The minutes affected the week

Markets had a knee-jerk reaction when the FOMC minutes were released last Wednesday.

• Risk aversion rose sharply
• As for production lines, the situation has become complicated
• We keep a close eye on any talk about the Fed shrinking its balance sheet

Markets had a knee-jerk reaction when the FOMC minutes were released last Wednesday. Yields on 10-year Treasuries broke above 1.7% for the first time since April 2021. Risk aversion rose sharply, sending equity markets lower, and especially high-PE stocks like US tech.

The Fed meant to prepare investors for monetary normalisation while leaving enough wriggle room, a sharp contrast with 2018 when fears of making a policy blunder were particularly strong. Even if Omicron cases delay a return to normal labour market conditions, it was essential for the Fed to reduce support. The US economy is doing well, inflation is rising and the jobless rate is trending towards full employment.

As for production lines, the situation has become complicated. A key zone like Shenzhen in China is a good example. Even so, the economy is holding up against head winds. The Caixin PMI for December reflected China’s economic resilience despite the new Omicron wave, persistent supply side constraints and property sector woes. Like manufacturing PMI, services PMI also picked up speed in December. This was thanks to a rebound in new orders and lower inflation according to the price component. Companies say the pandemic and shipping difficulties continued to affect exports. Labour shortages also entailed longer delivery times. Employment fell for the fifth month running so Beijing could be focusing on this in coming weeks. The government unveiled its educational support plan aimed at rural zones and the children of migrants.

In Europe, inflation is set to stay high at the beginning of this year after energy prices pushed it up to 5% in December. Tensions with Russia are deteriorating both on the Ukrainian border and because of unrest in Kazakhstan. Europe is now the first to be concerned by gas prices. The Omicron wave will delay a return to normal for economies and supply chains and so inflation will remain high. The ECB will gradually reduce monetary support this year so European government bond yields will gradually rise. 

In Germany, retail sales rose 0.6% in November after 0.5% in October. They are now on line to rise by 0.9% in 2021, a new record. And yet physical stores (textile, clothing and shoes, etc.) saw sales fall over the year. 

With volatility returning centre stage, we should stay the course while keeping a close eye on any talk about the Fed shrinking its balance sheet. We remain neutral on equity markets. Bond yields are now moving higher, justifying our caution over duration and our decision to be underweight government bonds and investment grade debt.

EUROPEAN EQUITIES

Indices ended the period slightly higher on cyclical sector strength. Over recent days, investors have become more confident on the recovery and now increasingly think the Omicron strain will only have a muted impact on the economy. Banks and insurance group were the best performers due to a rise in European government bond yields.

Commodities and oil also rose sharply as their prices increased. German inflation once again accelerated to 5.3% over a year, underpinning the idea that inflationary pressures will remain strong in coming months. Germany's finance minister promised the government would help people deal with higher energy prices. 

In company news, home-furnishings giant Ikea raised prices by 9% on average due to inflation. Elsewhere in the distribution sector, merger talks between Auchan and Carrefour resumed. In aerospace, Airbus could overshoot its 2021 target of 600 planes according to Reuters. The company made no comment. Worldline finalised the acquisition of 80% of Axepta Italia as agreed in July 2021, a move that could give fresh momentum to the stock. Preliminary fourth-quarter results at STMicroelectronics beat the company’s end-of-October guidance, a strong indication of sector momentum. Sanofi continued investing in immunotherapy and artificial intelligence. After several partnerships in recent years, the group announced a new agreement with Exscientia, a company it has been working with since 2016. The deal focuses on developing an AI-based drug pipeline.  

US EQUITIES

As we start 2022, here’s a brief recap of 2021. The S&P gained 27% and even 29% if we include dividend payments. Volatility was 13%. Above all, the strongest drawdown was only 5%, a 25-year low. And the S&P outperformed the Nasdaq by 120bp.

