- Economic data points to a sharp slowdown with PMI indices in Europe flirting with contraction levels
- Mounting tensions over Russian gas supplies are affecting the growth outlook
- We remain negative overall on equities with a preference for China over other geographical zones
Inflation concerns are gradually being replaced by recession fears on financial markets.
Central banks are worried that a de-anchoring of inflation expectations could lead to a price-wage spiral that will hit growth. In his testimony to the US Senate, Jerome Powell insisted that the Fed was determined to use restrictive monetary policy to get inflation back below 2%. He said the economy was strong but he could not rule out a recession.
In Canada, inflation came in at a surprising 7.7%, a 40-year high. It was the same story in the UK where inflation hit a 40-year record of 9.1%. The Bank of England is even expecting it to accelerate temporarily to 11% as winter approaches.
Faced with runaway inflation, it is useful to look at what is happening in so called satellite states. Over the week, the Czech Republic and Norway raised their benchmark rates by more than expected but long term bond yields actually fell back on the news. This suggested that worsening growth prospects are carrying more weight locally than worries over inflation. And all long-term global bond yields moved 30-40bp lower over the period.
Economic data points to a sharp slowdown with PMI indices in Europe flirting with contraction levels. Mounting tensions over Russian gas supplies are also affecting the growth outlook. As a result, European equities have underperformed. This situation makes the ECB’s job much more complicated as it seeks to exit negative interest rates to rein in complex inflation while trying to maintain the eurozone’s cohesion and stability.
We are upbeat on Chinese equities now that the economy is reopening and Beijing is introducing fiscal and monetary stimulus ahead of the Communist Party’s Congress later this year. But could the highly contagious BA.5 Covid strain undermine the move to reopen the economy?
We remain negative overall on equities with a preference for China over other geographical zones, and Europe in particular. We are also cautious on duration and prefer the long end of the curve due to recession risk.
EUROPEAN EQUITIES
After several difficult weeks, European markets rebounded a little despite persistently high volatility. ECB chair Christine Lagarde confirmed that benchmark rates would be raised by 25bp in July and then again in September, but with no indication of by how much. Her comments come as market worries over recession mount. The geopolitical, energy and monetary environments are still very problematic. Vladimir Putin raised the tone by threatening a riposte after the Lithuanian blockade on the Russian-held enclave of Kaliningrad. Lithuania is applying European sanctions on exports of certain products to Russia. The result was to put more pressure on energy and commodity prices.
Germany's production prices in May rose 1.6% over 12 months, or above the 1.5% expected. However, 2-year UK government bond yields retreated a little more than the rest of Europe (-17bp) following Friday morning’s May CPI data.
In company news, Crédit Agricole unveiled the rather pessimistic assumption behind its new plan, citing the weaker post-pandemic recovery due to the Ukraine war and surging inflation. The bank expects its cost of risk to rise and says it will need more capital. Elsewhere, shipping giant Maersk said it expected maritime freight volumes to fall as the economic slowdown continues to worsen. The group thinks there could even be a switch towards excess supply in the sector from the fourth quarter of this year. In energy news, Eni, TotalEnergies and Qatar Energy will work together on expanding the North Field East, the biggest liquefied natural gas project in the world. Qatar’s production would rise from 77m tonnes to 126 mtpa. In autos news, Stellantis is to idle several factories for at least 10 days due to semiconductor shortages.
US EQUITIES
US indices edged higher over the last 5 trading sessions up to Thursday with the Dow up 0.03%, and the S&P500 +0.15% better. The Nasdaq ended the period +1.20% higher. Some market players think the recent fallback in commodity prices on fears of an economic slowdown is good news given today’s strong inflation. Fed chair Jerome Powell insisted at his half-yearly testimony to the Senate that the bank had to get inflation back to the 2% target. He admitted, however, that engineering a soft landing would be very tricky. Michelle Bowman, a Fed committee member, said she was in favour of a 75bp move in July and then 50bp rises in the following months.
In an interview on ABC, Treasury Secretary Janet Yellen said she was in favour of scrapping fuel taxes to help households. She said energy represented half of inflation. She also said the Biden administration was thinking of lifting import duties on some Chinese goods.
Weekly jobless claims dipped from 231,000 to 229,000 in the previous week but they were still above the 227,000 expected.
According to Bloomberg, Comcast and Google are the favourites to help Netflix (+4.7%) create a video service paid for by advertising. Netflix has laid off another 300 employees as the streaming giant tries to bring costs under control following disappointing new subscriber numbers. JP Morgan made hundreds of staff working in property loans redundant as the US mortgage market slumped.
Tobacco producer Altria tumbled 9.1% in Thursday after the FDA said it wanted to reduce nicotine levels in cigarettes and ban Juul’s vaping products. Altria owns 35% of Juul. Cosmetics firm Revlon continued to surge (+34%) on rumours that India’s Reliance Industries was interested in bidding.
Fedex advanced 2.9% after the bell on better-than-expected company forecasts for fiscal 2023, higher prices and efficient labour cost controls. Despite the energy sector’s 3.74% decline, Occidental Petroleum gained 0.5% following news that Warren Buffett’s Berkshire Hathaway fund had reinforced its stake by buying 9.5 million shares.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX dropped 0.98% and 0.86% for the period, following sharp falls on Wall Street on recession fears early in the week. Later, the market bottomed out but concerns over the Chinese economy and the ongoing Ukraine war continued to weigh on sentiment.
