- Developments in the UK at the start of the week helped bond yields fall and equities and sterling rise
- In the US, weekly jobless claims pointed to persistent labour market tensions, raising expectations of more rate hikes to come
- We are still cautious on equities and duration pending better visibility on monetary policy at the Fed and ECB
Political turmoil in the UK bookended the week. Initially, markets were reassured when the new chancellor withdraw the contentious elements in the mini budget. But on Thursday, PM Liz Truss was forced to resign after less than 2 months in office. She was unable to keep her party’s backing despite appointing a new chancellor and changing the mini budget. Her successor should be chosen before the end of the month.
Developments in the UK at the start of the week helped bond yields fall and equities and sterling rise. 10-year gilt yields are just about managing to stay below 4% but yields in the US and Europe quickly started rising again. Minneapolis Fed president Neel Kashkari said he was worried about persistent inflation so the Fed is expected to continue tightening. And yet the week’s advanced indicators -the Empire Manufacturing index, Philadelphia Business Outlook and Leading Indicator- all showed that the economy was about to slow. The US property market is already struggling with higher rates. Housing starts tumbled in September and sales of existing homes fell again. On the other hand, weekly jobless claims pointed to persistent labour market tensions, raising expectations of more rate hikes to come.
In Europe, the definitive inflation reading for September was more or less in line with initial estimates. Total inflation rose 9.9% over a year and core inflation by 4.8%. Europe’s leaders then agreed to a road map to ensure energy supplies and rein in price rises. Japan’s inflation is significantly lower but it nevertheless hit an 8-year high of 3% YoY in September and 1.8% ex energy. The Bank of Japan is sticking with its ultra-accommodating policy for the moment but the data will put it under pressure, especially as the yen has slumped to more than 150 against the dollar.
At the 20th Chinese Communist Party Congress, Xi Jinping defended the zero-Covid policy. He reaffirmed the need to grow the economy but emphasised military security and the need to ensure food and energy supplies. The new 7-member permanent committee will be decided during the weekend. Xi Jinping’s third mandate will be made official on October 23.
Equities kicked off the week on the front foot but some of the gains were then wiped out by rising bond yields. Overall, we are still cautious on equities and duration pending better visibility on monetary policy at the Fed and ECB. However, now that the earnings season has really got off the ground, risk assets could rebound thanks to technical considerations like positioning and valuations.
European Equities
Markets swung between fears of a recession amid rapid interest rate rises and some enthusiasm over earnings. Instability in the UK was once again in focus when PM Liz Truss resigned. After sliding since the end of August, European gas prices rebounded sharply.
ASML’s encouraging results boosted sentiment in the semiconductor sector. The Dutch company reported record new orders. Pernod Ricard’s third-quarter sales were robust as customers continued to brush off price rises. Management sees the strong growth trend continuing next year. Following LVMH’s excellent results, Hermès once again reported a strong rise in sales. Demand in the US remained solid and sales in China rebounded despite prevailing sanitary constraints. Sales at Getlink also rose sharply to above pre-pandemic levels, partly thanks to the contribution of Electlink. In banks, Nordea raised guidance after revenues rose in line with rising rates. Costs and NPL provisioning were generally in line. Spain’s Bankinter also saw a steep rise in net interest income.
In contrast, disappointing figures triggered heavy selling. Adidas released a massive profits warnings for the year after a weak third quarter. The group slashed its 2022 targets due to a complicated trading environment in China and the need to cut inventory. Denmark’s Royal Unibrew also cut guidance as more consumers switched to less expensive drinks. Ericsson’s profits fell significantly due to more expensive components and logistics. Supply chain disruption continued to weigh heavily.
US Equities
Risk appetite bounced in the middle of the week after the UK’s mini budget was abandoned but indices ended the period in negative territory.
In a sign that US growth was starting to turn down, the Empire Manufacturing index came in at -9.1 in October, down from -1.5 in September and worse than the -3 expected. On the other hand, an unexpected fall in weekly jobless claims to 214,000 (vs. 235;000 expected) as well as various comments from Fed officials showed the fight against inflation was not over.
Philly Fed president Patrick Harker said that Fed would probably take rates well over 4% this year and keep them there for some time with the option to go further if needed. Neel Kashkari (Minneapolis Fed) said he saw no signs of inflation slowing and that rates would need to go on rising.
Fed fund futures are now 60% expecting rates to top 5% by May 2023, compared to zero only a month ago.
Elsewhere, the US is to dip into another 15 million barrels from strategic reserves, taking the count to 212 million since 2021. Reserves are now back to a 1984 low. Washington intends to build them up again when oil is trading around $67-72.
In company news, earnings have so far been upbeat, especially for banks. Netflix surprised markets by adding new users and across all geographical zones. Management expects the trend to continue in the current quarter. Good news for airlines: United Airlines is only 10% short of seat levels sold in 2019 and with a 13% rise in prices.
In activist fund news, Third Point took a stake in Colgate. The fund's chairman Dan Loeb sees upside if the company spins off its pet food business. Another fund, Starboard Value, bought a stake in Salesforce and in Splunk (data analysis).
The mood was different at Tesla and Snap. Tesla’s third-quarter sales were hit by the rising dollar and recurrent supply side bottlenecks. Social network player Snap plunged 27% in extended trading on Thursday after its advertising revenues for the third quarter fell and users were less active.
Japanese Equities
The NIKKEI 225 and TOPIX rose 2.93% and 2.20% in a volatile week. US and Japanese markets seemed to have factored in the Fed’s commitment to tighter monetary policy to some extent and started to focus on earnings.
