- After hitting new highs, equity markets were stopped by fresh bond market volatility.
- The fact that US inflation returned to below potential growth in the first quarter is good news for the fight against inflation.
- We are maintaining our tactical equity overweight because fundamentals are still improving.
After hitting new highs, equity markets were stopped by fresh bond market volatility. This week’s US Treasury auction saw low demand just before a record $340bn in new global issuance in June from the US, the European Union: and the UK. Goods inflation in Australia and services inflation in Germany also pushed bond yields higher.
As expected, the second estimate of GDP in the US was revised down to an annualised 1.3%. The fact that US inflation returned to below potential growth in the first quarter is good news for the fight against inflation. Moreover, this downward revision mostly concerned consumer spending. Weekly jobless claims continued on the path back to normal and hit an 8-month high over the past 4 weeks, another factor in favour of disinflation. However, these figures alone will not make the Fed change tack. First-quarter activity was hit by a surge in imports and lower company inventories while domestic demand stayed strong. Most importantly, April's rebound in consumer confidence took markets by surprise and instilled doubts over whether consumer spending, the main driver of US growth, would return to normal in the coming quarters. The Fed will release its new growth expectations at the June 12 FOMC. New York Fed president John Williams said on Thursday that he expected growth this year to be between 2% and 2.5%, so only slightly less than the 2.5% seen last year. This week, the Fed’s Beige Book showed that the economy remained robust with momentum still strong in services like travel and tourism. US labour market normalisation and growth moving towards its potential mean we can expect US monetary policy to be adjusted via a step-by-step move towards neutral rates as inflation trends back towards targeted levels. This is the market scenario. Trader expectations for a first cut in September are running at 50% and with the same probability for a second shift in December. An alternative scenario has the Fed considering more accommodating cuts if the labour market, and therefore domestic demand, sees a bigger fall back or regional banks begin to look fragile again. The FDIC this week released its quarterly report on US banks. It showed that commercial property loans made by regional banks still represented 30% of assets, compared to only 6.5% for national banks, and that they had $517bn in potential losses due to long bond volatility. However, deposits had returned to pre-SVB collapse levels which is reassuring.
In the eurozone, the second estimate of first quarter growth confirmed that growth could accelerate to 0.7% this year, up from 2.4% in 2023, amid a recovery in international trade after 18 months of contraction. The fact that wages are now rising more than inflation will also be a boost for consumption. European growth levels should therefore move towards US levels. True, inflation has surprised markets by rising but exceptional factors had some bearing. Services inflation continued to reaccelerate, moving from 3.7% to 4.1%. That will not stop the ECB cutting rates by 25bp next week but it could make the bank more cautious at future monetary committee meetings.
We are maintaining our tactical equity overweight because fundamentals are still improving. The really good news is that US and European growth levels are coming together. Nevertheless, interest rate volatility has led us towards ways of hedging diversified portfolios and we have gone from underweight to neutral on the dollar. As a long as the correlation between bonds and equities remains unfavourable and inflation remains the main risk, the US dollar is a good hedge and it offers attractive carry. As Fed and ECB rate cut expectations have been cut back, we are still keen on duration and are focusing on short-dated bonds. 2-year US Treasuries are now looking attractive again. They offer protection against any surprise downturn in the economy (jobs) or regional bank prospects while offering yields of close to 5%.
European equities
Markets ended the period lower, with tech stocks as the biggest casualties. Eurozone inflation rebounded slightly in May to 2.6% from 2.4% previously. Services were largely responsible and Germany’s IFO index provided confirmation that the country’s prospects were improving. Even so, central bank officials in Europe are still in favour of a rate cut. The Bank of France’s chairman said there would be one next week and the ECB’s chief economist Philip Lane said the bank needed to be less restrictive even with inflation likely to stay volatile this year.
Among companies left to report first-quarter results, UK retailer JD Sports beat expectations and reaffirmed its targets for this year. France’s Aramis Group (second hand cars) reported a creditable 14% jump in sales amid incipient easing in supply chain problems. The group raised guidance for 2024.
The wind farm sector is facing problems due to cheaper electricity prices. Siemens Energy's specialised subsidiary came under pressure and Shell said it was cutting jobs and restructuring. Elsewhere, asset manager Brookfield began exclusive talks to acquire France’s Neoen (renewable energy) at a 26.9% premium (18 times EBITDA). The plan is to delist Neoen subsequently. The €1.6bn bid boosted the entire sector and showed how big the valuation gap was between listed and non-listed green energy companies. French-Italian chip maker STMicroelectronics is to build a €5.5bn factory in Italy to produce silicon carbide components. The EU’s Chips Act will contribute €2bn. The European Commission said the venture would make Europe’s chip supplies more secure.
US equities
Monday's Memorial Day holiday meant a shorter trading week on Wall Street but it was nonetheless a busy period, notably for particularly disappointing results from software companies.
Markets are now starting to query GenAI’s ability to create value. For the moment, worries are focused on infrastructure companies like semiconductor and equipment makers and energy providers. MongoDB cut full-year guidance citing macroeconomic problems and the share tanked in pre-market trading. It is the same story for Salesforce, UiPath, SentinelOne: cyber security software groups are mostly seeing a turn-down in sales and investors are heading for the exit as the situation reminds them of the first few quarters of 2022. Computer maker Dell also plunged after posting its results. Admittedly, the bar had been placed very high given recent stock market returns. In healthcare, Veeva trimmed guidance, citing funding problems for biotechs due to high interest rates. UnitedHealth said it was struggling with current Medicare user rates and a cyberattack. As a result, short-to-medium term visibility had become complicated.
