- In the US, the Fed continued to eye labour markets
- The situation in Europe is even more fragile
- We remain cautious on equities and we are also prudent on duration
High inflation continued to put pressure on central banks. Growth forecasts are being revised lower across the globe: the war in Ukraine is still hurting, inflation remains too high, central banks are in a tightening cycle and the effects of China's lockdowns are still being felt. The big question now is how much economies will slow and the impact on activity and company margins.
Defying expectations, consumer price inflation for May in Germany and Spain continued to accelerate, hitting an annualised 7.9% and 8.7% respectively. The surge was essentially due to food and energy prices so the data added pressure on the ECB. What’s more, due to the conflict in Ukraine, poor weather which has accentuated supply tensions, and the European Union's decision to approve an embargo on Russian oil, the trend could last.
In China, official PMI for May registered sharp rises for manufacturing and services but both remained in contraction territory. Even so, the improvements are reassuring and there are increasingly bullish signals as China lifts restrictions in regions where Covid cases are under control and stimulus measures are rolled out. This augurs well for a recover in global supply chains and for reduced inflationary pressure over the medium term. Over the short term, however, commodity prices look set to continue rising.
The OPEC+ announcement on Thursday failed to send oil prices lower. Instead they stabilised at $117. The cartel is only adding 650,000 b/d this summer, a relatively small amount given strong demand.
In the US, the Fed continued to eye labour markets even if the Job Openings and Labor Turnover Survey (JOLTS) showed further signs of stabilising. Nevertheless, Fed vice chair Lael Brainard and Cleveland Fed chair Loretta Mester ruled out any pause in rate hikes over the summer. The Fed’s Beige Book revealed that companies were still struggling with higher prices.
The situation in Europe is even more fragile. Inflation is weighing on household purchasing power, especially as wage rises have been more moderate than in the US.
We remain cautious on equities. We are also prudent on duration, even if the rise in long bond yields since the end of May could provide a safe haven in any risk-off movement.
EUROPEAN EQUITIES
Indices ended the period in negative territory on worries over inflationary pressures and rising bond yields. Inflation continued to accelerate in Germany and Spain to historically high levels due to surges in food and energy prices. The conflict in Ukraine and poor weather have accentuated supply chain problems in both segments, a trend which looks set to continue. Real rates automatically pushed higher and stock valuations fell. In addition, the European Union's decision to approve an embargo on Russian oil should send oil prices higher over the medium term. And in Germany, retail sales plunged from +0.9% in March to minus 5.4% in April, a 12-month low and far below the 0.5% dip expected. The fall was the logical consequence of a slump in household confidence levels due to inflationary pressure.
In company news, Stellantis is once again to close a factory for a week due to chip shortages, another illustration of bottlenecks. The same conditions have affected the manufacturer of the GPS TomTom systems, leading to the company laying off 10% of its workforce as automation increases. In wines and spirits, Rémy Cointreau’s new focus on premium brands has resulted in better pricing power and better-than-expected quarterly earnings. In tourism, Pierre et Vacances raised guidance after better-than-expected half-yearly results, and notably a sharp improvement in sales. The group is upbeat on demand this year thanks to the recovery in post-pandemic tourism. In construction, Saint-Gobain posted excellent figures thanks to its strong pricing power. Despite rising interest rates, dynamic renovation sectors in Europe and strong construction trends in the US proved beneficial.
US EQUITIES
In a holiday-shortened week, the S&P 500 was up 0.45% over the period as of Thursday evening. Manufacturing ISM came in at 56.1, or better than the 54.5 expected and the new orders component rose to 55.1 when it was seen at 52.9. The data would appear to rule out a hard landing, at least for the moment. In similar vein, Fed vice-chair Lael Brainard said she thought it unlikely that the Fed would pause in its tightening cycle in the autumn. Her comments sent 10-year Treasury yields up from 2.75% to 2.92%.
