- Sector rotation was strong, with energy and commodities falling sharply before rebounding
- The problematic situation with gas supplies in Europe led to the euro moving closer to parity with the US dollar
- We continue to prefer US and Chinese equities to the eurozone and Japan
Equity markets ended the period higher but the underlying situation was more volatile. US investors returned from their long weekend with heightened concerns over a recession. Manufacturing ISM on the previous Friday had been disappointing, especially as concerned new orders and jobs. As a result, trading was highly volatile and government bonds played their part as a safe haven asset. The drop in yields also reflected a future fall in inflation as commodity prices continued to retreat (with the exception of natural gas prices in Europe). But upbeat US data on industrial orders and durable goods for May reversed the trend and markets actually ended the session higher, ahead of a week of up days.
The FOMC minutes provided no surprises. The Fed continued to put the accent on defeating inflation over and above growth concerns. Even so, better-than-expected Services ISM for June showed that growth was proving resilient.
Sector rotation was strong, with energy and commodities falling sharply before rebounding. Defensives were in vogue at the start of the week but were then snubbed. Interest rate volatility continued to rise with daily swings of more than 10bp. And on currency markets, the problematic situation with gas supplies in Europe led to the euro moving closer to parity with the US dollar. It also fell against the yen and the Swiss franc. Sterling moved higher after mass cabinet resignations forced Boris Johnson to resign.
Against this backcloth, we continue to prefer US and Chinese equities to the eurozone and Japan. China's PMI showed the economy rebounding sharply and the finance minister said the $220bn stimulus package was to be accelerated. In addition, there is some hope that discussions with Washington will result in lower import duties for Chinese goods.
We have reinforced our yen position. It has not proved a safe haven since the beginning of the year but we believe it could finally start to become one. As for government bonds, we remain cautious on duration, especially in the eurozone as the ECB has not yet embarked on its rate hike cycle.
EUROPEAN EQUITIES
It was another volatile week but confidence returned after encouraging signs that Beijing was keen to roll out significant economic stimulus. However, the euro continued to lose ground, notably against the US dollar. Investors are now chiefly concerned about the consequences of Europe’s energy crisis as gas prices pushed even higher, dragging electricity prices with them. German industry is being particularly hard hit by supply constraints due to the Ukraine war and higher costs. However, there is support from China’s gradual reopening and European stimulus funds.
Governments are starting to intervene to rescue European power companies which are unable to pass on all their higher costs to end users. Following rumours that Berlin might step in to prop up Uniper, France announced the renationalisation of EDF, a group which had been looking even more vulnerable after being forced to idle quite a few nuclear power stations. On a more positive note, the European parliament voted to rank nuclear and gas as transition energies.
Relations between Beijing and Washington are still ambivalent. Joe Biden has been trying to lift Donald Trump’s duties on Chinese imports to get inflation lower but at the same time has been on the offensive against China. For example, he asked ASML to stop selling essential semiconductor production technology to China.
In consumption news, Sainsbury’s said sales had fallen in the last quarter after households cut back on food due to rapidly rising prices. And yet despite the drop in the value of the average shopping basket, the supermarket group left its annual guidance unchanged. Management said cost controls were improving and it had gained market share after raising prices less than competitors.
US EQUITIES
In a good week on Wall Street, the S&P rallied 2%, practically cancelling out the previous week's losses. The Nasdaq bounced by more than 4% as growth stocks returned to favour. It is, however, down 26% year to date (-18% for the S&P).
Macroeconomic data improved markedly. Durable goods orders for May rose 0.8%, or better than the 0.7% expected. Services ISM was also a surprisingly good 55.3 vs. 54 expected. The release of the FOMC minutes held no big surprises. Rates will be raised by 50-75bp at the next meeting.
And M&A revived after a long hiatus. Bloomberg said that giant pharma Merck was mulling an approximately $40bn bid on Seagen, a biotech specialised in oncology. Electric truck maker Rivian, down 75% year to date, rebounded by more than 20% after declaring that its production levels were in line with expectations.
Cyclical consumption and technology led gains. Consumer discretionary and media stocks rose as fears of a brutal slowdown receded. But the 9% plunge in oil prices battered the energy sector which ended the period 3% lower. Similarly, falling commodity prices hit mines and basic material producers.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX ended the period 0.37% and 0.62% higher after a weak start due to declines on Wall St. However, both markets then fluctuated as US bond yields seemed to have peaked, oil prices fell and the US treasury curve inverted, generally a harbinger of a recession. Beijing’s decision to lift lockdowns was good news for Japanese equities despite global recession fears.