Results at Best Buy and Gap suggested some consumer softness but both said the outlook was brighter. Others like Kohl’s and Nordstrom continued to suffer. GDP data highlighted the downturn in consumption but it was no surprise.
M&A, resurfaced over the period. Merck paid $1.3bn for EyeBio. In telecoms, T-Mobile finalised its bid on USCellular.
The Nasdaq was down 1.6% as of Thursday evening and the S&P ended the period 1.3% lower. Small caps proved more resilient and only retreated by 0.3%.
Emerging markets
The MSCI EM index was down 2.30% in USD this week as of Thursday. All major emerging equity markets closed in the red. China (-1.70%) outperformed. Korea, India and Taiwan declined by 2.70%, 2.45% and 2.22%, respectively. Brazil and Mexico ended 2.03% and 2.02% lower.
In China, official manufacturing PMI for May dipped back into contraction territory at 49.5, down from 50.4 in April, and missing market expectations. Three of China’s biggest cities, including Shanghai, rolled out major easing measures for homebuyers by lowering the down payment ratio and mortgage rates. US and Chinese defence ministers discussed issues ranging from Taiwan and the South China Sea to Ukraine and the conflict in the Middle East, helping both sides avoid miscalculations. China iPhone shipments soared 52% YoY in April, and overall smartphone shipments jumped 25.5% YoY, but both were driven by discounts. China created a third edition of its chip fund, earmarking $47.5bn, or more than expected, to support the industry. The State Council released an action plan for energy conservation and carbon reduction for 2024-25. Tech heavyweights Alibaba, JD.com and Lenovo raised a combined $9bn in convertible bonds this week.
Taiwan’s GDP forecast for 2024 was raised to 3.94%, the highest in three years. April industrial output rose 14.61% YoY vs. estimates of 11.25%. Nvidia co-founder and CEO Jensen Huang is visiting Taiwan to attend Computex next week.
In Korea, industrial production increased 6.1% YoY in April, or more than the 4.4% expected. However, retail sales and investment dropped for the second consecutive month. The UAE’s president will make a state visit to Korea. Chinese Premier Li met Samsung’s CEO in Seoul. Samsung workers’ union announced its first-ever strike for wage increases.
In India, producers added 9.7GW of solar capacity in the first quarter, a 400% YoY increase. Power companies met record power demand of 250GW. The first hydrogen green plant by the Gas Authority of India was inaugurated. In election news, this weekend will be the last phase of voting and exit polls. Counting and results are on June 4 (Tuesday). Google will invest about $350m in Flipkart. Havells formed a JV with KRUT LED in the United States. Divis reported a beat on revenues and EBITDA margins while guiding for double digit growth in FY25. Tata Steel reported a miss on profits, dragged down by lower prices and a one-time loss. NTPC profits dropped on account of a jump in tax expenses, even as electricity sales rose. Apollo Hospitals reported a healthy 15% jump in revenues growth while EBITDA was up 31%, both driven by higher occupancy.
Brazil’s primary budget surplus of R$6.7bn in April was below estimates of 15bn. Unemployment edged down to 7.5% in April from 7.9% in March. Total outstanding loans inched up slightly in April to R$5.89 trillion vs. 5.87 trillion in March. The government released R$7.2bn to buy imported rice.
Mexico’s current account deficit for the first quarter was $12.6bn vs. estimates of $7.5bn. The unemployment rate for April was 2.61%, up from 2.28% in March. Asarco is planning to restart its mothballed copper smelter in the US. All eyes are on this weekend’s Presidential elections. Claudia Sheinbaum Pardo remains the favorite in the polls and has a14% lead.
Corporate debt
Credit
Financials were actively traded after inflation came in higher than expected, notably in Germany where the CPI came in at 2.8% over 12 months. The yield on the 10-year German Bund gained 10bp to 2.66% while the yield on the equivalent US Treasury bond rose to 4.55%. Even so, markets are still banking on an ECB rate cut in June. In the US, however, the bets are on a first rate cut in November or December.
Spreads remained at the bottom of the average range, i.e. 105bp for investment grade and 325bp for high yield. Inflows continued as IG is currently yielding 4% and HY 6.6% Wall Street and London were closed for holidays last Monday so new issuance was muted. But in the HY segment, there were two big deals from Burger King 2030 and Bité Telecom 2031. Year to date, around €40bn has been raised in new HY deals in Europe, or almost two-thirds of 2025 maturities, yet another indication that buoyant refinancing has reduced default and maturity wall worries.
Between May 24-30, rising bond yields meant IG lost 0.15%, taking YTD declines to 0.25%. Note however that spreads have so far this year provided a cushion for investment grade as government bond indices are down 2.4% since January 1st. Thanks to its shorter modified duration and resilient spreads, high yield edged 0.05% higher, taking YTD gains to an appreciable 2.6%.
Convertibles
Returns over the week were slightly negative along with risk assets generally. In the US, biotech company Insmed’s share price almost doubled thanks to very positive trial results for its Brensocatib drug used to treat bronchiectasis. The way now looks clear for FDA approval. The 2028 0.75% convertible soared more than 60% over the period.
In Europe, Brookfield Asset Management began exclusive talks with Neoen’s main shareholders to acquire their 53.32% stake at €39.85 a share, a 26.9% premium. If successful, Brookfield will then launch a bid for the outstanding shares. Neoen’s board approved the deal. During the subsequent bid procedure, the investment fund will offer €48.13 for the 2025 bond and €101.086 for the 2027 maturity.
New issuance was largely confined to the US. Microchip Technology raised more than $1bn at 0.75% due 2030. The bond came with a 27.5% premium.
Elsewhere, Safran is to call its 2027 0.875% convertible. Holders have until June 19 to choose to convert instead.
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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31/05/2024
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