- US economic data offered a more mixed picture
- News on China's economy was downbeat
- We are still slightly cautious on equities and close to neutral on duration
During the week of 8 August, risk assets rose after July inflation in the US came in lower than expected and down on June. Investors were reassured and Fed rate hike expectations declined, especially for September, today more divided between 50 and 75 basis points of increase.
The week of 15 August was calmer. US economic data offered a more mixed picture. The Empire State index tumbled in August, dragged down by its new orders component. The NAHB index for August showed the property market was still deteriorating with a drop in housing starts and sales for July. On the other hand, industrial and manufacturing production rose 0.6% and 0.7% MoM. And in an indication of US consumer resilience, retail sales were upbeat for July. The Philly Fed index also rose significantly in August, a stark contrast with the Empire State. To boost the economy, Joe Biden signed the $430bn Inflation Reduction Bill into law. The plan targets healthcare, energy transition and climate change.
In Europe, inflation continued to worsen, hitting an annualised 10.1% in the UK in July, or above expectations, with underlying inflation running at more than 6%. In Germany, producer prices rose 5.3% in July. Gas prices returned to March highs due to stock rebuilding, reduced Russian exports and unfavourable weather.
In Asia, news on China's economy was downbeat. True, consumption and production rose in July but less than expected and at a reduced pace. The PBoC reacted with an unexpected rate cut. In Japan, however, second quarter GDP rebounded by a more encouraging 0.5% and domestic demand recovered.
Towards the end of the period, government bond yields started rising again and equity markets turned more volatile. Equity indices are now looking a little fragile after making strong gains over a month and ahead of the Fed possibly offering more clarity on its monetary policy at the upcoming Jackson Hole meeting.
Given the summer rally and persistent uncertainty on rate rises and economic growth, we are still slightly cautious on equities. We are close to neutral on duration but more wary of eurozone bonds.
EUROPEAN EQUITIES
Worries over inflation forced investors to factor in more restrictive central bank policy, sending bond yields higher. Inflation in the UK accelerated more than expected. The labour market showed some slight indications of slowing but wage tensions persisted.
Gas prices continued to rally. Availability will be a crucial challenge in Europe over the next few months. Some companies, especially in Germany, are already basing their objectives on a 25% reduction in available gas. Uniper, which is already the object of a rescue plan by Berlin, reported heavy losses due to soaring prices and reduced supplies from Russia.
In construction, Geberit missed its second-quarter EBITDA target due to operating cost inflation from rising energy, transport and overhead prices. Pricing power is paramount and the group is to raise prices again in October to offset reduced volumes. After warning in May and June on a significant fall in its new order book, Kingspan said the situation would remain poor. The increase in sales was mainly due to higher prices and acquisitions.
First-half net revenues at Adyen were up, but less than expected. The EBITDA margin fell due to a larger-than-expected increase in operating costs but the group stuck with its long-term targets thanks to the ongoing trend out of cash and into digital payments. Carlsberg maintained its 2022 objectives despite inflation. Rising costs may have curtailed the brewer’s results but investors chose to focus on rising volumes amid a strong post-Covid recovery and favourable consumer trends. Sanofi had to contend with another setback. The group abandoned development of its breast cancer drug Amcenestrant.
US EQUITIES
As the earnings season drew to a close, a positive picture started to take shape. With 90% of S&P500 results in, 52% have beaten expectations by more than one standard deviation, compared to 47% historically and 11% have fallen short (compared to 14%). However, this was not enough. Earnings beats outperformed the S&P by 49bp on the day the figures were released (compared to 102bp historically) and misses underperformed by 260bp (214bp).
Nevertheless, the rebound over the past month has been significant: +6.8% for the Dow Jones, +8.8% for the S&P500 and +10.7% for the Nasdaq.
A few macro indicators were released over the period, ahead of the Jackson Hole symposium on August 25-27. Given the tight labour market and high inflation, consumption momentum is probably a key indicator for the Fed. So far, the Fed has been guiding markets towards further rate rises and brushing off any question of easing in 2023. But consumption has been trending lower in recent months (although there was a rebound in June) and recent results from companies like Walmart have been on the optimistic side.
On the other hand, last Monday’s data were hardly reassuring. The NAHB index of property developer confidence fell for the 8th month in a row, hitting a low not seen since 2014. The Empire State index tumbled more than 42 points in a month, pointing to a contraction in manufacturing in the New York region.
Analysts interpreted the latest FOMC minutes in a variety of ways, prompting comments from several Fed officials on Thursday that the bank was determined to raise rates to bring inflation under control. The pace of rate hikes is, however, still undecided. James Bullard (Saint-Louis Fed) wants another 75bp rise in September given the strength of the economy but Mary Daly in San Francisco thinks either a 50bp or a 75bp hike would be reasonable.
Elsewhere, in a rare show of Democrat Party consensus, the massive inflation reduction plan was approved. It is designed to boost investment in renewable energy and make access to some healthcare treatments easier. It also clearly favours US industry, a bias criticised by some other countries. China, for example, lambasted the $52bn earmarked for electronic chip subsidies. The vice-president of the Chinese semi-conductor industry association said the programme was overtly discriminatory.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX rose 4.04% and 2.94% for the period on expectations global inflation would slow and further yen depreciation. The Nikkei 225 briefly broke through the 29,000 resistance level. However, profit taking took indices lower on Thursday.
Other Manufacturing and Insurance rose 5.85% and 4.11% on buying of domestic demand stocks amid rising risk-off sentiment. Precision Instruments gained 5.14% as exporters rose on the lower yen. Elsewhere, Marine Transportation slipped 2.34% and Warehousing was almost flat (+0.47%) on profit-taking and reduced supply chain disruption. Mining fell 0.18% on profit-taking and falling commodity prices.