The best performing sectors were energy (+55%), property (+46%) and financials (+35%). Utilities (+18%), consumer staples (+19%) and industrials (+21%) were the worst laggards.

Strength in energy stocks carried into 2022. WTI oil rose 2% to hit a seven-week high of $79.5 as Kazakhstan reduced production and Canada and northern US states suffered supply problems after temperatures sank to 50°C below zero.

The release of the FOMC minutes then hit sentiment. They indicated that the Fed could be more aggressive than expected over rate hikes. The Fed justified its position by referring to a very stretched labour market, a view subsequently backed up by private sector job creation for December which blew past estimates (807,000 job creations vs.410,000 estimated). Some Fed committee members even argued for the Fed to reduce its balance sheet after the first rate hike, an additional way of tightening that markets had not factored in. Back in 2017, the Fed had waited two years after its first rake hike in 2015 before starting to shrink its balance sheet.

Fed fund futures reacted and are now 80% expecting a first rate hike in March.
In a sign of risk aversion, Bitcoin revisited its December low of $42,000 during the flash crash and the VIX volatility index jumped 16.7% to 19.73.

In company news, Apple was the first company to break (briefly) through the $3 trillion mark in market cap. Tesla surged 13.5% after reporting record deliveries for the last quarter of 2021.

Royal Caribbean (-3.3%) and Norwegian Cruise (-1.5%) came under pressure after several ports of call were cancelled due to mounting Covid cases across the globe.   

JAPANESE EQUITIES

After starting the year higher on the back of buoyant US markets, the NIKKEI 225 and TOPIX lost 1.45% and 0.10% for the period, dragged down by the Omicron variant spread and accelerating tapering in the US. The Mothers Index, which has heavy IT and growth stock weightings, tumbled 11.61%.

On the plus side, Insurance, Transportation Equipment and Marine Transportation gained 7.01%, 6.41% and 6.50%, respectively. Services, Precision Instruments and Air Transportation declined by 5.82%, 5.81% and 3.20%. Markets worried about possible economic restrictions due to the virus.

Nissan Motor jumped 10.34% on the weaker yen as interest rates rose abroad. Dai-ichi Life Holdings also gained 9.96% for the same reason. Mitsubishi Heavy Industries rose 8.07% on a broker upgrade and news of a project to build a next-generation fast nuclear reactor. Sysmex plunged 16.61% on concerns about competition in the Alzheimer diagnostics drug market. M3 slumped 12.19% as growth stocks sold off.

To prevent the spread of the Omicron variant, the Okinawa, Yamaguchi, and Hiroshima prefectures are to implement priority prevention measures from January 9. These are the first restrictions since the Kishida administration took office. Currently the government is using hospital bed occupancy rates as an emergency indicator. 

EMERGING MARKET

The MSCI Emerging Market index closed the first week of 2022 0.26% lower as of Thursday’s close. China retreated by 2.8% on concerns of further growth deceleration due to regional lockdowns before the Chinese New Year. Tencent’s sale of its Sea Ltd stake added pressure on the internet sector. India was up 0.46% regardless of mounting concerns over a new Covid wave as investors waited for the earnings season to start next week. Brazil fell as much as 2.24%, despite higher commodity prices.

China services and construction activity improved in December according to the Caixin China PMI Services survey. December manufacturing data rose to 50.9, or its highest level since June. China will also extend some personal income tax cuts until 2023. Premier Li Keqiang called for more tax and fee cuts for small/micro firms and individual businesses. The market regulator fined Alibaba, Tencent and Bilibili $78,000 each for violating anti-monopoly laws, and specifically not declaring previous M&A deals. The finance ministry said government subsidies for NEV would be cut by 30% in 2022. 

