Markets fed up with the Fed and inflation

• Investors wondered whether the Fed would raise rates by 25bp or 50bp if it acts, as expected in March
• Amid strong geographical and style performance deviation, growth and mid cap stocks were hit by rising rates and downbeat guidance from Netflix on future subscriber numbers
• After significantly underperforming in 2021, Chinese assets began to rebound

Equity market volatility persisted as investors wondered whether the Fed would raise rates by 25bp or 50bp if it acts, as expected in March. Some ECB members are more worried inflation will stay high and recent oil price rises have not reassured them. Christine Lagarde is confident inflation will ebb this year and is ready to act to adjust monetary policy to help this happen. Meanwhile, bond yields rose, with Germany’s 10-year Bund briefly moving into positive territory. However, mounting tensions due to the Russia-Ukraine stand-off triggered a risk aversion movement which helped yields fall back.

Equity markets started the week lower on fears rising rates would result in an economic slowdown. Sentiment tried to rebound but faltered as US-Russia talks became complicated. Amid strong geographical and style performance deviation, growth and mid cap stocks were hit by rising rates and downbeat guidance from Netflix on future subscriber numbers. Europe proved the most resilient as its indices have big weightings in more cyclical and cheaper stocks. 

China bucked the overall trend this week by making gains. GDP for the fourth quarter showed growth was a little higher than expected thanks essentially to exports. But the short-term outlook is less rosy due to falling consumer spending. The PBoC reacted by cutting rates and declaring that it wanted to stop growth slowing further. After significantly underperforming in 2021, Chinese assets began to rebound over the week. 

Geopolitical risks and stretched technical levels across all markets over the week have led us to stay neutral overall on equities. But we have raised exposure to Chinese equities. We have also softened our negative view on government bonds as they now look like a safe haven after steep rises in yields in recent weeks. However, we are more cautious on high yield bonds, especially in the US.

EUROPEAN EQUITIES

Indices ended the period in negative territory as last week’s worries over inflation and rising bond yields continued. Inflation in the UK hit a 30-year high in December. The mood was compounded by investor caution as the first full-year results started to come in and tensions worsened between Russia and the West. Moscow declared that it made no sense to resume talks with the US and the European Union as the two camps were still so wide apart. 

In the circumstances, short-term gas prices are unlikely to retreat for good. Commodities and energy were the biggest winners from the tensions even if the share prices of oil producers started to run out of steam after several weeks of outperformance. In contrast, tech stocks, previously the stars of the lockdown period, continued to struggle as higher interest rates began to look inevitable. 

In company news, Renault said sales had once again fallen in 2021 due to semiconductor shortages. Management expects the situation to improve in the second half of this year. A few days later, Holland's ASML said chip supply would still be problematic in 2022. The group expects sales to rise 20% this year but said growth would be constrained by supply failing to meet increasing demand. In financials, BBVA said it wanted to return more than €7bn to shareholders in its 2021-22 financial year through share buybacks and dividend payouts. This is a token of the group’s confidence in the coming years. In retail clothing, earnings continued to beat expectations at Puma and Hugo Boss which reported upbeat figures for the fourth quarter. However, AB Foods, Primark’s parent company, said footfall in its shops in December had been hit by the spread of the Omicron variant.

US EQUITIES

Indices suffered a sharp correction over the last 5 trading days up to Thursday with the Dow 4.34% lower and the S&P 500 down 5.15%. The Nasdaq tumbled 6.81%. The mood turned jittery ahead of the FOMC on January 25-26 and disappointing macroeconomic figures also weighed. New jobless claims hit a 3-month high and the Empire State survey fell sharply. Mounting political tensions with Russia only made matters worse. The Nasdaq broke below its 200-day moving average for the first time since the beginning of the Covid crisis. It is now 10.5% below its November 19 high and so officially in correction territory.

To mark his first year in office, Joe Biden held a press conference to discuss various issues. He said he approved the Fed’s move to tighten monetary policy to counter inflation. He also recognised that his stimulus plan would struggle to get Congressional approval in its current form due to splits in his own majority and that it would have to be broken down into several parts to succeed.

