- Central bankers reaffirmed their determination to curb inflation even at the risk of hitting growth
- Investors are still worried about gas supplies and the consequences for growth in the eurozone
- Persistently high volatility and threats to economic growth have led us to maintain our prudent stance on equities, especially in the eurozone
Jackson Hole provided central bankers with the occasion to reaffirm their determination to curb inflation even at the risk of hitting growth.
Government bond yields continued to rise and flirted with year-to-date highs. Short-term yields even went beyond. The ECB’s meeting will be tense as August inflation came in above expectations. Eurozone prices rose 9.1% year-on-year in August and “Core” inflation came in at 4.3%, or above the 4% expected. Investors are still worried about gas supplies and the consequences for growth in the eurozone. However, stocks are now at 80% of capacity which is earlier than expected. As a result, natural gas prices in the eurozone tumbled by more than 40%. Even so, that left them up 50% over the last 3 months.
The week’s US economic data was upbeat, leaving the Fed with some leeway to raise rates. The Conference Board Consumer Confidence index rebounded to 103.2 in August, up from 95.3 in July. The definitive figures for Manufacturing PMI were revised up from 51.3 to 51.5 and the various components are on an uptrend. The price component fell more than expected, a reflection of reduced supply chain tensions and lower energy prices. New commands and jobs were sharply higher, moving back above 50 into expansionary territory.
Equities, and small/mid-caps in particular, had a difficult week due to recession fears. China was the worst hit, chiefly because of a new Covid lockdown in Chengdu, a large city with over 16 million inhabitants. At the same time, the Caixin Manufacturing PMI confirmed that the economy was in difficulty by falling into contraction territory at 49.5 when it was expected at 50.2.
Given central bank clarity over policy, we remain cautious on duration. Persistently high volatility and threats to economic growth have led us to maintain our prudent stance on equities, especially in the eurozone.
EUROPEAN EQUITIES
Fears over rising interest rates and poor inflation data pushed markets lower. However, after a week which saw record gas and electricity prices, news that Europe had reached its 80% target in gas stocks sharply reduced price levels. Ursula von der Leyen said that the European Commission was preparing emerging measures to curb electricity prices and reform the energy market. Meanwhile, it only took a few press reports suggesting that some ECB rate-setting committee members wanted a 75bp hike when they meet next week for the markets to factor it in (+66bps). Eurozone CPI accelerated by 0.5% in August, up from +0.1% in July. This was faster than expected from German and Spanish inflation data which was released earlier. Over 12 months, inflation hit a record 9.1%, or above the 9.0% expected and up from 8.9% in July.
In company news, Pernod Ricard posted upbeat results. Management said it was confident with the group’s pricing power and that sales across all markets and price ranges were doing well. In contrast, Duralex (glassware) said it would be closing its factories over winter to avoid running at a loss because of surging energy prices. Germany’s flagship carrier Lufthansa was forced to cancel almost all its flights on Friday as a strike resumed following a deadlock in talks. Volkswagen has the same problem with its factories in Mexico where workers refused a 9% wage rise offer. Michelin posted market data for global tyre sales. Volumes edged 0.4% higher in July after +1.3% in June, -3.7% in May, -8.8% in April, -4.3% in March, +5.5% in February and +0.7% in January. The message for the sector is encouraging despite the crisis.
US EQUITIES
Markets continued to digest the Fed’s hawkish comments. Over the last 5 trading sessions, the Dow Jones fell 4.91%, the S&P500 5.53%, and the Nasdaq 6.76%.
Manufacturing ISM in August was steady, coming in at 52.8% thanks to a rebound in new orders and a sharp drop in prices paid from 60 in July to 52.5. At the same time, manufacturing PMI fell to 51.3, its lowest level since July 2020.
Better-than-expected consumer sentiment, at a 3-month high, and rising job vacancies fuelled worries over the Fed’s next decisions.
John Williams (New York Fed) said that benchmark rates should stay restrictive throughout 2023. But Raphael Bostic at the Atlanta Fed said there could be reasons to step back from 75bp hikes if inflation were to show clear signs of slowing.
