- In the eurozone, the likelihood of a recession was increased by PMI indices which contracted for the third straight month
- The latest news on energy prices is not good for growth or inflation
- In the circumstances, our portfolios are still cautiously positioned
After 2 months of non-stop rises in yields, bond markets paused for breath.
In the UK, it took a volte-face from the Bank of England over asset purchases, and an apology from Liz Truss after tax cuts for the well-off triggered an outcry, to stabilise sterling and gilt yields. The pressure was so intense that the three top rating agencies signalled a downgrade for the UK.
The whole episode is a useful reminder of how rapid interest rate hikes can undermine the UK and European ecosystems. Markets will not stand by idly when government finances run out of control, a fact that makes governing a country very difficult and even threatens political stability.
In the eurozone, the likelihood of a recession was increased by PMI indices which contracted for the third straight month, especially in Germany. In contrast, the US is proving resilient. The labour market is holding up and services PMI actually rose to 56.7, or better than expected. Nevertheless, the sharp drop in the prices paid subcategory of the manufacturing ISM provided an encouraging pointer to a looming fall in goods inflation.
Elsewhere, Australia’s central bank slowed the pace of its rate rises, taking them only 25bp higher to 2.6% when the market was going for 50bp. Poland’s central bank even left its benchmark rates unchanged. Clearly, central bank determination to fight inflation is being confronted with more and more resistance. Attention has naturally shifted to the Fed as investors try to spot any sign of an interest rate pivot.
However, the latest news on energy prices is not good for growth or inflation. OPEC+, for example, decided to cut production further despite pressure from the White House, and Europe has still not managed to agree on a single mechanism to cap energy prices. The agreement is confined for the moment to an 8th round of sanctions against Russia.
In the circumstances, our portfolios are still cautiously positioned even if we recognise that technical and valuation considerations could mean a short term rebound. We are currently neutral on duration.
European Equities
After the previous week’s bad news, markets seemed to have found some risk appetite. Major indices ended the period in positive territory on strong performance from cyclicals. The UK’s decision to backtrack on a tax cut for the well-off went down well with markets even if the amounts in question are a mere £2bn in the overall £45bn mini budget.
Elsewhere, retail sales in the eurozone fell 0.3%, the third down month in a row. Even so, the ECB thinks this slowdown in spending is not enough to quell inflation. The minutes from the bank's last monetary committee meeting showed that an increasing number of members were worried about inflation expectations running out of control.
In company news, Stellantis said its semiconductor supply chain would be stretched until the end of 2023. In contrast, Aéroports de Paris is confident that it can return this year to around 80% of 2019 traffic. Nestlé said it would continue to raise prices in 2023 but this would not enough to offset all its energy, agricultural commodity and wage costs. UK supermarket chain Tesco was on the same wavelength and cut earnings guidance for 2022. In pharma, Valneva completed its €102m increase of capital at €4.9 a share. The US fund Deep Track Capital took up 50% of the issue and existing shareholders like Bpifrance also participated. The French government filed its buy-in plan for EDF’s minority shareholders, offering €12 a share, or €9.7bn in all.
US Equities
Wall Street ended the period sharply higher. The S&P 500 gained 2.86% and the Nasdaq 3.13% on a steep drop in job offers to a June 2021 low of 10.05 million (vs. expectations for 11.1m) and a surprise decision from Australia's central bank to raise rates by 25bp instead of 50bp.
But the S&P logged its worse September since the 2008 financial crisis, tumbling 9.3%. For the third quarter as a whole, the Dow Jones fell 6.65%, the S&P 500 5.26% and the Nasdaq 4.11%. It was the third down quarter in a row for the S&P500 and the first time since 1938 and the Great Depression.
WTI oil gained 1% to $87.76 after OPEC+ voted to reduce production by 2 million b/d, its largest cut since 2020. The White House warned of the harmful consequences of the decision on the global economy and said it could release another 10 million barrels from its strategic reserves.
Several economic indicators beat expectations: private sector job creations in August came in at 208,000 (vs. 185,000 estimated), wages rose 7.8% YoY and Services ISM was 56.7 (56) and the prices paid subcategory remained at a lofty 68.7. Fed Funds futures are now 86% betting that the Fed will go for another 75bp rise when it meets on November 1 and 2.
In company news, Tesla lost ground after announcing fewer-than-expected deliveries in the third quarter. Its smaller EV rival Rivian, however, delivered a record number and maintained its output target for the year at 25,000. Two weeks before the start of Twitter's court case against him, Elon Musk did an about-turn and said he would buy the company for $54.20 a share (or $44bn), the price agreed in April.
Walt Disney said the activist Third Point fund had joined its board.
Micron rose after unveiling a $100bn investment programme over the next 20 years. The funds will be used to build the largest semiconductor factory in the US. IBM followed suit with a $20bn investment plan over 10 years to reinforce innovation in semiconductors, artificial intelligence and quantum computing.
For the first time, Apple asked its suppliers to transfer production of its AirPods and Beats headphones to India. The group wants to be less dependent on China for its supplies.