After a strong move up, oil took a breather and fell back to $84 after a surprising rise in US inventories. The statement from the White House that strategic reserves would be deployed more rapidly than expected also weighed on sentiment.

In earnings news, there were mixed reports from banks as costs rose significantly at JP Morgan and Goldman Sachs. Bank of America, however, managed to control costs to an astonishing extent and the bank’s loan growth is expected to accelerate. The market's reaction to these results was to buy the cheapest banks. Citigroup was unchanged but others tumbled by 6-7%.

Microsoft unveiled a friendly $68.7bn bid on videogame giant Activision Blizzard at a 25% premium. Microsoft CEO, Satya Nadella, justified the move by declaring that video games would play a pivotal role in developing the metaverse, tomorrow’s big theme. If the bid gets regulatory approval, it will be Microsoft's biggest acquisition. 

Netflix slumped 20% after the bell on Thursday after it said subscriber growth in the next quarter could be only 2.5 million instead of the 6.26 million expected. The plunge wiped out $45bn in its market cap. Amazon (-2.9%) announced the upcoming launch of a bricks-and-mortar clothes store. Shoppers will be able to receive buy suggestions based on algorithms.

JAPANESE EQUITIES

The NIKKEI 225 and TOPIX declined 2.51% and 3.34% over the period. The Bank of Japan stuck to easing and kept long-term rates around zero but rising US long-term bond yields depressed sentiment. The mood also deteriorated due to mounting Covid cases, higher oil prices and geopolitical tensions, notably over Ukraine. 

Mining bucked the trend by edging 0.94% higher but all other sectors ended in negative territory. Marine Transportation, Iron & Steel and Metal Products tumbled 12.25%, 9.50% and 5.77%, respectively.

Among individual stocks, Fast Retailing soared 14.37% after strong first quarter earnings. Asahi Group Holdings gained 2.76% thanks to a broker upgrade. Fujitsu rose 1.21% as investors bought on the dip. In contrast, Nippon Steel plunged 10.85% on a broker downgrade as trading declined in China and steel prices fell in South East Asia. Shimano dropped 9.12%. Z Holding fell 8.92% due to concerns over its demanding valuation.

As for the Covid situation, priority prevention measures were implemented in 13 prefectures including Tokyo. The Ministry of Health, Labour and Welfare approved the use of the Pfizer vaccine for children aged 5 to 11. Vaccinations will start in March and target 7 million children.

EMERGING MARKET

The MSCI EM Index ended flat as of Thursday’s close. China rebounded by 2.05%, closing at a two-month high after the most significant rate cut since April 2020. Brazil jumped 4.27% in USD on commodity price rises while India retreated by 2.88% due to downbeat global market trends and sustained foreign fund outflows.

China’s fourth quarter GDP came in at 4% (vs. 3.3% estimated), led by resilient exports and improved infrastructure capex, but house building and consumption softened. Industrial production was up 4.3% YoY, or higher than market expectations of 3.7%. Retail sales rose 1.7% YoY, or sharply below expectations, and down from 3.9% in November. Beyond being vocal on liquidity easing, the PBoC cut 1-year and 5-year LPR (benchmark lending rates) by 10bp and 5bp. This came after a 10bp cut on the 7-day reverse repo and 1-year MLF earlier this week. The PBoC also pledged to expand its monetary policy toolkit, push for faster credit growth, and front-load policy easing to turn market expectations around. Banks in some major Chinese cities, including Beijing and Shanghai, have accelerated approvals of mortgage loans; the waiting time has now been reduced to 1 month from 6-9 months. CTG Duty Free’s preliminary net profit for 2021 rose 54-66% YoY, implying a 46-69% drop in fourth quarter results, or below market consensus. China Merchant Bank released strong 2021 preview results, driven by strong non-interest income, and improving asset quality. Fourth-quarter Ping An Bank results showed net profits decelerating, probably because of higher credit costs, although asset quality improved further. Alibaba’s grocery chain Freshippo is considering raising funds at a valuation of $10bn. CATL unveiled its battery swap brand EVOGO.

