Moving towards a new equilibrium

• The Chinese market seems to be stabilising
• Strong outperformance from cyclical, discounted stocks
• We remain neutral on equities for the time being but are looking to increase holdings

US inflation smashed a new record, rising to 7% over 12 months in December and justifying the Fed’s decision to move towards more restrictive policies. But even though the data showed inflation shifting gradually from goods to services, the US dollar slipped and bond yields retreated. Clearly, markets had already factored in the Fed’s decision to start the move back to rate normalisation.

In Europe, ECB members appeared to disagree on the inflation outlook. Isabel Schnabel said she was worried about energy prices staying high because of the transition to cleaner solutions but the bank’s chief economist, Philip Lane, said he expected inflation to fall back significantly from the end of 2022.  

In Covid news, the Omicron variant is turning out to be highly contagious but much less dangerous than other strains. Existing pandemic policies are likely to be overturned: the US, the UK and Spain are considering reclassifying the virus as endemic and something we will all have to learn to live with. Most countries with a zero-Covid strategy recognise that they will have to adapt but China is still sticking with its approach.

Sanitary constraints and regulations are still hitting China’s economy but the market seems to be stabilising. Loan growth remains tepid but local governments are offering stimulus. We await confirmation of a loan recovery before raising exposure to China.
The week also saw further sector rotation with strong outperformance from cyclical, discounted stocks compared to growth plays. Equity market resilience and reduced forex volatility are two reasons for gradually increasing equity market exposure. We will have better visibility from company results over the next few weeks.

Amid reduced liquidity but sustained economic growth, we remain neutral on equities for the time being but are looking to increase holdings.

We are still underweight government bonds as well as investment grade credit and remain cautious on duration.

EUROPEAN EQUITIES

Indices ended the period slightly in the red amid wide sector dispersion. Equity markets are now less comfortable with monetary tightening as any over-aggressive moves could undermine growth. This is especially true for high-PE sectors like technology which are highly interest-rate sensitive. Meanwhile, the ECB said that it would continue to reduce monetary support to counter inflationary pressures in the coming months but would not rush into action. In these circumstances, European government bond yields should gradually rise. The situation is good for financials and cyclicals, both of which continued to outperform. Commodities and energy have benefited from higher prices. As for consumer spending, surveys suggest Omicron has hit sentiment despite relatively modest restrictions. Footfall in UK stores fell 6% over a week, essentially due to more people working from home. 

In company news, Airbus said it was closely monitoring the sanitary situation in China as its A320 production site in the port city of Tianjin could be affected. In telecoms, Finland’s Nokia said it had beaten its operating margin target and expected supply side problems to improve this year. In healthcare, Phillips issued a profits warnings due to component shortages and transport difficulties. European leader Just Eat Takeaway said fourth-quarter deliveries had risen 14%. The company is in one of the sectors to have benefited from pandemic-induced structural changes. Renault said it had hit its cost-cutting targets in 2021, or 2 years early, with a 30% drop in its breakeven point. Its CEO also said component shortages should ease over 2021.

US EQUITIES

Ahead of the fourth quarter earnings season, US markets were supported by macroeconomic data and Jerome Powell’s comments.

December’s US jobs report showed the Fed was right to turn more hawkish. Wages rose by 4.7% over 12 months or more than the 4.2% expected. Moreover, November’s increase was revised up to 5.1% from 4.8% initially.

In his confirmation hearing before the Senate, Jerome Powell reassured investors by saying the Fed would move pragmatically and not focus on inflation at the expense of the economic recovery. However, St Louis Fed chairman James Bullard said he now expects 4 rate hikes this year. And Loretta Mester (Cleveland Fed) and Raphael Bostic (Atlanta Fed) declared they were in favour of a first hike as early as March. Ahead of her Senate testimony, Fed vice-chair Lael Brainard said the Fed’s main mission was now to get inflation back to around 2%. 

The Beige Book showed the US economy growing modestly in December but business expectations had worsened due to the spread of the Omicron stain. It also noted big increases in consumer prices but added that the pace had eased slightly towards the end of the year.

Markets were also relieved to see that the consumer price index rose 7% YoY as expected.

Elsewhere, oil pushed even higher with WTI up 1.8% to $82.6. This followed news that weekly inventories had fallen by 4.6 million barrels to a 2018 low, or much more than the 1.9 million drop expected.

Factset said fourth-quarter S&P 500 earnings were seen rising 21.7% over 12 months. If so, that would mark the fourth quarter running of earnings growth above 20%. Jefferies, BlackRock and JP Morgan were due to kick off the earnings season on Friday, January 14.

In Covid news, the Wall Street Journal said more than 5 million Americans could be isolated in their homes due to the rapid spread of Omicron.

