The Ecb Raises Its Benchmark Rates

• Government bond yields in Europe retreated and sterling and the euro gained against the dollar
• The pleasant surprise came from third-quarter GDP, up in the US, in France and in Germany, even if the fine print in the US data showed domestic demand slowing
• We are sticking with our cautious approach to equities and duration pending Wednesday’s FOMC and labour market data

Two events led investors to consider that political risk in Europe had fallen back. First, Rishi Sunak became the UK’s prime minister and second, the new government in Rome included a finance minister viewed as pro-Europe. Government bond yields in Europe then retreated and sterling and the euro gained against the dollar. The feeling is that governments now seem to realise they have less room to manoeuvre over budgets now that financing costs have risen.

The ECB raised its benchmark rates by 75bp on Thursday. Chair Christine Lagarde said the ECB was now being pragmatic over its interest rate trajectory because of previous measures and the time monetary policy would take to have an impact. Markets interpreted the statement as being accommodating. It was at any rate out of step with the figures released on Friday which showed inflation in Europe was still a long way from stabilising. Consumer prices jumped, especially in Italy where they rose by 3.5% in September alone due to a 25% leap in energy prices. Government bond yields rose sharply on the news.

The pleasant surprise came from third-quarter GDP, up by an annualised 2.6% in the US, 0.2% in France and 0.3% in Germany. However, the fine print in the US data showed domestic demand slowing. Consumer spending decelerated and private investment, particularly in residential property, made a negative contribution. The figures were, in fact, boosted by a 3.2% contribution from exports.

And advanced indicators point to a contraction in this quarter. October’s PMI in the US fell again, down from 49.5 to 47.3 and the eurozone was also lower, down from 48.1 to 47.1. Germany saw the biggest fall, particularly in manufacturing which is the most exposed to energy restrictions.

The third quarter earnings season showcased big disappointments in the US tech sector and triggered heavy selling. 

In China, Xi Jinping won a third mandate as the Communist Party’s general secretary. The new politburo reflects a more ideological bias following the retirement of “moderates” like Li Keqiang and Wang Yang and the eviction of the former leader, Hu Jintao. The new five-year programme will continue the “common prosperity” theme, promote “Chinese-style modernisation” and develop “fighting spirit,” notably over any discussion of Taiwan's independence. 

We are sticking with our cautious approach to equities and duration pending Wednesday’s FOMC and labour market data. We will add back risk when we see inflation decelerating because of a property market slowdown and less tension on labour markets. But the Fed will also have to be more pragmatic, taking advanced inflation indicators on board as they start to turn lower, and less dogmatic, i.e. waiting until inflation trends towards its 2% target before becoming less restrictive.

European Equities

Equity markets rebounded sharply as falling government bond yields helped offset worries over downward earnings revisions. The ECB raised its benchmark rates by 75bp, a decision that had largely been discounted by markets. However, inflation in Germany and France then came in significantly above estimates.

The results season is in full swing. STMicroelectronics posted excellent figures but fell after revising its semiconductor sales and margins for this quarter lower. Companies delivered mixed messages. AB InBev raised guidance after strong consumer trends boosted its quarterly figures. In contrast, its rival Carlsberg expects the situation to worsen in 2023 with beer prices set to rise. And Heineken saw strong selling when its sales slowed. Management said it had seen the first signs of slowing demand in some European markets. 

Oil companies continued to make big profits due to high oil and gas prices. And in chemicals, BASF’s results reflected resilience faced with high commodity and energy prices. The group maintained its guidance for the full year. Covestro, however, once again cut guidance as price increases failed to offset energy and commodity inflation. 
In banks, Barclays, Deutsche Bank and Santander gained from higher interest rates and in spite of the difficult economic environment. 

Elsewhere, Interparfums had a good third quarter and raised guidance for the full year. The premium perfume specialist said demand for its products was still as strong as in previous quarters. The luxury sector continues to do well as results at Hermès and LVMH show.

US Equities

Wall Street rose in a busy week for company results and economic indicators. The S&P 500 gained 3.86% and the Nasdaq 1.68%. Industrials, financials and commodities in the S&P500 gained 7%, 6.6% and 5.8% over the week. Only communication stocks fell (-4.8%).

Weaker-than-expected indicators at the beginning of the week fuelled hopes the Fed would tighten less aggressively in the future. For the fourth month in a row, the composite PMI contracted, falling from 49.5 to 47.3. Services fell sharply from 49.3 to 46.6 while manufacturing hit a 28-month low at 49.9.

The Conference Board's consumer confidence indicator also fell in October from 107.8 to 102.5, again below the 105.9 expected. At the same time US property prices fell 1.3% in August from the previous month, the biggest drop since 2011.

In contrast, GDP rose by a robust 2.6% but still failed to convince investors. Growth was boosted by a sharp 14.4% YoY rebound in exports. Consumer spending, however, rose by only 1.4%.