The Fed’s balance sheet shrinking will reach its peak $95bn-a-month level from this week. The bank will allow $60bn in Treasury bills and $35bn in mortgage products to fall due. Fed Fund futures are now pricing in a 72% chance the Fed will hike rates by 75bp to 3-3.25% when it next meets on September 21.
In company news, social network company Snap is to lay off 20% of its staff in the next few weeks (source: Bloomberg). The stock is down by almost 80% year to date.
The semiconductor sector was battered by Washington's decision to ban exports of integrated circuits for artificial intelligence applications to China. Nvidia lost 7.7%. The group said the decision would reduce sales of its new-generation AI chips by $400m.
California declared a grid emergency due to temperatures topping 45°C in the ongoing heatwave, triggering peak demand for electricity and increasing outage risks.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX dropped 2.87% and 2.08% for the period due to a US equity market sell-off after FED Governor Powell’s comments at Jackson Hole confirmed prolonged monetary tightening to fight inflation and the release of disappointing economic data in China because of Covid-19 lockdowns.
Air Transportation and Land Transportation rose 2.42% and 0.52% on expectations of a recovery in tourism following the government’s relaxation of border controls and the possible introduction of stimulus measures. Iron & Steel gained 1.50% on news of Nippon Steel and Toyota Motor agreeing to raise automotive steel plate prices by 20-30%, an upbeat indication of the overall steel industry’s health. Elsewhere, Marine Transportation fell 4.98% after containership freight rates seemed to have peaked amid a decline in supply chain disruptions. Precision Instrument and Metal Products declined by 3.75% and 3.48% on concerns over the global economic slowdown.
Sekisui House jumped 5.52% on institutional buying at attractive valuations (P/E ratio 10.6, PBR 1.1). Nippon Steel gained 4.22% as higher prices will offset rising commodity costs. Subaru gained 4.13% on recovering plant utilisation as supply chain disruptions receded. On the other hand, M3 Inc., a medical information platform, and Fujitsu tumbled 7.56% and 5.50%, as investors sold large-cap growth stocks due to US and European rate cuts being put back. Canon declined by 5.14% on profit-taking on global slowdown concerns.
The yen fell sharply against the US dollar, trading at a 24-year low of 140.21 compared to 136.49, on diverging interest rates.
On Wednesday, PM Kishida said Japan would allow the entry of non-escorted visitors on package tours and raise the daily arrival cap to 50,000 starting September 7. This marks a significant step towards full resumption of tourism. He also said he would consider easing restrictions further based on conditions at home and abroad, a move designed to put border measures on a par with G7 countries.
EMERGING MARKETS
The MSCI EM Index retreated by 2.58% as of Thursday’s close, with most major regions in the red. Taiwan and Brazil were down by 4.2% and 3.9% respectively, while China fell 1.8% on new lockdown concerns. India (+0.9%) outperformed over the week.
In China, August’s PMI print was mixed with official Manufacturing at 49.4 and Non-manufacturing at 52.6, slightly higher than the expected 49.2 and 52.3, respectively. The US government announced restrictions on sales of Nvidia and AMD’s high performance AI chips to China and Russia, though the development of such chips and sales to American clients in China are still allowed. BABA, BIDU, JD and YUM China are included in US Public Company Accounting Oversight Board’s initial batch of audits for 3 months starting from mid-September. Chengdu (21 million residents and ~1.7% of China’s GDP) is under lockdown for 4 days for mass testing while Shenzhen shut the world’s largest electronics market in response to a small number of Covid cases. The 20th CCP congress meeting, where a twice-a-decade leadership reshuffle will take place, is set to start on October 16 and the market will be looking for any clues of zero-Covid policy relaxation.
On the corporate side, PDD delivered a strong beat in its second quarter results with revenues up 36% YoY on a consumption recovery since mid-May. Both Midea and Gree Electric delivered operating profit margin expansion despite a tough second quarter. In contrast, CTG Duty Free’s second quarter revenue and net profit decreased by 38% and 45% YoY and the pandemic remains the company’s largest uncertainty. NetEase acquired leading French game developer & publisher Quantic Dream. Tencent as reportedly set a soft target to divest $14.5bn of its $88bn listed equity portfolio this year.