Bandai Namco Holdings soared 13.26% after the coming revised April-September guidance higher thanks to rising sales, especially in high margin home-video game content. Olympus Corp jumped 9.56% on higher FY2023 guidance (consolidated basis) due to the weaker yen and strong sales growth. M3 Inc., a medical information services platform, surged 9.53% after a leading broking firm raised its target price. On the other hand, Fujitsu fell 1.28% on a 20% YoY drop in April-June 2022 consolidated earnings after supply chain disruption led to component shortages. East Japan Railway declined 1.13% on profit-taking. In pharma, Eisai dipped 0.62% on a 36% drop in consolidated earnings for the April-June quarter due to declining sales and falling margins.
The yen weakened from 132.89 to 135.89 against the dollar on solid US economic data and the Fed’s cautious stance on inflation.
Japan confirmed 231,499 new COVID-19 cases Wednesday, the first time in six days that the count had moved above 200,000. Amid a shortage of COVID-19 antigen test kits, the government is planning to remove a ban on internet sales to help people test themselves. The Health Ministry Panel gave the green light to the related guidelines on Wednesday.
EMERGING MARKETS
The MSCI EM Index was down 0.68% as of Thursday’s close. China (-1.85%) underperformed on weak macro data and power crunch concerns. India outperformed, up by 1.59%. Brazil closed almost flat in USD.
China’s retail sales growth moderated to 2.7% YoY in June, down from 3.1% in June. Industrial output was up 3.8%, or short of the 4.3% expected. The PBoC surprised markets by cutting MLF and OMO rates by 10bp from 2.85% to 2.75%. Chinese Premier Li Keqiang asked local officials to boost pro-growth measures. Sichuan and other regions in south-western China are under power rationing due to extreme hot weather, but the impact should be less severe than in 2021. Regulators are reportedly to have SOE firms guarantee the sale of new onshore notes for some large Chinese developers. On the corporate front, CATL announced a $7.6bn investment in Hungary for a 100 GWh battery plant. Tencent’s earnings were better than expected on cost cutting measures with capital returns as the next focus. NetEase had a solid second quarter despite macro headwinds and no new game license approvals. First-half revenues at Wuxi Biologic beat forecasts with a strong backlog and new project wins. China Resource Beer’s results beat expectations on continued premiumization.
Taiwan and the US agreed to begin formal trade and investment talks. Hon Hai will start production of the Apple Watch in Vietnam. Wiwynn plans to spend NT$1.9bn to build facilities in Malaysia.
In Korea, SK Hynix plans to set up an advanced chip packaging plant in the US next year.
As expected, the Philippines’ central bank raised its benchmark interest rates by 50bp on Thursday, the fourth rate hike this year aimed at cooling inflation.
In Singapore, Sea Ltd’s results missed expectations on weak gaming business and the absence of e-commerce guidance was another disappointment for the market.
India’s consumer inflation dipped to 6.71% in July, aided by lower food prices. KKR sold its entire stake in Max Healthcare for five times what it paid. The news went down well with the market as this divestment will mean more liquidity for MH.
In Brazil, Anima’s second quarter results were in line and operating margins were robust. Natura delivered another second-quarter soft result: sales improved sequentially on strong core brand growth while the net loss was wider than expected.
CORPORATE DEBT
CREDIT
The traditionally becalmed August fortnight is decidedly a thing of the past. Despite low volumes over the week, interest rate and credit spread volatility continued to drive markets. After a strong recovery in performance in July and the first two weeks of August, inflation worries resurfaced after UK inflation topped 10% and some central bankers made hawkish comments. Short term bond yields in the UK and US came under pressure and yields on 5-year debt in the eurozone moved back above 1%. Volatility spread to credit indices with the Main and Xover widening by 8bp and 42bp to trade around 100bp and 500bp.
Note that credit derivatives sharply underperformed cash bonds due to reduced liquidity. Technical factors were slightly more balanced as inflows to most credit sub-segments returned.
High Yield slipped 0.9% over the period, outperforming Investment Grade (-1.2%).
Lower trading volumes helped boost the new issues market to start August. BNP, Barclays and Standard Chartered issued AT1 debt in US dollars, SHB, Swedbank and ING sold Tier 2 debt, and Zurich issued a Tier 2 bond. There were also a number of senior debt issues. The new deals were relatively well absorbed but the market seems to be running out of steam. In the previous week, CoCo spreads widened slightly even if they outperformed synthetic indices in thin trading.
News flow was typically calm for August. The end of the earnings season confirmed that markets were underpinned by excellent fundamentals in the first half. Asset quality remained robust and capital ratios stayed high. Even so, the outlook for 2023 is more uncertain.
CONVERTIBLES
It was a mixed week for convertibles as broader equity markets whipsawed. The focus shifted towards an active primary market and fund flows were largely dictated by company specific news.
There were two new US deals: Halozyme Therapeutics, a biopharmaceutical company, announced a $625m convertible with a 1% coupon and a 30% premium. Sunnova Energy International, a renewable energy solutions provider, raised $500m at 2.625% and with a 30% premium. Both deals were upsized to meet market demand and traded actively on the secondary market.
In Asia, Lenovo came back to the primary market, raising $675m at 2.5% and a 42.5% premium for a convertible due 2029. The group also tendered for some of its outstanding convertibles due 2024, offering a repurchase premium of 1.5pt.
In Europe, Just Eat Takeaway.com agreed to sell its 33% stake in Latin American joint venture iFood to Prosus NV for €1.8bn. The company will use the proceeds to strengthen its balance sheet and repay debt. After the news on Friday morning, all four related convertible bonds gained from 3 to 6 points in active trading.
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
19/08/2022
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