Stormy weather...

• Equity indices dropped by around 3% over the period up to Thursday evening, with an additional FX effect of 2% for a US investor
• The prospect of the Fed tightening by 50bp at the May 3-4 FOMC is now weighing on the growth outlook
• We remain underweight equities as downside risk from reduced liquidity carries more weight than persistently upbeat prospects on company earnings

The post-election lull in France quickly petered out as various negative factors combined to sour the mood. Equity indices dropped by around 3% over the period up to Thursday evening, with an additional FX effect of 2% for a US investor.

First, China’s zero-Covid policy does not seem to be working against such a contagious variant as Omicron. Shanghai’s “temporary” lockdown, initially supposed to last 2 weeks, was maintained and even extended to other cities with no clear exit scenario. Despite protests, there is no sign of a change in strategy but simply measures to help the economy. In spite of this help and the renminbi’s fall, China’s economy has slowed and there is severe supply chain disruption.

Second, the escalation in the Ukraine conflict is weighing on market sentiment. A ceasefire looks less and less likely over the short term. On the one hand, Germany's parliament approved sending heavy artillery to Ukraine, Finland and Sweden are moving towards asking to join NATO and the US officially wants to weaken Russia’s military heft to stop other countries being threatened. On the other, Moscow stopped delivering gas to Poland and Bulgaria and thinks NATO is waging a proxy war. Meanwhile, tensions are mounting in Moldavia.

Third, the prospect of the Fed tightening by 50bp at the May 3-4 FOMC is now weighing on the growth outlook. The US economy contracted by an astonishing 1.4% in the first quarter due to a drop in exports and some destocking. Even so, household and company demand is still robust and earnings are coming in as expected.

Meanwhile, monetary tightening is becoming the norm. Hungary raised its rates by 100bp and Sweden by 25bp. Only Japan is shunning the trend and continuing its efforts to control the yield curve by unlimited daily buying of Japanese bonds. As a result, the yen has tumbled and there is now a higher risk of currency market disruption.

Against this backdrop, we remain underweight equities as downside risk from reduced liquidity carries more weight than persistently upbeat prospects on company earnings. We have also reduced exposure to Japanese equities. The Bank of Japan might have to reverse course in the coming months due to the yen’s depreciation and rising commodity prices. We remain cautious over duration, especially in Europe. In the US, however, duration is looking interesting again, particularly at the short end.

EUROPEAN EQUITIES

Despite persistent inflation, European markets rallied in the second half of the week on strong earnings reports and upbeat macroeconomic data. Germany’s IFO business climate index was on the positive side, rebounding in April to 91.8 from 90.8, and better than the 89.1 pencilled in by analysts. Even though the figure is not very high compared to historic data, the previous Friday’s PMI had already shown a sharp bounce in services as economies reopened. On the negative side, the effects of the Ukraine war continued to undermine business leaders’ confidence in manufacturing, commerce and construction. 
Consumer inflation in Germany and Spain swept past expectations, up again in Germany while core inflation in Spain rose significantly, triggering concerns that inflation would spread beyond volatile index components. 

Elsewhere, the European Union is putting together fresh sanctions against Russia. Moscow’s decision to suspend gas deliveries to Poland and Bulgaria is unlikely to improve matters.

In company news, Maersk raised guidance on its 2022 profits even if the shipping company thinks the boom in maritime freight will run out of steam in the second half of the year. Switzerland’s Kuehne+Nagel said the same thing: its first-quarter sales soared 68% due to resilient demand but the group expects the Ukrainian conflict will aggravate maritime freight tensions.

Elsewhere, first-quarter profits at Mercedes-Benz beat estimate thanks to the group refocusing on premium cars. Demand for upmarket models has helped the group protect its margins. STMicroelectronics reported robust results but warned that the future was less promising. Its production capacity has been hit by China's sanitary situation and the Ukraine conflict so it will still fail to meet demand. 

Finishing on a bright note, Carlsberg said it had managed to pass on higher aluminium and freight costs to consumers with no impact on sales.

US EQUITIES

Equity indices ended the period lower with the Dow down 2.52%, the S&P500 2.42% lower and the Nasdaq off 2.30%. Earnings reports, particularly from GAFA stocks, and geopolitical tensions contributed to the drop.

Theoretically, an economy goes into recession after two quarterly contractions in a row. The US has already notched up one as the economy contracted by 1.4% in the first quarter for the first time since the second quarter of 2020. In fact, the figure is not alarming as lower exports and destocking were responsible but household consumption and investment spending remained strong. Markets logically brushed off the news.