Air Transportation rose 5.37% thanks to government subsidies like “Go to Travel” and easing of border controls. Defensives like Pharmaceuticals and Food gained 3.88% and 3.47%. Elsewhere, Mining, Marine Transportation and Oil & Coal Products tumbled 12.78%, 7.40% and 6.54%, respectively, on fears of a global slowdown.
Unicharm rose 7.30% as investors returned to Chinese consumption stocks after restrictions in the country were eased. Eisai gained 6.63% due to its defensive status and strong guidance on 2023 earnings. Kirin Holdings rose 5.99% thanks to its ability to pass on input costs. On the other hand, Mitsubishi Heavy Industries plunged 13.46% on profit taking triggered by the resignation of the Administrative Vice-Minister of Defense who was a key supporter of increased spending on defence in PM Kishida’s administration. Sumitomo Metal Mining plummeted 13.31% on fears a global recession would lead to lower commodity prices. Tokyo Electron tumbled 11.17% as investors dumped high tech stocks amid rising interest rates.
The yen weakened to 134.98 against the US dollar (down from 132.21) and even touched 136.57 on June 21. This was a reaction to the BoJ’s determination to remain accommodating.
Official campaigning for the 26th House of Councillors election began on Wednesday, with 545 candidates facing off before the July 10 vote. This time, 125 seats will be contested out of a total of 248, with 75 chosen from constituencies and 50 through proportional representation.
EMERGING MARKETS
The MSCI EM Index slipped 0.8% during the week as of Thursday’s close. China outperformed (+1.98%) followed by India (+1.66%) which benefited from cooling crude prices. Brazil lost 2.61%.
In China, President Xi reiterated his economic and social targets for the year, while promoting the healthy development of the payment and fintech sectors. China will further accelerate fiscal spending as well as the sale of special local government bonds, according to the finance minister. The government may also extend tax exemptions on electric-car purchases in a bid to boost the automobile sector. Home sales in 70 large-to-medium cities are showing signs of a recovery. 618 shopping festival results were in line with expectations, with overall GMV growth of 20.3%. A China-developed mRNA Covid-19 vaccine can induce an immune response to the Omicron variant. The government is mulling a ban on third-party platforms selling medicines online. Macau approved a new gaming law allowing six licenses for 10-year periods. Tencent is forming a new division with over 300 employees to build up extended reality software and hardware. According to Bloomberg, Ant Financial is set to apply for a key license with the authorities this month. NetEase has delayed the launch of its Diablo Immortal game. Ximalaya is reportedly to push back its Hong Kong IPO launch due to market volatility.
Hong Kong’s incoming leader John Lee is working on a strategy to reopen the city’s border with mainland China and further consumption stimulus for the city.
In Taiwan, Mediatek came under heavy pressure amid press talks regarding high inventories and 3Q22 order cuts.
In India, the RBI June meeting minutes showed the committee was focusing on price stability over growth and keen to anchor inflation expectations. Net direct tax collections were up 45% YoY in 1Q22. Power companies, including NTPC, are said to be reviewing new coal power projects to meet surging electricity demand. Foxconn plans to manufacture electric vehicles in India.
In Brazil, the government plans to increase tax on oil production revenues.
Mexican CPI rose more than expected in the first half of June, pushing inflation to a new 21-year high, driven by energy and raw food prices.
CORPORATE DEBT CREDIT
High yield cash bond spreads widened by 40bp but government bond yields fell sharply, with the 5-year German Bund down 25bp to 1.20%. The probability of a recession is increasing and investors are turning away from inflation fears to worries about growth slowing. Investment grade returned around 1.2% over the period and high yield fell 0.3%.
In company news, Orpea is being advised by investment bank Ondra on selling its assets in Germany (around €1bn). Any sale would mean the loss of Orpea’s biggest foreign market. Last year, sales in Germany were close to €600m and EBITDA was €150m, or around 15% of the group’s total. But the disposal would help the group's finances and stretched cash position. French banks have just given the group a €1.7bn syndicated facility to refinance part of its debt and investments scheduled for this year. Germany’s Zalando (e-commerce) slashed its annual guidance, citing worsening economic conditions in the second quarter. In pharmaceuticals, Biogroup confirmed that its CEO Stéphane Eimer had died.
In financials, new issuance picked up speed despite persistently difficult conditions. Spreads remained wide with euro and US dollar CoCos widening by a further 20bp over the period. Even so, Barclays raised £1.25n with an AT1 at 8.875%. The regulatory calendar also pushed smaller peripheral banks like BPER, Unicaja and Permanent TSB to issue senior debt in spite of high financing costs. Italy’s Monte de Paschi released a new 2026 strategic plan which aims to help it recover. The plan includes a €2.5bn increase of capital with the support of the Italian government which has a 64% stake.
CONVERTIBLES
The convertibles market edged higher over the period despite the persistently uncertain economic environment.
The new issues market remained open thanks to reduced volatility across indices. In the US, JPMorgan raised $500m at 0.5% with a bond exchangeable into Boeing shares. Ormat Technologies raised $375m at 2.5% due July 2027 with a green convertible. The company, a specialist in geothermal energy, builds and runs power stations across the world.
In company news, speculation continued around Atos after last week’s news that its CEO had resigned after the company's board decided to split the business in 2023. Thales is expected to buy the cyber security business with the agreement of the French state which owns 25.7%. The government wants to ensure control of a strategic division as it is used in France’s defence systems and it also provides a supercomputer to NATO. Atos is looking for €1.6bn to fund its restructuring so a deal involving its cyber security business would be good news.
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
24/06/2022
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.
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