In Korea, export growth slowed in August, led by a decline in chip exports, whereas import growth rose again owing to higher LNG and coal imports amid moderating oil imports. As a result, the trade deficit widened to $9.5bn, its highest level since trade statistics began in 1966. LG Energy Solution will establish a JV with Honda in the US that will build 40GWh of battery capacity with production expected to start in late 2025.
In India, 1QDY23 GDP grew 13.5% YoY. Although this fell short the 15.3% estimated, the domestic contribution remained strong with investment increasing 20.1% YoY and private consumption up 25.9% YoY. On the other hand, government spending only rose 1.3% YoY. August Manufacturing PMI stayed strong at 56.2 vs 56.4 last month. GST collections were up 28% YoY. Foreign institutional investors were net buyers for a second consecutive month after 9 months of selling, buying $6.8bn worth of Indian equities. Reliance held its annual AGM and announced a commitment to invest Rs2 trillion for 5G rollouts in India.
In Brazil, real GDP recorded solid 1.3% QoQ growth in the second quarter (above consensus of 0.9%), driven by strong domestic demand (strong labour market and fiscal stimulus) and higher investment. In June, credit growth accelerated to 18% YoY, driven by a 25% jump in individual loans. Private banks (+25% YoY) gained market share from public banks (+13%). Spreads were higher, with flat asset quality. Itau’s management indicated that fintech peers were adopting more rational strategies (largely on pricing), due to the higher cost of capital.
In Mexico, July’s remittances rose again, up by a strong 16.5% YoY or more than expected. According to AMLO, trade between Mexico and the US hit a $384bn record this year.
In Chile, all eyes are on the September 4 constitutional referendum vote.
CORPORATE DEBT
CREDIT
Market momentum remained negative over the week as eurozone inflation hit a record 9.1% over 12 months in August and China announced new lockdowns. The Xover widened by 27bp and the Main by 7bp. Yields on Germany’s 10-year Bund gained 22bp over the period and 10-year US Treasuries 21bp. Investment grade credit indices ended the period 1.53% lower and high yield fell 1.82%.
There were no new issues but lots of news on companies, with more upbeat second quarter reports. Like-for-like sales at Loxam (equipment rentals) rose by a creditable 10.4% over a year and EBITDA was up 9.7%. The group managed to preserve EBITDA margins in spite of inflation, an indication of strong pricing power even in a very competitive market. France’s Iliad (telecoms) saw sales accelerate by 8.1% to €4.02bn. Subscriber numbers rose in every geographical zone and net profits soared 168% to €639m over the first half.
In M&A, Italy gave exclusivity to the Certares, Air France-KLM and Delta Air Lines consortium in talks over buying a stake in ITA, previously Alitalia. For the moment, Air France-KLM would simply be a commercial partner, not an investor, but the group could consider taking a minority stake once it has paid back 75% of its government-backed loan.
In financial debt, credit premiums started rising again due to high eurozone inflation and a busy new issues market in senior and CoCo debt, including issues from Intesa et BNP. Euro CoCo credit premiums rose by around 50bp from the beginning of the week to flirt with 830bp. However, results continued to strike an upbeat note. The Bank of Cyprus, for example, followed the lead established by Greece's banks with surprisingly ambitious profitability targets.
CONVERTIBLES
Due to the unfavourable macroeconomic climate, the new issues market was almost becalmed but Swiss pharmaceutical group Zur Rose raised CHF 95m at 6.875% due 2026. The company is already well-known as a convertible issuer following its first venture in March 2020 at the end of the Covid crisis.
In results news, there were a few disappointing indicators from US tech companies. Software publisher Okta had a good second quarter with a 43% rise in sales and an improved operating margin but management revised down sales guidance. Second-quarter sales at MongoDB were also upbeat but the company now expects a larger-than-expected loss.
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
02/09/2022
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