OPEC+ said it would increase daily output by 648,000 b/d in July to offset shortages caused by anti-Russian sanctions. The news, however, failed to make a significant dent in the upward trend in oil prices. ADP’s private sector job creation data came in lower than expected, marking the lowest increase since the pandemic ended and reassuring investors that perhaps the labour market had started to cool down and inflation had peaked.
In company news, Microsoft cut guidance for the current quarter. However, the group said demand was still strong and the change was primarily due to an unfavourable currency effect. In contrast, Tesla said it would have to lay off 10% of its workforce. Elon Musk said there was a risk of recession in the US. JP Morgan chief Jamie Dimon also sounded a cautious note on the economy. Delta Airlines was the latest to lift guidance for the second quarter but the stock failed to move on the good news.
JAPANESE EQUITIES
The NIKKEI 225 and TOPIX rose 3.04% and 2.60% over the period on easing COVID-19 lockdowns in China, stable results and buying from non-domestics lured in by lower valuations.
Insurance added 6.95% as all three major companies announced record profits for FY22 and share buybacks. Transportation Equipment and Machinery gained 6.13% and 5.50% on hopes supply chain disruption would end after China lifted lockdowns. In contrast Pharmaceuticals and Electric Power & Gas fell 2.73% and 2.61% as investors turned risk-on and sold defensive sectors. Precision Instruments edged 0.27% lower, led by Terumo Corp on profit taking after its sharp rise on the back of record FY22 consolidated operating profits and a probable upward revision in FY23 guidance.
Subaru Corp and Nissan surged 11.04% and 10.54% on expectations auto production would recover thanks to China reopening. Sompo added 8.39% on record FY22 earnings, an increase in its dividend payout and a share buyback. On the other hand, Ono Pharmaceutical, Ajinomoto and Tokyo Gas tumbled 8.36%, 5.20% and 3.46% respectively, as investors moved to cyclicals on hopes the economy would return to normal.
Over the week, the yen plunged from 127.12 to 129.84 against the US dollar due to strength in US equity markets.
Last Tuesday, the government announced a plan which aims to double corporate HR investment. The text features in the draft of PM Fumio Kishida's "new capitalism" initiative. The draft, presented on the same day as the Kishida-chaired Council of New Form of Capitalism Realisation, also targets a ten-fold increase in startups over five years. The Kishida administration expressed strong concerns over Japan's international competitiveness which has declined because companies have been focusing on building up reserves rather than actively investing in facilities and wage increases.
EMERGING MARKETS
The MSCI EM Index outperformed global markets, up 1.85% as of Thursday’s close. China rebounded 3.60% in USD as Shanghai started to lift COVID and tech companies reported better-than-expected quarterly results, India gained 2.43% while Brazil edged down 0.64%.
China’s economy showed a slight improvement in May. Manufacturing PMI was better than expected, up from 47.4 in April to 49.6, while the non-manufacturing index improved to 47.8 in May from 41.9 in April. China continued to announce growth supportive measures: an additional RMB10bn in agricultural subsidies will be issued to grain growers who are bearing the cost of rising agricultural materials. The government will also provide support to coal and renewable energy sources to increase production. Shanghai released a fiscal and consumption stimulus package to facilitate a broad resumption in production. The city will increase the license plate quota for passenger cars by 40,000 this year and provide subsidies for spending on EVs and home appliances. Shenzhen rolled out consumption vouchers for citizens. Alibaba reported better-than-expected FY4Q22 results, with total revenue up 8.9%. Meituan’s first quarter revenues beat estimates, with better core margins and narrowing new initiative losses. PDD delivered another quarter of strong growth and profitability well above consensus, mainly on higher GPM and more rigorous sales and marketing.
In Korea, Samsung Group unveiled a $360bn capex plan for semiconductors and Biotech in the next 5 years following the presidential election and Biden's visit to Korea.