More than a third of S&P500 companies reported over the week. Apart from Apple, GAFA stocks posted disappointing figures. Alphabet fell 7% when advertising revenue growth came in markedly lower than expected. Microsoft declined by 8% after revising sales guidance for the current quarter lower, especially for its Azure cloud computing division. Meta plummeted 24% after the bell when its guidance on sales fell significantly short of estimates and the company said it would have to ramp up spending in coming months. Amazon plunged 13% in after-hours trading on disappointing sales guidance for the current quarter. The group is expecting Christmas sales to rise by 2-8% YoY, its lowest ever increase. Apple, in contrast, edged higher thanks to laptop sales compensating for disappointing iPhone figures.

Caterpillar jumped 7.7% on upbeat figures. Margins were well ahead of expectations thanks to price rises largely offsetting input costs. The group said the outlook was particularly healthy for its energy and transport businesses.

Despite disappointing results, Intel gained 5% after the bell on its plans to cut costs by $3bn in 2023 and up to $10bn by 2025. Mobileye, Intel’s autonomous driving technology subsidiary, gained 35% to $28.41 on its first day of trading.

Japanese Equities

The NIKKEI 225 and TOPIX rose 1.25% and 0.54% for the period. As in the US, Tokyo was driven by hopes the Fed would slow its rate hikes, better-than-expected company results and signs of resilience in Chinese equity markets. 

Electric Appliances rose 2.83% on hopes for a less aggressive Fed. Rubber Products gained 2.36% as auto production rose due to less supply chain disruption. Mining rose by 2.26% on a rebound in commodity prices. Land Transportation and Air Transportation fell 4.07% and 3.24% on profit taking following a sharp rise in tourism plays. Pulp & Paper declined by 2.98% on concerns over rising commodity and fuel prices.

Nitori Holdings jumped 10.97% after same-store sales rose 11.4% YoY in October (September 21 to October 20). Tokyo Electron gained 7.87% as large-cap growth stocks returned to favour on hopes for less radical rate hikes in the US. Eisai rose by another 7.30% on news that its Lecanemab drug had successfully slowed the progress of Alzheimer’s disease in a final-stage trial. West Japan Railway Company fell 4.89% on profit-taking. Canon declined by 4.83% after revising down guidance for its full-year net profits. Chugai Pharmaceutical retreated by 4.25% after net earnings in the third quarter fell 21% compared to the previous quarter.

The yen rallied from 150.15 to 146.29 against the US dollar on rumours of Bank of Japan intervention and falling 10-year Treasury yields.

EMERGING MARKETS

The MSCI EM Index was down 0.6% as of Thursday’s close. China fell 5.1% after the 20th Congress on concerns of growing power concentration. Brazil (-6.6%) underperformed. Mexico outperformed, rising 4.5% and India was up 1.4%.

In China, the 20th CCP congress concluded last weekend with a third term for XI Jinping. All members of the Politburo Standing Committee are Xi loyalists. On the macro side, 3Q GDP grew at 3% YoY, or above the 3.3% expected. Industrial Production was up 6.3% YoY, or higher than the 4.8% expected. Retail sales growth (+2.5%) was below consensus. FAI also fell short of expectations, +6.4% vs 7.3% projected. The PBoC adjusted cross-border borrowing rules to allow more inflows and set the fixing at its weakest level in 14 years. China plans to increase the number of international flights from October 30, doubling current levels but still way below the pre-pandemic period. Shanghai added an inhaled COVID-19 vaccine to boost its vaccine list. Ping An Insurance’s 3Q NBV fell 20%, although largely in line with market expectations, mainly due to continued agent team downsizing. The company appointed a new CFO. Online broker East Money reported both top line and profit declines, the first time in three years, mainly on lower fund distribution and securities business amid turbulent markets. Third-quarter results at Tigermed were in line with revenues up 35% YoY. As expected, Aier Hospital revenue was up 16% YoY but with improved margins. New Oriental delivered better-than-expected quarterly results as new initiatives made meaningful progress.

In Taiwan, industrial production unexpectedly dropped 4.8% in September on soft global demand, and well below the +0.4% expected. Third-quarter earnings at AirTac missed estimates on lower operation margins. The company reduced its 2022 full-year guidance on low demand visibility. In Korea, SK Hynix said third-quarter revenues and operation profits were down 20% and 61% sequentially, or below consensus. The company announced a more than 50% cut to capex for 2023. Elsewhere, Samsung has no plans to cut its memory production despite near-term industry weakness. LG Energy Solutions posted strong results helped by strong pricing power and steady volume growth.

In India, Axis Bank released much better-than-expected earnings, driven by a 31% YoY jump in NII, strong fees and much lower OPEX. ICICI Bank delivered another strong set of results, beating expectations in core operating profit on the back of strong 27% NII growth. Quarterly results at Hindustan Unilever were in line with expectations. Although the top line beat estimates, operating profit was far more challenging.

