Recession worries resurface

• Economic data fell short of expectations
• Central banks maintained their restrictive message
• We are still cautious on equities

An initially calmer week turned negative after the worse US sell-off in 2 years dragged down every other market. Distribution companies were particularly savaged after poor figures from Walmart and Target in the US reflected worrying trends in consumer spending and margins. Recession fears resurfaced and government bond yields edged lower, the first time in weeks that bonds had acted as a safe haven. Economic data, notably the Empire Manufacturing index and the Philadelphia Business Outlook, fell short of expectations, coming in at lows that seemed to augur a weak economy ahead. 

However, central banks maintained their restrictive message. Jerome Powell reaffirmed the Fed’s determination to raise rates as much as was needed to beat inflation even if growth could be affected. Klaas Knot at the ECB said a 50bp hike in July was possible. Such a move looks unlikely but investors are already expecting four 25bp hikes this year, with the first in July according to ECB officials. Among developed countries, only the Bank of Japan has stuck to a more accommodating tone and continues to rule out any change in policy. However, with core inflation running above 2% (2.1% in April), the bank will find it difficult to resist pressure.

Markets were reassured on Friday by a bigger benchmark rate cut in China and looked set to end the week on a more positive note.

Given the circumstances, we are still cautious on equities. Technical rebounds are always a possibility but medium-term economic risks are growing. We are also still reserved on duration, especially in Europe. US Treasuries seem to have mostly factored in future rate hikes so they could act as safe havens if recession fears were to get worse.

EUROPEAN EQUITIES

European indices held up better than US markets and ended the period only slightly lower. Selling continued amid mounting worries that growth in developed countries would slow due to inflation and pressure on company margins. Unsurprisingly, the European Commission slashed its growth forecasts for this year from 4% to 2.7% and from 2.7% to 2.3% next year. But UK employment data showed the labour market was just as strong. Elsewhere, EU leaders and diplomats said they were confident an embargo on Russian oil would soon be approved. The EU also released its new Repower EU plan which seeks to diversify energy supplies to replace Russia, accelerate energy transition and cut energy consumption over the long term.

In company news, furniture market Made said demand had fallen due to Covid easing and inflation cutting into households’ purchasing power. In contrast, the UK's Marks & Spencer said it was sure it could pass on higher costs to end consumers without affecting demand. Contract caterer Elior said it had benefited from sanitary restrictions being lifted but was worried about inflation hitting company margins. After raising its targets following an upbeat first quarter, Engie said it had managed to limit its Russian exposure and diversify its supply sources. Daimler Truck posted good first-quarter figures thanks to strong, post-Covid demand and said it had easily managed to pass on cost increases to protect margins.

US EQUITIES

US markets ended the period sharply lower on mounting worries over growth and persistent pressure on rates. Several Fed officials said the bank would continue to raise rates to beat inflation but that the process would be gradual so as to avoid damaging the economy. At the same time, concerns over the ability of companies to resist soaring input costs rose after several consumer sector companies reported poor figures. Elsewhere, Secretary of State Janet Yellen said it was unlikely the US would allow Russia to continue making bond payments on its foreign-currency debt. And the Senate reinforced tensions between the US and Russia by approving a $40bn aid programme for Ukraine. Janet Yellen reaffirmed Washington's refusal to import Venezuelan oil but the Biden administration is considering easing sanctions on the country to allow European countries to do so.

In company news, Elon Musk said his bid price for Twitter might be revised lower. Twitter’s board looks unwilling to accept this and Musk would face a $1bn break-up fee if the price were changed. By Thursday evening, Walmart had fallen 20% over the week after cutting guidance for this year due to higher oil and food prices along with supply problems. Target, Walmart's biggest discount rival, followed suit with equally disappointing figures. McDonald’s is to sell all of its Russian restaurants, a symbolic move as the group moved into Russia shortly after the end of the Cold War. Netflix laid off 2% of its workforce as a result of the slowdown in its streaming activity. In IT, Cisco's guidance was largely below market expectations due to significant supply chain problems and China’s lockdown.