However, saving as a percentage of disposable revenue fell from 7.7% to 6.6% over the quarter. Note that spending held up primarily because of a good January. Some areas like clothing, restaurants and food are beginning to suffer.

A third of S&P500 companies released first quarter results over the period.

Alphabet/Google fell 6% after the bell on Thursday due to disappointing figures that were dragged down by soft ad spending in Europe and YouTube activity. Texas Instrument tumbled 9% in extra-hours trading after the group cut guidance for the current quarter due to supply chain disruption, especially in China. 

Amazon plunged 10% after the close on Thursday after second-quarter guidance fell short of expectations. The group warned that inflation would affect purchasing power and that online buying was returning to normal levels after economies reopened.

Apple also shed 6.2% after the bell as management said supply chain problems could reduce revenues for the current quarter by $4-8bn. 

Sentiment was also dented by General Electric (down 10.3% after annual guidance came in at the bottom of the spread), UPS (-3.6%) and indications that Elon Musk would be funding part of his Twitter acquisition with his own shares in Tesla (-12%). Bloomberg said that the big drop in Tesla might undermine Musk’s bid on Twitter. Margin calls would be triggered If Tesla’s share price were to fall below $740. In a sign that traders were treading cautiously, Twitter slipped 3.9% to $49.68, or below the $54.2 a share bid price.

On a brighter note, Microsoft jumped 7% after a surge in its cloud computing business helped its results beat expectations.

And Meta/Facebook soared 18% with a big earnings beat. Strong subscriber growth assuaged fears the group was losing market share to TikTok. 

PayPal advanced by 4% after the close. Its quarterly earnings came in slightly above expectations and management unveiled a simplification drive aimed at boosting profitability. 

JAPANESE EQUITIES

The NIKKEI 225 and TOPIX fell 4.23% and 3.49% for the period, still weighed down by 1) the Fed’s hawkish stance, 2) energy and food inflation, 3) Shanghai’s lockdown and 4) the Ukraine situation. There were also mounting concerns that Beijing might go into lockdown as new Covid cases returned to June 2020 levels. 

All sectors ended the week lower. Land Transportation, Electric Power & Gas and Communication outperformed, only down 0.19%, 0.52% and 0.71%, as investors moved into oversold domestic demand stocks. But Mining and Non Ferrous Metals declined by 9.97% and 9.84% on profit taking as commodity prices fell. Other Financing fell by 6.32% due to Japan Exchange Group tumbling 12.65% after saying higher operating expenses would lead to a JPY 45bn loss in FY 2023.

Shionogi rose 4.75% after revising up net profit guidance for this year by 14% and raising its dividend payout. Asahi Group Holdings gained 4.63% after the company said it would be increasing alcohol beverage prices from October, or earlier than market expectations. Kirin Holdings, another large alcohol beverage maker, rose 4.09% on expectations they would also raise prices. On the other hand, Sumitomo Metal Mining plunged 14.08% on news its nickel smelter construction in Indonesia which was expected to contribute to its business growth had been cancelled. Shimano was down by 13.27% as first-quarter operating profits missed market expectations despite the weaker yen.

The yen plummeted to a two-decade low against the US dollar before stabilising around 128 after US interest rates stopped rising.

The BoJ carried out unlimited buying operations of 10 year JGBs at a fixed yield of 0.25% over four business days up to Tuesday. It bought just over 2 trillion yen ($16bn). The bank has been trying to keep the 10-year-JGB yield within a range of plus or minus 0.25%. As the yield stayed close to the bank's upper limit on Tuesday, buying continued up to Thursday.

EMERGING MARKETS

The MSCI EM Index was down 2.02% in USD this week as of Thursday’s close. China (-0.65% in USD) outperformed on support measures rolled out by the PBoC and talk of stimulus. India (+0.10%) was mostly driven by results, while Brazil saw some profit taking as the market declined by 6.66%. 

In China, President Xi made comments on infrastructure spending, spurring hopes for a stimulus package to boost growth. The PBoC lowered bank FX ratios from 9% to 8% to counter renminbi weakness. Banks were also allowed to ease financing for 12 distressed developers, including Evergrande, Sunac China and Shimao. The PBoC sought looser requirements on a range of financing, from lending for property acquisitions to extending debt maturities. According to the National Bureau of Statistics, profits at Chinese industrial companies grew by 8.5% in the first quarter from a year ago to RMB 1.96 trillion, vs. 5% growth for January and February. Their revenues reached RMB 31.27 trillion, +12.7% on the year. Beijing started mass Covid-19 testing and lockdowns in certain districts. Hong Kong announced it would allow arrivals of non-residents from May 1st.On the geopolitical front, China's UnionPay cut operations with Russian banks. US Treasury Secretary Janet Yellen suggested the US was open to scaling back widespread Trump-era tariffs on merchandise imports from China to help give Americans relief from the fastest inflation in four decades. On the corporate side, CATL booked lower profit than expected for FY21. Results at Longi Green were in line, with topline sales up 17% YoY and net profit up 6.5%. First-quarter revenues at Kweichow Moutai rose 18.3% YoY, while net profits increased 23.6%, or 4% above its preliminary results. Goertek posted upbeat results and gave strong guidance driven by increased shipments of VR headsets. 