Defensive sectors Pharmaceuticals and Communication rose 3.15% and 2.84%. Precision Instruments gained 2.96% on hopes China’s economy would stabilise after lockdowns were lifted. In contrast, Mining and Non Ferrous Metals fell 8.34% and 4.75% as commodity prices retreated from highs. Air Transportation declined 5.41% on profit taking as Covid cases increased again.
Aeon jumped 12.57% on a better-than-expected March-May quarter. Z Holdings gained 9.49% on news it would be integrating the e-commerce services of “Yahoo!” and “Pay Pay”, thereby increasing items on sale while smoothening online payments. Sysmex, a healthcare company, gained 9.10% because of its defensive status. On the other hand, Tokyo Gas tumbled 12.68% on profit taking as well as news that Russia was to transfer the Sakhalin 2 gas field to a Russian company. Two Japanese trading companies have holdings in Sakhalin 2 and export gas mainly to Japan. West Japan Railway declined 6.31% on profit taking as Covid-19 cases started to increase again. Dai-Ichi Life Holdings fell 5.18% on falling US interest rates: life assurance companies rely on higher yields to secure long-term income.
The Yen fell from 135.72 to 136.01 after hitting 135.21 on July 1st when Fed chairman Jerome Powell said the priority was fighting inflation with rate hikes, not preventing a recession. On the contrary, BoJ chairman Haruhiko Kuroda reaffirmed the bank’s commitment to accommodating monetary policy, putting more pressure on the Yen.
EMERGING MARKETS
The MSCI EM Index edged 0.43% higher as of Thursday’s close. India (+2.29%) outperformed. Brazil rose 1.45% in USD while China closed flat.
China’s Services PMI for June was 54.5, an 11-month high, vs 41.4 in the previous month and 49.6 expected. The Ministry of Finance was reportedly considering allowing local governments to raise RMB 1.5 trillion ($220bn) with special bonds, or more than the RMB 300m expected. Beijing city announced a Covid-19 vaccine mandate for residents to enter public venues. Shanghai conducted mass testing in targeted districts. Auto sales rose 21% YoY in June, or +34% MoM, with all major NEV makers reporting increases of more than 100% YoY. Shimao failed to repay a $1bn note. Wuxi Biologics is reportedly to be removed from Washington’s ‘unverified list’ as US authorities were able to conduct an onsite facility inspection. Tencent bought back shares for the seventh straight session throughout the week. Li Ning’s CFO unexpectedly announced his retirement, raising market concerns on strategic decision continuity. Sungrow will supply PV inverters to Romania’s biggest PV project.
Hong Kong suspended the flight ban for passengers with Covid to encourage international travel. The new health secretary expects the border with mainland China to be reopened before August 4. Taiwan’s CPI hit 3.59% in June, the highest in 14 years. Foreign investors withdrew a net $17bn by selling stocks in the second quarter, surpassing previous peaks in 2008, 2013 and 2018. TSMC has reportedly seen its top 3 clients (Apple, AMD, Nvidia) reduce chip orders as macro uncertainties and inflation pressure impact end demand.
South Korea’s June CPI rose 6%, or higher than the 5.9% expected and up from 5.4% in May. Preliminary sales at Samsung Electronics were up 21% YoY, driven by the semiconductor division, but the operating margin was marginally below expectations. Second quarter results at LG Energy Solutions missed consensus estimates due to higher metal prices and the impact from the China lockdowns but the share price rallied as most analysts expect a sequential recovery for margins starting from this quarter. China's Silk Road Fund is reportedly to invest up to $3bn in Indonesia’s sovereign wealth fund.
India’s services activity expanded at the fastest pace in eleven years in June 2022, rising from 58.9 in May to 59.2 in June, while Manufacturing PMI weakened to 53.9 vs 54.6 previously. The June trade deficit widened to a record $25.63bn on a rise in crude oil prices and coal imports. The government tightened oil exports and gold imports in an effort to rein in the worsening deficit and tame the rupee’s record fall. The RBI approved HDFC Bank’s merger with HDFC.