Taiwan’s export orders rose 12.1% YoY in December, or higher than market expectations of 7.3%. Apple has reportedly agreed to pay higher prices on TSMC's 4nm process. Mediatek unveiled the world’s first Wi-Fi 7 chip, which is expected to launch in 2023. The company also said it would be raising its R&D budget by 10%-20% and hiring more than 2,000 engineers this year.

In India, Maruti Suzuki announced a 2nd round of price hikes within 6 months to offset higher input costs. Quarterly results at HDFC Bank were in line as improving asset quality offset lower fee income growth. Hindustan Unilever’s third quarter was broadly in-line with estimates with underlying volumes up 2%. Asian Paints delivered strong growth on a high base, with commodity price inflation partly offset by a 15% price hike, leading to a sequential recovery in the EBITDA margin.

Thailand announced the resumption of quarantine-free entry for international travellers from February 1st.

Indonesia is to relocate its capital city to remote Borneo and name its new capital Nusantara. The move will boost infrastructure construction.

In Mexico, November cement volumes fell 3% MoM. Demand is expected to slow down after two years of strong gains. Grupo Financiero Banorte reported better-than-expected results and upbeat guidance as NIM increased 10bp QoQ at the group and 20bp at the bank level; asset quality continued to improve, leading to lower provisions.

In Chile, the local press reported that president-elect Gabriel Boric would appoint current central bank chairman Mario Marcel as finance minister.

CORPORATE DEBT

CREDIT

Markets were choppy due to inflationary pressures. Brent crude, for example, moved above $89, a level not seen since 2014. Concerns over more expensive commodities came with fears that wage increases would follow suit after Goldman Sachs said its payroll had risen 33%. This environment pushed bond yields higher during the first part of the week -Germany’s 10-year Bund yield even moved into positive territory for one day- but they fell back on the Thursday. Credit spreads widened between Monday and Thursday with the Main up1bp and the Xover 4bp high. This left the investment grade credit index down 0.12% over the week and the high yield index 0.29% lower.

There were a number of big deals over the week. Autostrade raised €1bn with two tranches, 6 and 10 years and Italy’s WeBuild €400m at 3.875% with a sustainability linked bond (SLB) due July 2026.  

In company news, Italy’s Atlantia is to pay €950m for Yunex Traffic, a Siemens mobility equipment subsidiary. Atlantia’s sale of Autostrade should boost its cash holdings by around €8.2bn by end March. Some of the proceeds will go on driving growth in the Benetton-owned company in new sectors.

In results, fourth-quarter sales at Netflix were in line but management dismayed investors by only banking on 2.5 million new subscribers in this quarter or much less than the 6.3 million pencilled in by analysts. 

The new issues market in financial debt was relatively busy. BPER raised €600m with a Tier 2 bond at 3.875% and French insurance group CNP €500Mn at 1.25% with a Tier 3 issue. US bank results have so far disappointed markets due to rising costs but Spain’s Bankinter reported €82.5m in net earnings for the fourth quarter, or much higher than expected.

CONVERTIBLES

New issuance continued despite highly volatile markets. Glanbia Co-operative raised €250m at 1.875% with a bond exchangeable into Glanbia PLC shares. The proceeds will go on buying in Glanbia PLC’s stake in Glanbia Ireland.

A week after Take Two bought Zynga, the videogames sector was again in the headlines with Microsoft buying Activision Blizzard for $68.7bn. The deal will reinforce Microsoft’s product portfolio and rank the group as a major player in the metaverse theme. The deal is subject to approval from the European Commission that it does not create a dominant position. The news sent the entire sector higher, and Ubisoft in particular. The French company would be a logical target for a similar deal.  

As the earnings season got under way, American Airlines continued to reduce its losses and now even expects to return to the black in March this year. The group has emerged stronger from the crisis with cash at a record $15.8bn. It has also consolidated its position as leader in the US with 165 million passengers transported in 2021.

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
21/01/2022
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