- Investors think central banks will be forced to act against inflation, especially as economies are holding up well
- With liquidity down a little, tensions persisted on the corporate debt market
- Central banks are still pivotal in an environment where investor nerves are being sorely tested
Recession worries sent government bond yields and equities lower over the period. The MSCI World index in USD ended the week 2.8% lower. Supply side constraints, notably in energy and semiconductors, led to a strong focus on demand components. 10-year US Treasury yields dipped back below 3% for the first time since the beginning of June. This was due to reduced consumer spending even if services partially offset the decline.
And yet household earnings rose 0.5% MoM in a persistently robust jobs market. Property loan applications rose for the third week in a row, taking them back to 2019 levels. 30-year mortgages at 6% are still not putting off home buyers. The Case Shiller property price index was up more than 20% over 12 months in April.
European government bond yields also fell back even if investors think central banks will be forced to act against inflation, especially as economies are holding up well. The Caixin manufacturing PMI moved back into positive territory, up from 48.1 in May to 51.7, or better than the 50.1 expected.
With liquidity down a little, tensions persisted on the corporate debt market. Heavily leveraged issuers, those rated CCC and property companies which require recurrent financing, were the hardest hit. Central banks are therefore still pivotal in an environment where investor nerves are being sorely tested.
Given the circumstances, we are still cautious on equities. Valuations are less demanding -the S&P500 is now back to its 10-year- so technical rebounds are still a possibility. Investors are also underexposed, the Fed has managed to regain some credibility and external risks are generally less pressing. We are also still cautious on duration.
EUROPEAN EQUITIES
Worries over energy supplies dragged Europe lower over the period. The risk of severe shortages keeps on rising due to very low Russian gas exports. And LNG supplies from the US have been hit by technical hitches and Asian competition. Meanwhile, hydroelectric production is struggling because of droughts and most of France’s nuclear power station network is still idle due to a complicated corrosion problem. And then Germany’s Gkf consumer confidence index for June hit a record low. In France, Insee reported that consumer confidence had fallen to levels not seen since 2013 due to inflation.
Following lower-than-expected German inflation and higher-than-expected Spanish inflation, ECB chair Christine Lagarde said inflation expectations were still the ECB’s primary focus. More hawkish ECB officials like Martins Kazaks (Lithuania) and Belgium’s Pierre Wunsch are in favour of a 50bp rate hike as early as July.
In company news, difficulties at German energy group Uniper began to feed through. Following Gazprom’s decision to slash its agreed deliveries by 60%, Uniper had to buy on the spot market but without the capacity to pass on the substantial extra costs to end users. In tourism, companies are struggling to meet strong demand due to labour shortages and strikes. Scandinavian airline SAS (+5.9%) warned on possible disruptions if its pilots went on strike. H&M (apparel) announced new price rises when reporting its quarterly results. The company managed to raise margins despite soaring inflation. Volkswagen said it was optimistic the semiconductor shortage would start to ease from this second half but Mercedes still expects difficulties to persist.
US EQUITIES
Wall Street had a bruising week as worries over a serious recession rose. Household consumer spending for May only rose 0.2% when it was seen 0.4% higher and April's figures were revised lower. At the same time, the May price deflator, the Fed’s preferred inflation gauge, remained at a lofty 6.3% YoY.
Over the second quarter, the S&P lost 16.5% and the Nasdaq 22.4%, their biggest quarterly drop since 2008. Year to date, the S&P500 is down 20.5%, its worst performance since 1970. The Nasdaq (-29.5%) chalked up its worst half-yearly drop since it was created in 1985. Netflix (-71%), Meta (-52%), Tesla (-36%) and Amazon (-36%) were some of the biggest losers. In contrast, the oil sector outperformed: with ExxonMobil up 40% and Chevron 23% better. Occidental Petroleum rocketed 103% after Warren Buffet increased his stake.
John Williams (New York Fed) and Mary Daly (San Francisco Fed) both said beating inflation was an absolute priority but added that achieving a soft landing was possible.
In company news, some sectors were battered after companies issued cautious guidance for the rest of the year. Nike’s quarterly results beat expectations but the stock still shed 3.5% after the bell. Markets were disappointed by the drop in the gross margin and the outlook in China where sales plunged 20% over the quarter. Semiconductor giant Micron plunged more than 8% in after-hours trading following its sharply lower guidance for the third quarter due to weak demand for phones and computers.
However, banks and leisure plays managed to post some good news. Following the convincing results of the Fed’s bank resilience test, Morgan Stanley (+2.5%) and Goldman Sachs (+1.7%) said they would be raising dividend payouts. Cinema chain AMC jumped 13% after the Elvis biopic beat weekend expectations. The film ranked equal with Top Gun which has now raked in more than $1bn across the globe.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX rose 0.85% and 1.03% over the period.
After a solid start to the week following a Wall St rebound as bond yields peaked, the market weakened after poor US retail data and results, a possible harbinger of a recession. Soft Chinese economic data and the ongoing Russia/Ukraine war continued to weigh on sentiment.
Electric Power & Gas rose 5.82%, a defensive haven in a volatile market. Marine Transportation gained 4.52% on a rebound after profit taking. Services ended 3.47% higher on hopes for economic normalisation. Elsewhere, Rubber Products abandoned 4.73% led by tyre makers as supply chain disruption delayed a recovery in vehicle manufacturing. Other Financing Business slipped 1.92% on lower US bond yields. Air Transportation dipped 1.77% on profit taking.