In Brazil, October’s IPCA-15 inflation rate came in higher than consensus (0.16% versus 0.09% expected), a return to inflationary territory after two months of deflation. Unemployment was 8.7% in September, or in line with consensus. Total loans in September continued to grow sequentially, up 16.8% YoY. WEG announced solid 3Q results with a higher-than-expected EBITDA margin on commodity price stabilisation and cost reduction programmes. French oil company Total bought 34% of Casa dos Ventos for R$4.2bn, one of the largest wind projects in Brazil (6.2 gigawatts of installed capacity). With the second round of Brazil’s 2022 presidential election taking place on Sunday, ex-president Lula is leading the polls (on a consolidated basis).

In Mexico, real activity expanded almost 1% sequentially, or above consensus, driven by services. Banorte reported strong results with good operating momentum, higher NIM and stable asset quality. Banorte raised guidance for this year and the outlook for 2023. Moreover, the management announced that it is dropping its bid on Citi Banamex to focus on its core business and digital initiatives. FUNO reported strong 3Q22 results with strong operating performance offset by higher interest expenses.

In Chile, the central bank paused its tightening cycle.

Corporate Debt

Credit

Indices gained on a cocktail of poor economic indicators and less hawkish comments from central banks.

Between Monday and Thursday, the high yield index rose 1.7% and the investment grade index by 1.94%, a reflection of a 47bp drop on the Xover and a 12bp decline on the Main. 10-year Bund yields eased by 38bp over the week.

Spanish casino operator Cirsa raised €350m at 10.875% due 2027 to refinance some of its outstanding 2023 bonds.

Third-quarter results at Atos were satisfactory. Sales rose 5.7% to €2.8bn on strong performance from its cybersecurity subsidiary Evidian and the contribution from Tech Foundations which managed to stabilise profitability. Evidian has attracted potential investors like the Apollo and Cerberus funds. Air France KLM made €460m in the third quarter, or more than in the pre-Covid period. This was thanks to strong demand over the summer and efforts to cut costs over the last few years by reducing its fleet and head count.

The Orpea soap opera continued with a second attempt to find an agreement with creditors in an attempt to restructure the retirement home operator’s debt. The company is being strangled by its heavy borrowing in recent years to fund international growth. It is also struggling with accusations of mistreatment and the share price has lost 90% year to date. Converting unsecured debt into capital would help the company take out new loans and allow it to bolster its capital base.

For a change, October was a good month for financial bonds. With most issuers posting robust figures and government bond yields down -yields on the 10-year Bund lost 40bp over the week- the segment gained around 2%.

Revenues at Lloyds rose 13%, mainly due to interest rate margins and a 0.2% increase in the capital generation rate which took the bank’s CET 1 to 15%. There were also upbeat figures from Sabadell (+20% in its interest rate margin), Danske, Deutsche bank (CET1 +0.3% to13.3%) and UniCredit (CET1 >14.5%). Results at Barclays and Santander were in line.

Credit Suisse posted a CHF 4bn loss but helped bond holders see some light at the end of the tunnel by unveiling restructuring plans which will involve a capital raising for close to CHF 4bn, cost cutting, significant layoffs and asset disposals. The bank’s dollar CoCos rallied by 10 points over the last 10 days, another illustration of the different fates of its creditors and shareholders. Throughout the restructuring programme, the Bank's CET 1 should be close to its target of 13-15%.

Credit premiums contracted over the period with euro CoCos down 100bp to around 1075 compared to 1180bp. US dollar CoCos also saw premiums narrow from 950 to 830bp. Senior debt also gained. Actuarial yields on senior euro financial bonds are now around 4.2% with euro CoCos at 13% to call.

Convertibles

Despite steep falls in US tech stocks, indices gained ground and the global convertible bond index ended the period 138bp higher. The mood was also in evidence in new issuance. In the US,  Nextgen Healthcare (healthcare software) raised $200m at 3.75%. with its first convertible. The proceeds have been earmarked for external growth.

Israel’s Selina Hospitality raised $147.5m at 6% due 2026. The company had been listed earlier this year via a SPAC and will use the proceeds to expand its property portfolio.
In results news, Merck’s profitability soared thanks its cancer drug Keytruda and its Gardasil vaccine against papillomavirus. Sales jumped 14% over the third quarter to $15bn and earnings rose to $4.7bn. 

In contrast, adjusted earnings at Ford fell 40% over the quarter even if sales rose to $37.2bn. Exiting the Argo AI autonomous vehicle joint venture with Volkswagen cost the group $2.7bn in the quarter.

Elsewhere, Elon Musk finally acquired Twitter after months of dithering. The Tesla founder waited for the next-to-last day set by judges before paying the $44bn agreed. He immediately sacked 3 executives including the CEO Parag Agrawal.

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

28/10/2022
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