Taiwan’s first-quarter GDP advance estimate slowed to 3.1% YoY from 4.9% in the previous quarter, but it was still above consensus estimates (+2.8%). Mediatek’s first-quarter results and second-quarter guidance beat expectations. The company also left its 2022 guidance unchanged despite lowering its global smartphone shipment estimates.
In Korea, LG Chem released strong results with higher-than-expected battery OPM and resilient OPM in petrochemicals thanks to a better product mix.

In India, ICICI Bank’s results came in above expectations. Hindustan Unilever’s fourth-quarter FY 2022 results also beat expectations thanks to its strong execution capabilities and market leadership and despite inflationary pressure and a weak demand environment. Management expects further margin pressure but is more positive on the demand outlook. Varun Beverages released stellar results with almost 20% volume growth and strong operating leverage which more than offset gross margin pressure.
In Brazil, IPCA-15 inflation came in better than expected. Weg posted better-than-expected first quarter results, driven by increasing domestic demand for renewable energy generation sources and upbeat industrial demand, mainly in agricultural machinery.

In Mexico, Alsea saw impressive 49% sales growth (SSS rose 18%) although the figures were in line.

CORPORATE DEBT

CREDIT

The period got off to a very negative start as the sanitary situation in China worsened and the Russo-Ukrainian conflict got bogged down. Shanghai has been in lockdown for more than a month and now Beijing could go the same way. As a result, investors are fretting about China's growth slowing and the knock-on effect on global growth. Between Monday and Thursday, risk premiums in high yield cash bonds widened by 44bp and by 30bp for the Xover. In investment grade, they eased by 13bp on cash bonds and 6bp on the Main index. And yet there was less pressure on yields than in previous weeks. Yields on the 10-year German Bund fell 9bp and by 7bp for US 10-year Treasuries. Between Monday and Thursday, this led to high yield corporate debt falling 1.19% while investment grade shed 0.24%.

In new issuance, Miller Homes was due to end 11 weeks of inactivity on the high yield market. On Monday, the company said it was to launch a dual euro-sterling issues to raise the equivalent of £815m. The proceeds are to go on funding its acquisition of Apollo, Bridgepoint’s asset management affiliate. 

In company news, the headline event was the release of KPMG’s audit on Germany’s Adler Real Estate. This followed fraud accusations made by Viceroy Research in the autumn of 2021. The audit revealed compliance and governance failures at Adler, prompting an accelerated sell-off in the group's shares and bonds. 

There was also a profit warning from Faurecia. In spite of like-for-like growth of 1.1% in the first quarter, management is worried about mounting pressure on margins as commodity prices continue to rise. In contrast, US drink can manufacturer Ardagh Metal Packaging benefited from strong demand for its products. Sales rose by an annualised 21% over the quarter and it returned to the black with net profits of $57m.

The primary market for subordinated debt stayed shut but results generally continued to be positive with incipient signs of an upturn in margins. More junior segments lost ground as €CoCo spreads widened by 56bp. $CoCo spreads widened by 70bp.

CONVERTIBLES

The new issues market remained closed due to the troubled macroeconomic situation. Investors focused on earnings reports instead. Results from convertible issuers were particularly upbeat. 

First-quarter sales at STMicroelectronics rose 17.6% to $3.55bn. Net profits were up sharply to $747m, or much better than expected. Despite the impact of the Russo-Ukraine conflict, sales at Worldline (payment services) were up 11.6% on a like-for-like basis (excluding its payment terminals business which is to be sold to Apollo in the current quarter). Safran (aerospace systems) saw robust growth in the first quarter and the strong recovery in air traffic helped its maintenance division rebound.

But the main news of the week was Twitter's acceptance of Elon Musk’s $44bn bid. Twitter had a mixed first quarter with sales of $1.2bn, or less than expected despite signing up more users. It is possible that the bid by the founder of Paypal and Tesla might provide a solution to Twitter’s troubled economic model which is based on ad revenues. Elon Musk wants to introduce several subscription services to diversify revenue streams.

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
29/04/2022
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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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