Free money is over

• The ECB is no longer ruling out a rate hike this year
• European inflation hits a new high
• The earnings season is triggering severe, asymmetrical adjustments

Trading was dominated by central bank news and particularly the ECB’s drastic shift in tone. The ECB chair Christine Lagarde refused to rule out a rate increase in 2022 due to inflation looking less and less “transient”.

Eurozone inflation hit a new peak of 5.1%, or above expectations, even if core inflation started to ebb to 2.3%. Energy prices have soared 28.6%, putting households in difficulty and increasing pressure on the ECB to act. Yields on Germany's 10-year Bund gained 20bp over the period and are now firmly in positive territory. And although Sergio Mattarella was re-elected Italian president at the start of the week, the prospects of ECB tightening caused spreads between Germany and Italy to widen sharply. The tone was even more marked at the Bank of England where benchmark rates were raised by 25bp. Four committee members even argued for a 50bp hike. The BoE also said it wanted to accelerate balance sheet shrinking to counter galloping inflation which it now sees peaking at 7.25% in April.

But caution remained the watchword in Australia and Japan. Central banks there played for time and said they would wait before thinking about raising rates. Meanwhile, Brazil's central bank hiked by another 150bp, taking its benchmark rate to 10.75%. At these levels, some emerging country debt is looking attractive again. The zone, for once, is ahead in its monetary tightening cycle.

Elsewhere, the earnings season triggered brutal adjustments and particularly among tech stocks. Meta slumped by more than 20% on flat results while Amazon jumped 15% after almost doubling earnings.

Prospects for a remake of the Cold War over Ukraine abated amid diplomatic dithering and pressure from Beijing not to disrupt the winter Olympics. Given today's reduced liquidity but sustained economic growth, we remain neutral on equities. We are still underweight government and investment grade debt and remain cautious on duration.

EUROPEAN EQUITIES

Persistently strong inflation pushed bond yields sharply higher. Eurozone inflation came in higher than expected, reflecting widely different approaches by countries to efforts to rein in rising energy prices. ECB chair Christine Lagarde triggered a strong market reaction on Thursday by refusing to stick with her previous comment that benchmark rates would not rise this year. With the results season in full swing in the US and Europe, upbeat figures initially drove a rebound in equity market indices. Most European companies managed to beat expectations, an indication that they had managed to pass on higher input prices. 

Results prompted sector switches. In spite of rising bond yields, telecoms outperformed. Deutsche Telekom moved higher thanks to its US subsidiary T-Mobile. Shell increased its dividend and boosted share buybacks. The oil group naturally benefited from the surge in crude oil and gas prices. Management is particularly confident about the outlook for 2022. 

But there were a few disappointments. After several profit warnings, Siemens Gamesa (wind turbines) confirmed its downbeat guidance for this year, citing rising costs and supply chain disruption. Kone said it also saw persistent obstacles in 2022, notably higher input costs -freight prices have risen five to six fold since the pandemic started- and problems in China’s property market. A profit warning from Casino for its 2021 results triggered particularly heavy selling. The group said tourism was struggling to recover and people had not returned to eating out as much as expected. Its upmarket status has also proved to be a handicap as shoppers move to cheaper outlets due to the economic slowdown and higher prices.

US EQUITIES

Markets fluctuated in line with earnings, the latest economic data and central bank comments. Esther George, head of the Kansas City Fed, said the Fed’s objective was not to jeopardise the economic rebound. But James Bullard, one of the most aggressive hawks, thought betting on five rate hikes in 2022 was a reasonable punt. Macroeconomic data was mostly in line. January’s manufacturing PMI came in at 55.5, or just above the 55 expected, and manufacturing ISM was 57.6  (57.5). Oil prices continued to rise. WTI hit $90.3 on news that several terminals in  Germany, the Netherlands and Belgium had been hit by cyber-attacks.

It is still too early to draw conclusions from the earnings season but some companies, and particularly, internet stocks, saw massive market reactions. Facebook/Meta cratered 26.4%, wiping out $251bn in market cap, the biggest cap drop ever in one trading day. The plunge was set off by an earnings miss and the first-ever decline in the number of active users. Mark Zuckerberg said Meta was suffering from competition with China’s TikTok and had been hit by Apple's new confidentiality rules. Spotify also plummeted 23% on disappointing guidance on user growth. In sharp contrast, Snap rocketed 54% in afterhours trading on Thursday after reporting its first profit since the company listed.