Brazil’s biggest port is getting a new railway system which will double its rail capacity in the next 5 to ten years from 50 million to 115 million tons. The government cut red tape on Lithium imports and exports in a bid to join the battery metal race.
As expected, Peru’s central bank raised rates by 50bp to 6% and remained hawkish.
CORPORATE DEBT
CREDIT
Market sentiment was split between concerns over a recession and upbeat news from China after Beijing approved stimulus measures. Government bond yields edged higher due to a flight to quality. The yield on the 10-year German Bund was up 5bp and by 10bp for 10-year US treasuries. The Main tightened by 3bp and the Xover by 9bp, leaving high yield and investment grade bonds up 0.35% and 0.3% over the period.
There was no high yield issuance ahead of the second quarter results season,
In company news, Ryanair said its planes flew at a record 95% capacity in June, another example of the reopening bounce. The new head of troubled retirement home group Orpea is to be Guillaume Pepy, the previous head of French railways. His appointment will be put to the vote at the July 28 AGM. This is the first step on the recovery path for the group. Its share price has fallen more than 70% after a book alleging systematic mistreatment was published.
Financials returned to positive territory this week with euro CoCo spreads tightening by 22bp. Investor risk appetite is returning, albeit selectively. The UK life assurance group Legal & General pre-announced certain details in its first half results: operating profits were robust and its solvency ratio increased by 28 points to 215%. In banking news, Austria’s Raiffeisen and Greece’s Alpha Bank and Piraeus all announced that they had completed their asset disposal plans. Despite the macroeconomic environment, this is good news as they all had less than average capital cushions.
CONVERTIBLES
As with equity and credit markets, convertibles had a volatile week. However, the ICE BofA Global 300 Convertible Index closed the period 0.62% higher thanks to positive news from China and some easing in bond yields.
The new issues market was flat but newsflow was active. The French government is to renationalise EDF and change its CEO. France wants to prioritise the development of its nuclear power station network and plans 6 new EPR reactors. The government already owns 84% of EDF’s shares. The move is potentially positive politically as the group is currently struggling: half if its 56 reactors are idle, either because of maintenance or due to corrosion problems. EDF’s delisting could benefit its zero coupon 2024 convertible which has a ratchet clause.
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
08/07/2022
This document is issued by the Edmond de Rothschild Group. It is not legally binding and is intended solely for information purposes.
This document may not be communicated to persons located in jurisdictions in which it would be considered as a recommendation, an offer of products or services or a solicitation, and in which case its communication could be in breach of applicable laws and regulations. This document has not been reviewed or approved by a regulator of any jurisdiction.
The figures, comments, opinions and/or analyses contained herein reflect the sentiment of the Edmond de Rothschild Group with respect to market trends based on its expertise, economic analyses and the information in its possession at the date on which this document was drawn up and may change at any time without notice. They may no longer be accurate or relevant at the time of reading, owing notably to the publication date of the document or to changes on the market.
This document is intended solely to provide general and introductory information to the readers, and notably should not be used as a basis for any decision to buy, sell or hold an investment. Under no circumstances may the Edmond de Rothschild Group be held liable for any decision to invest, divest or hold an investment taken on the basis of these comments and analyses.
The Edmond de Rothschild Group therefore recommends that investors obtain the various regulatory descriptions of each financial product before investing, to analyse the risks involved and form their own opinion independently of the Edmond de Rothschild Group. Investors are advised to seek independent advice from specialist advisors before concluding any transactions based on the information contained in this document, notably in order to ensure the suitability of the investment with their financial and tax situation.
Past performance and volatility are not a reliable indicator of future performance and volatility and may vary over time, and may be independently affected by exchange rate fluctuations.
Source of the information: unless otherwise stated, the sources used in the present document are those of the Edmond de Rothschild Group. This document and its content may not be reproduced or used in whole or in part without the permission of the Edmond de Rothschild Group.
Copyright © Edmond de Rothschild Group – All rights reserved
EDMOND DE ROTHSCHILD ASSET MANAGEMENT (FRANCE)
47, rue du Faubourg Saint-Honoré 75401 Paris Cedex 08
Société anonyme governed by an executive board and a supervisory board with capital of 11.033.769 euros
AMF Registration number GP 04000015
332.652.536 R.C.S. Paris