JAPANESE EQUITIES

NIKKEI 225 and TOPIX rose 2.54% and 1.69% for the period. The Japanese equity market was almost solid this week supported by stable global equity markets and sound business results of Japanese corporations. However, it fell sharply on 19th following major US equity markets which fell to this year’s new low reacting to disappointing results of retailers possibly impacted by the inflation.  

Warehousing & Harbor Transportation Service sector rose 10.55% as handling fees rose due to supply chain disruptions. Oil & Coal Products and Mining sectors rose 6.18% and 5.17% with high prices of natural resources. Meanwhile, Pulp & Paper sector fell 3.49% by profit taking sales. Insurance sector declined by 2.55% mainly due to temporal peak-out of US government bond yields. Security & Commodity sector fell by 1.45% as trading volume has declined due to risk-off sentiment of investors. 

Mitsubishi Heavy Industries, Ltd. surged 9.64%, deemed as a beneficially of military expenditure increase by the government, and supported by the strong FY22 results and FY23 guidance announced on 12th May. SMC Corp rose 9.45% as FY22 sales and operational profit hit record highs and is expected to further renew record highs in FY23 guidance, supported by strong demand of semiconductors and batteries. Eneos Holdings Inc. rose 9.44% deemed as a beneficiary of high crude oil price, and buoyed by the announcement of share buyback (with upper limit of 9.3% of outstanding shares, about JPY100billion). On the other hand, Asahi Group Holdings, Ltd. tumbled by 11.50% disappointed by poor results of 1Q22 profits (operational profit -82.7% y/y, net profit -86.9% y/y, consolidation basis) due to rise in raw material costs. Secom, Co., Ltd. fell by 8.64% as FY23 profit guidance fell y/y due to increase in costs, such as fuel costs for data center business and salaries. Resona Holdings Inc. fell 6.21% as FY22 net profit was -11.7% y/y due to loss made in proprietary investment mainly in US government bonds.

JPY was almost flat against USD at around 128 yen level due to temporal peak-out of US interest rate and sharp fall of the US equity markets. 

On Tuesday, the Japanese government announced that they will accept small-scale tours of vaccinated tourists from US, Australia, Thailand and Singapore as a trial later this month, toward the full-scale acceptance of foreign visitors planned in June.

EMERGING MARKETS

The MSCI EM Index gained 1.08% this week as of Thursday’s close, outperforming global markets, on hopes China’s COVID restrictions would continue to ease. China rebounded 1.76% in USD, India closed flat, while Brazil (+3.26%) continued to outperform, mostly driven by the Real’s appreciation.

China’s economic data disappointed in April as the Covid lockdown weighed. Credit data was well below expectations with RMB 645bn in new loans, down from 3.1 trillion in March. Industrial production dropped by 2.9% YoY in April, or more than the 0.5% drop expected, while retail sales fell 11.1% when they had been seen falling 6.1%. The PBoC then cut its 5-year LPR by 15bp to 4.45%. It also reduced the first home mortgage yield floor by 20bp to LPR-20bp (4.4%), the first action taken by Beijing to support the housing market. More tier-two cities relaxed property-purchasing restrictions. Senior government officials met with top technology executives in further signs of a detente for internet companies. Shanghai port returned to 90% of cargo-handling capacity. The IMF lifted the renminbi’s weighting in the SDR basket. The EU commission accelerated renewable energy targets and emphasised its reliance on solar power: 70% of current EU solar demand is met by Chinese imports. Xiaomi, Vivo and Oppo trimmed smartphone orders by 20% for the coming quarters as the lockdown severely disrupted supply chains. Tencent’s 1Q22 results missed market expectations as the Covid lockdown resulted in soft advertising, payments and Cloud activity. JD.com posted positive revenue performance in 1Q22 as its customer base continued to expand.