In company news, Citigroup announced the sale of its retail banking business in Mexico, its largest branch network in the world. Boeing advanced 3.1% after unveiling a sharp rebound in orders last year to 535 planes, or more than its rival Airbus (507 orders). Zynga (mobile phone video games) soared 40.6% on Thursday after being acquired by Take Two Interactive for $12.7bn. Take Two Interactive slumped 13.1% on the news. Moderna jumped 9.3% after revising its 2022 sales forecast higher thanks to new contracts for its Covid-19 vaccine.

JAPANESE EQUITIES

The NIKKEI 225 was unchanged and the TOPIX edged 0.43% higher over the period. Sentiment was weighed down by the Fed’s decision to accelerate tightening and the spread of the Omicron variant but there was some support from solid US jobs statistics and buy-on-dip movements.

Mining, Iron & Steel and Nonferrous Metals gained 9.88%, 7.89% and 6.63%, respectively. Commodities were also in vogue. However, Precision Instruments, Retail Trade and Electric Appliances shed 3.93%, 2.68% and 1.67% due to the Covid-19 resurgence.

Sumitomo Metal Mining jumped 11.39% due to interest in the Nonferrous Metal sector. Nippon Steel surged 10.51% thanks to its status as a typical cyclical value stock. Mitsubishi Heavy Industries also gained 10.13% supported by upbeat news from the previous week on the construction of a next-generation fast nuclear reactor. In retail, Aeon dropped 8.33% on deteriorating earnings in its September to November quarter. Weakness continued at Sysmex, down 7.59% on concerns over fierce competition in the Alzheimer diagnostics market.

The Bank of Japan’s December producer price index was up 8.5% over 12 months. Japanese companies were bearing the cost of higher input prices themselves but have now started to pass them on to end users. Earnings are expected to recover as a result. 
In Covid news, Tokyo’s hospital bed occupancy rate was 15.1% as of January 13. Preventive measures are likely to be introduced if it hits 20%.

EMERGING MARKET

All major MSCI emerging markets closed in green as of Thursday’s close. The MSCI EM Index was up 3.05%. China rebounded by 3.43% as heavily shorted stocks, led by internet plays, jumped. India was up 3.17%. Brazil and Taiwan also traded higher, up 5.47% and 2.68% in USD respectively.

China's CPI grew 1.5% YoY in December (vs. 2.3% previously). PPI was 10.3% higher YoY, (12.9%). Both indicators came in lower than expected. In December, M2 and TSF growth picked up, while loan growth decelerated slightly. Exports rose by 20.9% YoY in USD, beating market expectations of 18.2% while imports grew 19.5%, slightly missing the 22% rise expected. China is stepping up infrastructure projects to boost its economy with the RMB 3 trillion launch of infrastructure projects in the first two weeks of 2022, vs. RMB 1.2 trillion in the same period in 2021. Hangzhou city shortened the property mortgage lending cycle, and second-hand property transactions are warming up. Shimao defaulted on a trust loan and proposed delaying full payment on 2 ABS until December. The company is reportedly considering property sales to help resolve its debt crisis. DiDi is in talks with HKEX to launch its IPO in the second quarter. Tigermed‘s preliminary results for 2021 beat estimates mainly on investment gains. CITIC Securities issued a positive profit alert for FY2; lower provisioning is likely to be behind the big earnings beat. Tsingtao Brewery said recurring preliminary net profits for 2021 rose 21%, or in line with expectations.

Taiwan's exports rose 23.4% YoY, marking the 18 consecutive month of year-on-year growth. TSMC reported a beat and raised its quarterly forecast, adding that revenue growth and margins would be well above market expectations this year. Its capex plan may surpass $100bn in 3 years.

In Korea, the institutional tranche for LG Energy Solution’s IPO was oversubscribed more than 1,500 times according to local media reports.

In India, December CPI inflation numbers rose to 5.59 but were well within the RBI’s manageable limits. December’s debit bounce rate for banks was the lowest since the start of the pandemic, a sign of a revival in individual income levels. Equity mutual funds saw record inflows in December with more than double than the previous month. Infosys 3QFY22 beat estimates on top line growth, with margin pressure seeming to abate. The company hiked its revenue guidance for the third time this fiscal year. TCS reported Q3FY22 revenue significantly above estimates but margins fell short due to heavy subcontracting. Third quarter revenues and margins at DMART were in line. 

Santander Chile reported better-than-expected results, driven by higher loan growth, a better mix, NIM expansion and higher fee revenues.

In Mexico, Citigroup is to exit retail banking by selling its subsidiary or through an IPO. Banorte and Santander Mexico are potential buyers.