Air Transportation rose 4.89% on less restrictive border controls in Japan and the possibility that Beijing could shorten quarantine periods. Precision Instrument and Marine Transportation gained 4.14% and 3.82% as equity markets rebounded. The worst performing sectors were Oil & Coal Products, Mining and Glass & Ceramics which only edged 0.09%, 0.12% and 0.32%, higher as commodity prices started to reflect a possible global recession.
First Retailing jumped 7.05% after a leading European broker upgraded the stock to a buy on strong sales growth outside Japan. Eisai rose 5.46% on upbeat final stage trials showing its Lecanemab drug could slow Alzheimer’s progression. ANA Holdings gained 5.08%. Shimano tumbled on a downgrade from a US broker. Chugai Pharmaceutical fell 2.57% on profit taking. Kirin Holdings slipped 1.32% on fears higher prices would hit their beers and beverages.
The yen weakened from 147.12 to 150.15 yen against the dollar, hitting a 32-year low as US 10-year Treasury yields pushed higher on expectations the Fed would continue to tighten.
Emerging Markets
The MSCI EM Index was up 1.2% as of Thursday’s close. Most major regions advanced. Brazil outperformed, rebounding 4.8% from the previous week’s falls. China (-1.6%) underperformed amid no immediate clarity from the Party Congress on zero-Covid and economic growth policies.
In China, the 20th Party Congress offered no hints on the future of the zero Covid strategy. The opening speech emphasised national security and economic development. Members of the new Politburo and Standing Committee will be announced this weekend. The PBoC kept the LPR unchanged. China’s major airlines are to resume more international flights starting at the end of October. Property developers Longfor and Country Garden plan a second sale of state-backed bonds. CATL signed a $1.2bn contract (1.4GWh) with Primergy to supply ESS batteries for a project outside Las Vegas. Third-quarter sales at sportswear companies were in line with expectations, but inventory was slightly higher than normal, suggesting more sales promotions before the year-end.
In Taiwan, Hon Hai hosted its 3rd annual (EV) tech day and unveiled two new self-developed EV models. In Korea, Kakao suffered a significant service outage, prompting further scrutiny around its quasi monopoly in the online space. LG Chem disclosed a plan to acquire Aveo Oncology, a North American oncology-focused biopharmaceutical company.
In Indonesia, confirming the strong economic backdrop, BCA reported stronger-than-expected results, with higher margins, healthy volumes and better asset quality. EPS jumped 25% YoY.
In India, HDFC Bank reported a steady quarter with NII at a 3 year high, robust loan growth and stable asset quality. In Havells’s September quarter results, sales were in line but margins missed expectations on high costs from inventory. Dixon delivered solid quarterly earnings, with margins improving across segments. Axis Bank also reported better-than-expected results. Results at Asian Paints disappointed, with slower growth than expected and weaker gross margins.
In Brazil, Jair Bolsonaro is closing the gap on Lula. Natura announced a potential IPO/spin-off of Aesop. In Mexico, Banorte reported better-than-expected figures with higher net interest margins and stronger consumer loan growth. Management raised guidance for its net income range by 8% for this year.
Corporate Debt
Credit
High volatility persisted on bond markets. Indices rebounded strongly to start the week thanks to a slew of upbeat earnings but were stopped in their tracks as yields accelerated on the upside. Yields on US 10-year Treasuries rose 25bp to reach 2007 levels. Instability in the UK also dented sentiment. PM Liz Truss resigned after only 44 days in office. Between Monday and Thursday, the investment grade index lost 0.22% while high yield eked out a 0.12% gain thanks to a 22bp tightening in risk premiums.
Euro-denominated high yield issuance stayed dormant as investors focused on earnings. Fnac Darty was among resilient companies. Sales rose to €1.85bn, or more than expected. Margins were also maintained and even edged up by 90bp.
Germany’s Lufthansa also surprised by beating EBIT expectations by 11%. The group raised its guidance for this year and now sees €1bn in EBIT for the full year.
The financial debt situation improved slightly compared to the beginning of October. Valuations remained low with credit premiums close to historic highs but the recent trend has been positive. For example, credit premiums on Euro CoCos fell from 1,250bp to 1,150bp. in senior financial debt, they also tightened slightly from 250 to 242bp.
Thanks to higher rates, results were robust despite a complicated trading environment. Net interest margins at Nordea, Bankinter, Handelsbanken and Bawag all saw double-digit rises over a year. US banks JPM, Citi, Morgan Stanley and Wells Fargo had preceded them on the previous Friday with higher retail and merchant banking revenues.
As a result, banks were able to continue selling debt, unlike companies which are struggling with a more complicated situation. Permanent TSB sold an AT1 in euros at a whopping 13.25% while BCP placed a senior 3-year maturity at 8.5%.
Convertibles
There was no new issuance but lots of company news. Swiss chemicals company Sika reported mixed results. The company enjoyed strong sales growth but inflation stopped profitability following suit. The group still expects to make more than CHF 10bn in sales this year thanks to infrastructure stimulus packages in the US.
Kering's results were also mixed. Third-quarter sales jumped 23% but the group is too dependent on Gucci and sales actually fell in China. Third-quarter sales at American Airlines jumped to $13.5bn compared to $9bn in the same period in 2021. The company continued to benefit from a strong dollar helping it to maintain high plane ticket prices.
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
21/10/2022
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