Omicron and inflation fuel investor concerns

• The emergence of a new Covid variant destabilises markets
• The risk is that this development will boost inflation as global trade is once again disrupted
• The ECB is all on its own as far as monetary policy is concerned

All it needed to destabilise markets was the emergence of a new Covid variant. European indices tanked, down 6% from their all-time highs, and the V2X volatility index soared 50% over the week. 

Apart from its name, Omicron, not much is known about this variant. We will have to wait another week to get more meaningful statistics. The CEOs of Moderna and Pfizer made contradictory statements on how effective their vaccines might be against Omicron, but preliminary observations suggests that it is less aggressive albeit more contagious. 

Europe, which is struggling with a powerful new Delta wave, is particularly worried about the new variant and several countries have brought back social distancing measures. Covid strategies vary across the globe: China is still going for ‘zero Covid’ while Austria has reintroduced a lockdown. Germany has restricted travel but the US says it wants to avoid stopping people moving around. 

The risk is that this development will boost inflation as global trade is once again disrupted. That is why Jerome Powell’s latest comments not only confirmed that he wanted to speed up bond tapering but indicated a change of tune on inflation. “Transitory inflation” has been replaced by “persistent inflationary pressures”.

Meanwhile, inflation in Europe has risen further to 4.9%, and even 6% in Germany, leaving the ECB all on its own as far as monetary policy is concerned. A change of direction is possible. But at least the bank can capitalise on the fact that oil prices have fallen 20% over a month and the decision by OPEC + countries to increase output.
On bond markets, this more hawkish development has led to some yield flattening with long bond yields down 20 basis point more than short rates.

We are sticking with our neutral stance on equities even if growth is still robust. But we are ready to increase exposure if risk indicators improve.

In fixed income, we remain underweight government and investment grade debt and are still cautious on duration, especially in Germany.

EUROPEAN EQUITIES

The new Omicron variant has dictated market trends for the past week. Indices have been rising and falling in line with the latest uncertainties and discoveries. No fundamental trend can emerge until we have convincing results from tests into the variants’s real impact. 

At the same time, inflation in eurozone countries was higher than expected. Unlike the US, the ECB is still betting on inflation turning out to be merely temporary but the most recent data could cast a shadow over the ECB’s stance. The next deadline is the ECB meeting on December 16. Sectors most exposed to the consequences of the resurgence in Covid cases were naturally the most volatile and were still trading below November 26 levels, the day news on the variant broke.

Meanwhile, the autos sector continued to suffer from semiconductor shortages. Faurecia and Volva Car once again cut their end-of-year forecasts. Car rental app Toosla made its IPO on Euronext Growth official. It hopes to raise more than €5m to drive growth and new projects. France’s DroneVolt signed a contract to supply 275 Hercules 20 SPRAY drones over 3 years. The deal could generate sales of up to €5m. In the renewables sector, Ediliziacrobatica (wind farm maintenance) saw orders soars 80% in November to €8.3m. In healthcare, Biomérieux raised guidance for its Molecular Diagnostics division after the resurgence in Covid cases and the arrival of the Omicron variant. AB Science started phase 2 trials for its COVID-19 treatment. Qiagen said its tests were efficient in detecting Omicron, and Valneva is to work with Germany’s IDT BIOLOGIKA in producing its COVID-19 vaccine. On a more original note, Kering said visitors to its site had jumped after the House of Gucci film was released, a possible indication of the impact of cinema on brand attractiveness.

US EQUITIES

US indices suffered sharp falls over the 5 trading sessions up to Thursday with the Dow down 3.25%, the S&P off 2.65% and the Nasdaq 2.93% lower. The sell-off was triggered by the emergence in South Africa of a new Covid variant, Omicron, which the WHO described as preoccupying.

BioNTech and Pfizer said that it would take up to two weeks of tests to see if the new strain was resistant to vaccines. It will then take them 6 weeks to adjust the vaccine with the first batches ready within 100 days. But less reassuring comments from Moderna's CEO worried markets.