CORPORATE DEBT

CREDIT

Fixed income markets were relatively resilient in spite of the Fed’s more hawkish turn and inflation at a 40-year high. Yields on 10 and 30-year US Treasuries only gained 1bp between Monday and Thursday. European yields had been rising since mid-December but fell back slightly. Yields on the 5 and 10-year Bund retreated by 2-3 and 4-5bp respectively. Spreads were also resilient with the Xover widening by 2bp and the Main by 1bp. As a result, euro-denominated high yield credit fell by 0.05% between Monday and Thursday while investment grade returned 0.03%. Credit premiums on subordinated financial debt remained more or less stable so performance was flat over the period. The one notable exception was in the hybrid corporate segment where premiums widened by10bp.  

In a busy new issues market, Tereos (sugar) raised €350m at 4.75% with a 2027 maturity. The proceeds will go on buying in its existing 2023 maturities. United Group, a telecoms player in South East Europe, raised €500m over 8 years at a fixed rate and €480m over 7 years at a floating rate. The proceeds will go on funding its acquisition of Greece’s Wind Hellas. United hopes to create Greece’s second largest operator by merging Wind Hellas and Nova which it bought in 2020.  Mexico’s Alsea (restaurants) raised €300m at 5% to refinance its debt and extend its maturity profile. Alsea runs Burger King, Starbucks, Domino’s Pizza and Cheesecake Factory in Europe and the US.
In investment grade, low cost airline Wizz Air took advantage of market conditions to raise €500m at 1% due 2026. The proceeds will be used to reimburse £300m in emergency Covid financing. 

Following the AT1 reopening in the previous week, new T2 issues from Unicaja and Banco BPM were easily placed. Note that Germany’s regulator Bafin will be raising capital requirements for the country’s banks from February 2023. In banking sector M&A, the FITD, Italy’s deposit guarantee fund, gave BPER exclusivity in its talks with Carige. US banks will kick off the earnings season from January 14. 

In company news, there were more and more rumours that Volkswagen would bid for McLaren with a view to enabling Audi to take part in the Formula 1 world championships by 2026. The acquisition could also include McLaren’s truck division, a segment which has been battered by the Covid pandemic. To offset losses in 2020 and 2021, McLaren raised €680m in the summer of 2021 and sold its historic headquarters in Woking. The McLaren Technology Centre now rents the premises.

France’s Atos issued a profit warning after a big contract with a UK financial firm was revised and margins fell from 6% to 4%. The company now expects negative FCF of €420m for 2021.  

CONVERTIBLES

For a change, the new issues market got off to a strong start to the new year ahead of the first earnings reports in the US. Space flight company Virgin Galactic issued its first convertible, raising $425m due 2027. The company made history last year when its founder Richard Branson made his inaugural flight but the news for investors has been rather negative since. The share has lost close to 75% in the last six months due to technical problems and delays. The company now only expects to start regular tourist flights before the end of this year at the earliest. There was also a €375m Barclays bond issue due January 2025 which is exchangeable into Daimler shares.

On the M&A rumour mill in the US, Dish Network is reportedly in talks with DirecTV. A merger involving their virtual MVPDs, Sling TV and DirecTV Stream, would create a pay-tv network with 20 million subscribers, the largest in the US. Note that their market share and financial difficulties no longer represent a risk for competition, as was the case 20 years ago when the regulator prevented a tie-up.

Elsewhere, Take Two (video games) paid $12.7bn for Zynga. The deal will reinforce Take Two’s mobile and tablet video games presence as it will come with popular games like Farmville, Zynga Poker, Empires & Puzzles and Words With Friends.

EDF issued a profits warning for 2022 after the French government announced measures to limit electricity price increases to protect consumers. The group estimates that its EBITDA could be slashed by €7.7-8.4bn.

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

14/01/2022
This document is issued by the Edmond de Rothschild Group. It is not legally binding and is intended solely for information purposes.
This document may not be communicated to persons located in jurisdictions in which it would be considered as a recommendation, an offer of products or services or a solicitation, and in which case its communication could be in breach of applicable laws and regulations. This document has not been reviewed or approved by a regulator of any jurisdiction.
The figures, comments, opinions and/or analyses contained herein reflect the sentiment of the Edmond de Rothschild Group with respect to market trends based on its expertise, economic analyses and the information in its possession at the date on which this document was drawn up and may change at any time without notice. They may no longer be accurate or relevant at the time of reading, owing notably to the publication date of the document or to changes on the market.
This document is intended solely to provide general and introductory information to the readers, and notably should not be used as a basis for any decision to buy, sell or hold an investment. Under no circumstances may the Edmond de Rothschild Group be held liable for any decision to invest, divest or hold an investment taken on the basis of these comments and analyses. 
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.
Past performance and volatility are not a reliable indicator of future performance and volatility and may vary over time, and may be independently affected by exchange rate fluctuations.
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