529bp. Financial bond premiums were also unchanged.

The investment grade new issues market was very busy over the period with large subordinated financial debt deals and highly attractive coupons. The new BNP CoCo was priced at 9.25% and we subscribed to the Deutsche Bank euro CoCo at 10%. Issues from Credit Suisse for €3bn and $2bn were easily absorbed by the market. Elsewhere, Faurecia successfully placed a bond in a bridge financing deal for its acquisition of Hella.

Results out over the week showed that macroeconomic worries had so far failed to translate into hard figures, or only moderately. Financials like Alpha Bank, Sondrio and Intesa continued to report upbeat results driven by higher interest rate margins.

In company news, Vodafone agreed to sell half its 82% stake in Vantage to KKR/GIP. Jaguar Land Rover recovered in its second quarter but still revised down guidance due to difficulties at the beginning of the year. Coty had a solid first quarter and launched a $200m bond buy back. Casino’s buyback tender on its 2023 bond was more than 80% successful. Carrefour released the broad outlines of its 2026 strategic plan.

Convertibles

This week it was Europe’s turn to be active in new primary market. Ubisoft, the video game publisher, comes back to the market with a 450 m EUR convertible bond priced at 2.375% coupon and 47.5% premium. This is the largest convertible issue of the year for France, and had Tencent subscribing up to 5% of the amount. The issuance of the convertible bond, had a strong demand from investors, and alongside the company announced the placement of 3.1 million existing shares. 

To continue with the primary market activity, RAG-Stiftung issued 500 m EUR in exchangeable bonds into Evonik Industries shares. The new deal with a maturity in 2029 was priced at 1.875% coupon and a 20% premium . RAG-Stiftung, which owns 56% of Evonik Industries, holds three outstanding bonds exchangeable into existing shares of Evonik. At the same time, RAG-Stiftung plans to repurchase up to 50 million euros of the outstanding 500 million-euro senior, unsecured exchangeable bonds due in 2026 and to fund as well the potential buyback of the outstanding bonds due in 2023 and 2026.

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.
10/11/2022
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