In other moves after the bell on Thursday:

• Pinterest jumped 32% after shooting past expectations.
• Alphabet gained 9% on better-than-expected results and a 33% YoY rise in ad revenues. The group also announced a 20-for-1 stock split.
• Amazon jumped 19% on an earnings beat and its plans to increase it Prime subscription fee by a hefty $20 to $139 a year. The service offers rapid deliveries and some video access. In a further indication of video game consolidation, Sony paid $3.6bn for Bungie, the American company which designed games like Halo.
• Boeing gained 5% on Thursday after Qatar passed a $20bn order to buy 34 777 aircraft, 8 of which will be used for freight and committed to buy 25 737 MAX planes for $7bn. This followed a visit by Qatar’s emir to the White House.
• PayPal slumped 17% as payment volumes only increased 23% YoY, the lowest rate in 2 years. The company refused to give any guidance. The discovery of 4.5 million illegitimate/inactive accounts has undermined growth assumptions.
• AT&T fell 4.2% after announcing that WarnerMedia would be spun off to merge it with Discovery to create one of the biggest media groups. The deal entails a reduction in the AT&T dividend from $2.08 to $1.11.
• Ford slipped 3% on disappointing results due to ongoing chip supply problems.

JAPANESE EQUITIES

The NIKKEI 225 and TOPIX rose 1.96% and 2.29% over the period, starting the week with a sharp rebound and then moving higher for four consecutive days before profit taking set in. 

Cyclical sectors such as Marine Transportation, Precision Instrument and Air Transportation gained 8.65%, 6.31% and 5.38%, respectively. In contrast, Textiles & Apparel, Machinery and Insurance dropped 2.19%, 0.84% and 0.17%.

Shionogi, a leading pharma play with a blockbuster anti-infection drug, soared 25.48% after disclosing that its Covid antiviral pill had proved effective in a study. Z Holdings, the holding company of Yahoo! Japan, jumped 9.54% as investors bought on the dip. Chubu Electric Power declined 9% after the company revised down its third quarter results due to procurement costs. Toray Industries shed 7.96% on news of an inappropriate process in certification tests for certain resin products.

New Covid-19 cases in Japan moved above 100,000 and continued to surge. The government said it would be securing deliveries of Molnupiravir, an antiviral pill, earlier than initially planned and revealed that the treatment had already been administered to 25,000 patients.

EMERGING MARKET
The MSCI EM Index was up 1.61% as of Thursday’s close. Most Asian markets were closed for the Lunar New Year holidays. The MSCI China rose 2.12%. India rebounded by 2.98%, driven by strength across sectors as investors cheered the budget. Brazil extended gains, rising 2.26% thanks to strong foreign inflows.

In China, the year of the Tiger started on a positive note with the HK index opening 3% higher. Official manufacturing PMI declined to 50.1 in January from December's 50.3, or slightly better than the 50 level expected. The Caixin manufacturing PMI fell to 49.1, or short of the 50 expected, hitting its lowest level since February 2020. The Beijing Winter Olympics kicked off on January 4 within a “closed loop” system. Hong Kong and some other large cities in mainland China are expecting a significant increase in Covid cases after the Chinese New Year Golden Week. JD’s founder followed the footsteps of Meituan and TikTok by donating $2.3bn USD in shares to a charity foundation. Volkswagen said it would be able to build 1 million EVs a year in China, starting in 2023.

India unveiled its federal budget for the coming fiscal year, emphasizing capex-led growth as the government targets a 6.5% fiscal deficit. Infrastructure, digital economy and new energy sectors are the main focus. Google has announced plans to invest up to $1bn in a partnership with India’s second-largest mobile network operator Bharti Airtel and take a 1.3% stake. Amber Enterprises reported strong results driven by the components segment, and a sequential recovery in margins as the company was able to pass on most of the commodity price inflation to customers.