India’s GDP rose 4.1% for Q4FY22 and 8.7% for FY22. GST collections for May rose 44% YoY, or 12% on a 3-Year CAGR basis. The fiscal deficit came in 20bp lower than budgeted at 6.7%. The government raised tax on steel and iron ore exports, but cut taxes on fuel to curb inflationary pressure, and set export limits for sugar. Foreign institutional investors continued to be net sellers in May (-$5.1bn), but this was largely offset by domestic institutional investors (+$5.6bn). Results at Dixon Technologies missed expectations but the EBITDA margin improved both YOY and QoQ after 5 quarters of decline. Ultratech Cement announced the next phase of its capacity expansion with an additional 22.6mtpa expected by FY25 (almost 20% of its current capacity)
In Brazil, unemployment fell to 10.5% in the three-months up to April, its lowest level since 2015, driven by the agricultural and construction sectors.
In Mexico, worker remittance flows remained strong in April, beating expectations. In Colombia, the first round of the Presidential run off surprised the market after Rodolfo Hermandez finished ahead of Federico Gutierrez to face Gustavo Petro. The second round will be on June 19. Petro is still leading the polls. On March 13, voters elected 100% of both houses of Congress. The congress is still divided, enough to block any radical proposals.
CORPORATE DEBT
CREDIT
The headline event was an 8.1% surge in eurozone inflation in May. Half of the rise was due to energy prices, a further complication for the ECB as energy inflation differed markedly from one eurozone country to another. Ten-year government bond yields leapt, up 28bp in Germany between Monday and Thursday. Risk premiums widened by 25bp in the high-yield segment and by 5bp on the investment grade index (Main). Assets with structurally high duration suffered. Investment grade credit dipped 0.73% over the period while high-yield edged 0.13% higher.
In high yield issuance, Finland’s Huhtamäki (packaging) raised €500m at 4.375% with a Sustainability-Linked Bond (SLB) due June 2027. In company news, Bain Capital Private Equity replaced NexiCap Partners as the biggest shareholder of Belgium’s House of HR. Bain took a 55% stake via an LBO which put the human resources company at €2.9bn in enterprise value and 11 times EBITDA. Italian telecoms group TIM signed a provisional agreement to merge its fixed network assets with Open Fiber (60% owned by state lender Cassa Depositi e Prestiti). The deal should open the way to the creation of a sole operator in Italy controlled by the Cassa Depositi and investment companies KKR and Macquarie. Note, however, that TIM’s largest shareholder, Vivendi, is for the moment opposed to this development on the grounds that the fixed network's valuation is too low. Auto parts maker Faurecia is to launch a €705m increase of capital to fund some of the cost of its acquisition of Germany's Hella.
All financial debt segments have rallied since Friday, May 27 and especially AT1 bonds where credit premiums have returned to around 625bp, down from 700bp in the euro segment.
This improvement, a relatively rare occurrence since the year started, helped the new issues market reopen. SEB sold a US dollar denominated AT1 at 6.875%, Julius Baer another at 6.875%, and Erste Bank sold a 10-year euro-denominated T2 at 4%.
Elsewhere, AXA announced via its XL affiliate that it would be repaying all its subordinated bond early and above par.
CONVERTIBLES
Reduced volatility and more favourable prospects led to some new issues. In the US, ConMed (healthcare) raised $700m at 2.25%. ConMed is active in general and orthopaedic surgery and especially in the production of equipment and implants.
There were also some first quarter results in the US. Robust results at Zscaler (cloud security) were a pleasant surprise for markets. Sales soared 62%. The company also revised guidance for the full year higher and now expects to make EPS of 65 cents, up from 54 cents. In similar vein, first-quarter results at MongoDB (data bases) jumped 57% compared to the first quarter in 2021 thanks to the success of its Atlas solution for new generation applications. Elsewhere, Chegg (education technology) announced a $1bn share buyback. Its shares have massively underperformed recently and are down by 72% over a year. Earlier this month, Chegg had been mentioned in connection with Indian start-up Byju’s declaration that it might move into the US market by buying an EdTech firm.
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
03/06/2022
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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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