Hong Kong reimposed a series of pandemic control measures after Omicron cases were detected. Tencent decided to sell 2.6% of its Sea stake, reducing it to 18.7% and also converted triple voting right shares to common stocks ahead of potential further divestments. Shenzhou put some of its Ningbo production site on lockdown after a few Covid cases were confirmed. Property developer Shimao defaulted on a loan after missing a RMB 645m payment. Some high-quality developers were informed by banks that M&A loans would not be counted under “three red line” metrics.

In Korea, Samsung Electronics' preliminary fourth-quarter earnings missed market estimates mainly due to a one-off special bonus and lower memory shipments amid price adjustments.

India is seeing a surge of Covid-19 cases due to Omicron and fresh restrictions have been introduced by local governments. Hospitalisation and fatality rates, however, remain low. Manufacturing and Services PMI moderated in December to 55.5 after November’s strong print. The auto industry saw weak December wholesale growth, as both PVs and 2Ws sales declined 8% YoY. HDFC Bank’s third-quarter pre-results showed strong loan growth momentum for the second consecutive quarter (+16.4% YoY after +15.4% in the second quarter of FY 2022). Hindustan Unilever, on the other hand, flagged a slowdown in its rural sales in its pre-quarterly update.

Indonesia announced a ban on coal exports in January to avoid outages at its own generators.

Brazil’s December PMI came in at 49.8, unchanged from November and below the expansionary 50 threshold. Iron ore prices continued rising. Fenabrave (car sector association) forecast a 5% increase in sales in 2022. This is better than 2021 (+3%), but still 21% below 2019 levels. Despite the rising employment rate, real salaries continued to go down.

CORPORATE DEBT

CREDIT

After being more or less closed for three weeks, the new issues market returned to mark the new year. Crédit Agricole, BNP Paribas and UBS all raised more than $1bn with AT1 issues. But the big development was a surge in bond yields, both in the US and Europe. Yields on 5 and 10-year Treasuries gained 21bp over 4 days. Europe followed suit, albeit to a lesser extent. Germany’s 5 and 10-year Bunds saw their yields increase by 4bp and 13bp. Investment grade bonds with stable spreads around 96bp quite logically suffered, ending the week 0.26% lower. And the longest-dated maturities finished 0.5% down.
The consolidation theme remained in vogue. Société Générale bought Leaseplan, a move that will make its ALD affiliate one of the world's top vehicle leasing companies.

In high yield, cash premiums have tightened by 5bp since the beginning of 2021 and are now running at 279bp on average. The market, which is shorter duration, remained in positive territory, returning 0.15% thanks to higher yields. B-rated bonds led gainers. But the more technical Xover reflected higher volatility and widened by 8bp to revisit 250bp on its 100 day moving average.

CONVERTIBLES

It was a very busy week on the convertible market, with the FOMC and bond markets dominating action as growth names and equities moved to risk-off mode.

Big moves on the convertible market did not start in 2022 but picked up speed. Investors rotated out of growth names, especially in the software and biotech sectors, and financials and energy outperformed.  

The new issues market opened up the year with two new deals. In Europe, JP Morgan raised €375m with an exchangeable bond into Sanofi. The issue was upsized by €25m. The bonds offer diversified exposure to the pharmaceutical sector through a respected underlying stock. In Asia, China Meidong Auto Holdings, an auto dealership that has had an impressive run over the last few years, raised HKD 2.54bn with a convertible and HKD 22.5m with an equity placing. 

M&A made headlines in our market this week with rumours on KPN and Carrefour. Both stocks were already potential takeover targets. In the US, Stryker (medical devices) is to buy Vocera Communications, for around $3.1bn in enterprise value. This is an interesting move: Stryker is acquiring a technology and software provider with solutions that fit with their product portfolio as it incorporates more communication capabilities in its medical solutions.

In other news, STM’s preliminary fourth quarter results beat expectations. The company ended the fourth quarter with net revenues above the outlook range and gross margins at or slightly above the high end of guidance. This was primarily due to better-than-expected trading in a persistently dynamic market.

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

07/01/2022
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