Brazil’s manufacturing PMI dropped to 47.5 from 49.8 in December due to increasing cases of the Omicron variant and inflation pressure. The central bank increased the interest rate by 150bp for the third consecutive time, taking overall rate increases to 875bp since March 2021. The policy rate is now at 10.75%. The bank also revised inflation expectations upwards for 2022 to 5.4% (from 4.7%) due to a higher tariffs rate. The primary budget was released with a surplus of 0.7% of GDP in 2021. Both the government’s gross and net debt levels fell as of December 2021. The telecom regulator Anatel approved the sale of Oi SA's mobile operations to local rivals TIM SA, Telefônica Brazil's Vivo and Claro, a subsidiary of Mexico's America Móvil.

In Mexico, January PMI declined to 51, but was still above the 47.5 pre-pandemic level. The government is preparing a new stimulus package.

Peru’s prime minister and its investor-friendly finance minister quit as the President reshuffled his cabinet amid a political crisis.

CORPORATE DEBT

CREDIT

An unexpectedly hawkish shift by ECB chair Christine Lagarde wiped out the initial upbeat mood that had followed robust company earnings and a more accommodating tone from some FOMC members. The ECB’s worries over inflation sent yields on Germany’s 10-year Bund 19bp higher. The yield on 10-year US Treasuries rose by a more modest 6bp. Credit spreads continued to widen with the Xover up 15bp over the period and the Main 3bp higher. The mix of wider spreads and higher rates hit investment grade credit which ended the period 1.13% lower. High yield debt shed a more modest 0.52% thanks to its structurally shorter duration.

The primary market was open despite market volatility and earnings results. In high yield, Italian pharma group Fabbrica Italiana Sintetici (FIS) raised €350m with a sustainability linked bond at 5.625% due August 2027. 

In company news, Britain's junior oiler EnQuest reported $395m in free cash flow for 2021 and cut borrowings to $1.22bn. The company’s production is facing structural decline as its largest field is in the North Sea but surging oil prices helped it improve profitability.

French grocer Casino, however, disappointed markets by reducing 2021 EBITDA guidance for its French business. Management was previously expecting bigger margins but now sees a 1.7% contraction to around €1.28bn (vs. €1.3bn in 2020). Italy’s Saipem (oil services) also triggered heavy selling after cutting EBITDA guidance for 2021 by a billion euros due to operating cost overruns and poor control over large-scale contracts. The 2021 accounts are expected to report losses representing more than a third of the company's shareholders’ equity.

Banks, however, continued to post upbeat figures thanks to wealth management and investment banking. Two trends stand out: higher dividend payouts and almost systematic share buybacks.

Elsewhere, Austria’s Raiffeisen Bank International reassured markets on its financial situation and said its Russian and Ukrainian affiliates were doing well despite Moscow’s potential annexation of the disputed Donbass region.

CONVERTIBLES

With markets trending higher at the beginning of the week, new issuance was concentrated in the US with $1bn over the week. The biggest deal was from Wolfspeed (semiconductors) which raised $750m at 0.25% due 2028. Xometry Inc raised $250m at 1%. The group operates an on-demand industrial parts marketplace. Last December, it acquired its rival Thomasnet.com for $300m.

The earnings season trend has so far been upbeat, especially among tech stocks even if expectations were relatively high. No less than 93% of US tech companies managed to beat expectations. Tinder’s holding group Match Group also posted robust growth but its guidance for the current quarter was considered too cautious. Snap Inc swept past top line expectations with fourth quarter sales up 42%. Its guidance for the first quarter was also better than expected. The company actually reported its first ever quarterly profit, making $22.5m. In Europe, Elis (multi services) saw sales up 17.4% to €833m in the fourth quarter thanks to its Commerce and Services division returning to pre-Covid levels. However, commodity inflation pushed margins to the bottom end of expectations.
Ford continued to reinforce its electric vehicle drive with plans to invest an additional $20bn in the segment by 2030. The group had already committed $30bn to help convert its factories and increase R&D in electric vehicles.

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

04/02/2022
This document is issued by the Edmond de Rothschild Group. It is not legally binding and is intended solely for information purposes.
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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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