Japanese Equities
The NIKKEI 225 and TOPIX rebounded by 3.37% and 2.87% for the period after a weak start due to falls on Wall St and in Europe as investors fretted over a global recession. The rally was driven by more attractive valuations- after steep falls from the middle of September- lower oil prices and further yen depreciation.
Mining soared 10.33% after OPEC+ agreed to slash output by 2 million b/d. Precision Instruments and Real Estate gained 6.18% and 5.31% as concerns over soaring inflation receded due to weak PMI data. Electric Power & Gas and Land Transportation declined 2.44% and 0.29% due to profit taking in defensive sectors and sectors due to benefit from border control relaxation.
Mitsui Fudosan, SMC and Olympus gained 7.86%, 7.27% and 7.02%, respectively, as cyclicals returned to favour and concerns over sharp interest rate hikes receded.
The yen weakened from 144.46 to 145.14 against the dollar after BoJ governor Haruhiko Kuroda confirmed that Japan was sticking to its accommodating monetary policy.
Emerging Markets
The MSCI EM Index had rebounded by 3.98% as of Thursday’s close. Brazil largely outperformed, soaring 11.7% after the first-round election results, which confirmed a balanced congress and a second round to decide on the president. China rose 3.7% (mainland China’s stock market closed for national holidays). India ended the week almost flat.
China plans to utilise in advance part of a 2023 special bond quota to stabilise economic growth. In property news, the PBoC and the banking and insurance regulator asked the six largest banks to offer financing support, including mortgages, loans to developers and purchases of their bonds. The Ministry of Finance also unveiled a rare tax incentive for homebuyers. The Beijing Marathon will be held on November 6, the first since 2019. Travel bookings increased by more than 125% on the first day of Golden week vs. Mid-Autumn Festival, according to local travel agency Ctrip.
The Hong Kong government is to launch a series of promotions to encourage inbound travel, giving away 500,000 airline tickets worth HK$2bn. Macao’s Government Tourism Office said the average daily number of visitors arriving in the first 4 days of Golden Week had jumped 20 times. In Taiwan, Hon Hai reported record September sales on robust new iPhone demand. In Korea, Naver acquired Poshmark, a US online second hand fashion company, for $1.2bn, or a 15% premium to the last quoted price.
India's Manufacturing PMI stood at 55.1 in September against 56.2 in August. The Modi administration is creating a 100 trillion rupee ($1.2 trillion) mega digital project -PM Gati Shakti- to accelerate infrastructure projects. Mumbai home sales had their best September in a decade. The Zee-Sony unit merger got conditional approval from the competition regulator.
Brazil’s leftist presidential candidate Lula (48.4%) led over right-wing President Bolsonaro (43.2%) in the first round of the Presidential election. The second and final round will take place on October 30. The mining company Vale is in discussions to sell a $2.5bn minority stake in its metals business. Mexico is considering a reform to its stock market law to facilitate the listing of family-controlled companies.
Corporate Debt
Credit
Indices rebounded amid the first signs of tension in the US economy. A sharp drop in Manufacturing ISM in September to below consensus expectations caused bond yields to tumble as investors began to hope the Fed would soon ease. As of Thursday evening, the high-yield corporate debt index had risen 1.02% over the week, with investment grade 0.34% higher. This was thanks to the Xover tightening by 28bp and the Main by 7bp.
Euro high-yield new issuance started up again with Spain’s fashion retailing group Tendam, owner of the Women's Secret and Cortefiel chains, raising €300m at 11% due 2028. The proceeds will be used to refinance the outstanding 2024 bond and cut leverage by 19%.
In company news, Atos announced the departure of its CEO Bertrand Meunier next summer. He had been targeted by a group of minority shareholders for strategic mistakes over the proposed spin-off of its infrastructure management business from its digital transition and cybersecurity arms. Its cybersecurity business is to become independent in 2023 under the name of Evidian and is already attracting suitors like Thales, Orange, and Onepoint which has bid €4.2bn.
It was a mixed week in financial debt. Premiums may have stopped widening for junior debt- Euro CoCos were trading at a 1,200bp to call spread, down from 1,250bp last Friday- but the market was hit by rumours swirling around Credit Suisse. Pending details of the bank's vast restructuring on October 27, its share and bond prices suffered big swings. Its CDS are now trading at 350bp or 100bp higher than at the end of September. A major restructuring will probably mean more capital, either through a capital raising or from asset disposals. Meanwhile, S&P confirmed its rating and the bank launched a tender on some of its senior bonds in an attempt to reassure markets.
The subordinated financial debt market is still broad and its Euro CoCos are offering a yield to call on close to 14%.
Convertibles
Convertibles had a good week, up 1.89% between Monday and Thursday, thanks to some easing in interest rates and a strong rebound on equity and credit markets.
In new issuance, Australia’s Seven Group Holdings raised AUD 250m at 4.625% due 2027. The group has a varied portfolio comprising media (TV and press), energy (oil and natural gas production) and also mining and public works.
The French government launched the renationalisation of EDF, offering €12, or a 53% premium, for the 16% held my minorities. The deal will leave the government free to run a strategic company amid an energy crisis. And it will bring down the curtain on a disappointing stock market career as the stock was listed in 2005 at €32 a share.
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
07/10/2022
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