The Indian government restricted wheat exports to rein in domestic prices. Life Insurance Corp of India (LIC), the country’s biggest insurance group, raised $2.7bn in its IPO, or far below the initial $12bn target; the stock fell in the first few days of trading, reflecting weak overall market sentiment and a slump in the broader market. Eicher Motors reported a better than expected 16% rise in 4QFY22 earnings. The company managed to hike prices by 20% with only a limited impact on demand. Amber’s 4QFY22 results were significantly below market expectations on slower-than-expected moves to pass on costs and an unexpected mix change. Adani Group acquired a controlling stake in Holcim AG's cement businesses to become the second biggest cement producer in the country.

Indonesia posted its largest-ever trade surplus thanks to a commodity export boom. The lifting of the palm oil export ban relieved the global market. In Singapore, SEA Ltd reported lower-than-expected earnings on weak e-commerce trading. 

In Brazil, auditors approved the Eletrobras privatisation plan. The government will sell its shares on June 13. The stock exchange announced plans to launch Bitcoin (BTC) futures this year. Hapvida reported disappointing 1Q22 results due to Covid related higher claims and lacklustre organic growth. In Mexico, there were reports that the CEO of real estate investment trust Fibra Uno had been named in a government money laundering probe.

CORPORATE DEBT

CREDIT

In a mixed week, China provided positive news with some signs the zero-Covid policy might be eased and the central bank's decision to cut the preferential 5-year loan rate, the property market’s benchmark, by 15bp. On the down side, indices started to factor in recession risk in the US after major retailers like Walmart, Target, Home Depot and Lowe’s posted disappointing results. Bond yields were highly volatile but trended lower with 10-year US Treasury yields down 7bp on recession worries. However, risk premiums widened with the Xover up 32bp to 488 and the Main up 6bp, leaving returns on investment grade and high yield 0.28% and 0.36% lower.

In high yield issuance, Elis (textile, hygiene and facility service solutions) raised €300m at 4.25%. There was an astonishing tie-up between Derichebourg (environment and corporate services) and French contract caterer Elior. Through an agreement with the holding company of Elior’s founder, Derichebourg agreed to increase its stake from 4.9% to 19.6% and pay a 70% premium on the price before the deal was announced. The news dismayed Derichebourg’s investors, especially as the company was expected to participate in the consolidation of Europe’s waste disposal sector. Air-France KLM sold part of its stake in its engine maintenance subsidiary to investment firm Apollo for €500m. The proceeds will go on reimbursing part of the French government-backed €4bn loan granted during the crisis. Earlier in the week, shipping company CMA CGM said it would take part in Air-France KLM’s increase of capital and take its stake to 9%.

In upbeat results from companies in defensive sectors, first-quarter sales at Iliad rose 4.8% thanks to strong performance in Italy and France while EBITDA was 5.4% higher on a like-for-like basis. German pharma company Stada swept past expectations in the first quarter with a 20% jump in sales to €886m and an 11% rise in EBITDA to €168m. In contrast, Consolis (precast concrete) was hit by inflation and higher commodity prices. Sales rose 26% over a year to €319m but the EBITDA margin fell 1.3% compared to the last quarter in 2021, a source of worry for investors.

CONVERTIBLES

Despite persistent volatility, the new issues market stayed open. Bank of America raised $500m with an exchangeable bond into Merck shares at 0.6% due May 2027. US insurer HCI Group raised $150m at 4.75% due 2042. Swiss-based travel retailer Dufry reported a 176% jump in sales as people started travelling again in Europe. Free cash flow was still a negative CHF 87m due to unfavourable seasonal effects and depressed conditions in Asia prompted by China's zero-Covid policy. In the US, Palo Alto Networks reported a solid 40% jump in quarterly sales. Operating margins also increased by a sizeable 120bp as demand for cybersecurity solutions surged.

In M&A, JetBlue Airways launched a hostile bid on Spirit Airlines only two weeks after having its offer for a tie-up refused. Spirit is keener on merging with low-cost Frontier to attain the critical size needed to compete with major airlines like American Airlines, United, Southwest and Delta.

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
20/05/2022
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