In stock news, M3 Inc. jumped 8.16% as US growth stocks bounced off year lows. Ono Pharmaceutical surged on strong earnings guidance for FY 2023. Ajinomoto gained 7.35% on its success in passing on input costs. On the other hand, Bridgestone fell 5.55% on reduced vehicle production (see above). Japan Exchange Group fell by 4.84% as stock exchange trading volumes fell on risk-off sentiment and fewer IPOs. Subaru fell 4.42% after a new EV recall.
The Yen continued to weaken against the US dollar, moving from 134.95 to 135.72, and even hitting 136.59 yen June 29 after several FED officials said inflation was going to be strong in the US for the time being.
EMERGING MARKETS
The MSCI EM Index was down 0.8% this week as of Thursday’s close. Brazil, China and India outperformed global equities, +0.68%, -0.16% and -0.37% in USD respectively.
In China, official manufacturing PMI rebounded to 50.2 in June from 49.6 in May on easing Covid restrictions. May industrial profits rose sequentially, down 6.5% YoY vs. -8.5% in April. China is on track to issue RMB 1.5 trillion ($224bn) in local government bonds in June, up nearly 80% YoY and above the previous record of RMB 1.3 trillion in May 2020. The State Council plans to raise RMB 300bn via financial bond sales to fund major projects that help boost investment, employment and consumption. The government shortened inbound travellers’ quarantine time from 3 weeks to 10 days. In Shanghai, dining in restaurants gradually resumed and Disneyland reopened after an extended closure. June new home sales recovered sequentially, +61% MoM but were still down 43% YoY.
Prosus is reportedly selling Tencent shares to fund a buyback, while its sale of JD stock has concluded. Elsewhere, Tencent restarted a daily HKD 300m share buyback right after the announcement by Prosus. First quarter earnings at Trip.com beat expectations with revenue strength across all segments despite Covid-related disruptions. Vanke’s chairman said the housing market had reached bottom. Longi is to raise wafer prices by 6%, or the 7th price hike of the year. China Duty Free is set to relaunch a planned Hong Kong listing that could raise around $2 billion to $3 billion.
President Xi arrived in Hong Kong for celebrations to mark the 25th anniversary of the handover.
India raised taxes on oil exports and gold imports to combat the falling rupee. It recorded its best ever quarter for M&A with $82bn of pending and completed deals in the second quarter, or more than double its previous record in the third quarter of 2019. Akash Ambani, Mukesh Ambani's son, was named chairman of Reliance Jio, kickstarting a leadership transition. Zomato agreed to buy quick commerce company Blinkit.
In Korea, LG Energy decided to reconsider its plan to build a battery plant in the US due to the deteriorating business environment and soaring costs. Samsung Electronics and LG Electronics have decided to cut production of their TVs and other home appliances to cope with declining consumer demand.
Vietnam’s GDP grew 7.7% in the second quarter vs 5.9% estimated on solid exports and consumer spending.
Brazil's jobless rate reached 9.8% in the three months ending May, the lowest level since early 2016, amid economic growth spurred by the reopening of many businesses. Petrobras resumed the privatisation process of three refineries which had been halted in 2021. Audi Brasil relaunched its national production line in June.
CORPORATE DEBT
CREDIT
Recession fears dominated sentiment again, leaving 10-year German and US Treasury yields 21bp and 24bp lower. Spreads widened by 15bp in investment grade and 59bp in high yield.
In company news, fourth-quarter sales at Picard (frozen food) for the financial year ending March 31 fell 10% and EBITDA was 18% lower. The drop was due to a return to normal from a very high comparison base. The gross margin slipped 30bp to 44.3% due to dilution from an increased number of franchisees. After rents and interest payments, free cash flow was a negative €70m, down from €94m a year earlier, leading to leverage rising from 5.6 to 6.3 times. The cash position was a robust €207m.
Italy's Treasury Department is about to guarantee a €2bn bank loan to Telecom Italia. The loan will bolster the group’s finances as CEO Pietro Labriola tries to restructure the group by separating the wholesale fixed network from the services divisions.
In financials, the fundamental position is still upbeat thanks to ratings and better margins from higher interest rates but Andrea Enria, Chair of the European Central Bank's Supervisory Board, called on banks to be reasonable over dividend payouts, citing recession risk and the collateral impact of stiffer sanctions against Russia. These risks now have to be taken into account when banks calculate capital requirements as part of their macroeconomic scenarios.
Despite difficult conditions, Generali sold a 10-year Green bond at 5.8%, Italy’s Credito Emiliano a Tier 2 10NC5 at 7.625% and Barclays raised SGD 450m with an AT1 (CoCo). CoCo spreads with government bonds widened by 90bp to 950bp.
CONVERTIBLES
In the news this week, Dufry and Autogrill confirmed press reports of a possible merger, a deal which would see Dufry buying Autogrill in an all-equity deal. According to El Confidencial, Cellnex is seeking a €6bn loan to buy Deutsche Telekom’s towers unit.
The new issues market is slowly starting to reopen. Pharmaceutical company Cytokinetics is to raise $450m (+a $90mm greenshoe) with a 5-year maturity at between 3% and 3.50%. It will use the proceeds to repurchase a portion of its outstanding convertible notes due 2026. Shares in Aspen Aerogels jumped close to 50% after the insulation maker said it would not proceed with concurrent public offerings of common stock and green convertible senior notes due 2027, contrary to its announcement on Tuesday; The decision was due to a reassessment of current market conditions.
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
01/07/2022
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