The Thanksgiving weekend was not as successful as expected. Black Friday online sales came in at the bottom end of expectations at $8.9bn, or slightly lower than in 2020.
Addressing the Senate, Jerome Powell said inflation could no longer be termed transitory and speeding up tapering would be on the agenda when the FOMC next meets on December 14-15.

The Fed’s Beige Book confirmed that the economy was growing at a modest to moderate pace up to mid-November and that prices were rising overall due to supply chain problems and labour shortages.

Private sector job creations amounted to 534,000 and manufacturing ISM came in at 61.1. Both figures were in line with expectations.

The US competition watchdog started legal proceeding to stop Nvidia acquiring ARM Ltd. It fears the resulting entity would harm innovation in the semiconductor sector by undermining Nvidia’s rivals.

In other news, Twitter lost 2.7% after its founder Jack Dorsey was replaced as CEO by Parag Agrawal, its current technology expert.

Hewlett Packard Enterprise, HP's server/network division, plunged 10% after the bell when the group said results in the current quarter would miss expectations. Shortages of electronic components had left the company unable to meet demand. 

Apple told its suppliers that iPhone 13 demand was not as strong as expected. The news sent shares of suppliers lower.

JAPANESE EQUITIES

The NIKKEI 225 and TOPIX plunged 5.92% and 5.40% over the week as the Omicron variant spread and Jerome Powell mentioned the possibility of speeding up bond tapering.

Only Marine Transportation managed to advance (+ 7.76%). All other sectors declined. Air Transportation sank 11.16% as the government asked airlines to suspend new reservations for flights to Japan for a month. Land Transportation and Communication tumbled 8.03% and 7.41%. The worry is that Omicron fears will weigh on activity. 

Ono Pharmaceutical rose 3.81% on a stock buyback and broader use of its cancer drug, Opdivo. Shimano gained 2.40% on interest in the leisure sector. Nissan Motor dived 15.14% on concerns over its supply chain. Mitsubishi Chemical Holdings sank 13.30% after its new business forecast fell short of investor expectations.

The government withdrew its ban on inbound flight bookings after 3 days. Merck applied for approval of its COVID drug. The Japanese government ordered $1.2bn billion worth of pills, enough for 1.6 million people.

EMERGING MARKET

The MSCI Emerging Market index was flat for the week as of Thursday’s close. India and Brazil rose 1.96% and 1.92% respectively. China underperformed (-1.21%).
China’s official manufacturing PMI in November rose to 50.1 vs. 49.6 expected. Industrial profits rebounded for a second month (+24.6%) in October, driven by mining and commodity plays. China is expected to adopt a more proactive economic policy next year to meet the challenges from an uneven recovery of the global economy and instability in pandemic control and prevention. The PBoC will pursue prudent monetary policy and maintain ample liquidity to support employment. Liquidity will be ensured through the issuance of special local bonds. 

In third quarter results, Meituan’s revenues and operating profits were in line. Management delivered a soft outlook due to COVID restrictions and weaker macro. PinDuoDuo’s topline missed expectations due to growth decelerating in the loss-making business while net profits beat consensus. The company changed its sales and marketing strategy to spend more on R&D instead. Li Auto’s results beat expectations, with net losses declining significantly on the back of decent volume growth. All three top EV makers, Li Auto, XPeng, and Nio’s made record deliveries in November as chip supplies improved. Weibo, the top social media platform, launched a secondary listing in Hong Kong. Other data-sensitive companies like Netease Music and SenseTime also received approvals for a Hong Kong IPO.  DiDi said it was going to delist from the US with a filing for a Hong Kong listing planned by March.

Korea’s manufacturing PMI came in at 57.6 in November, a 10-month high. Exports rose 32.1% YoY to a record high in November, beating the 27.2% expected. Nidec is reportedly buying 70% of Hanon Systems. 

India's third-quarter GDP grew 8.4%, or more than expected as COVID disruptions eased. Manufacturing PMI hit a 10-month high in November at 57.6. November GST collections rose 25% YoY, their second highest level since 2017. The government is planning a Rs760bn ($10.2bn) incentive package over 6 years to entice companies into producing semiconductors in India. Reliance followed Bharti and Vodafone Idea in raising mobile tariffs by up to 20%. Maruti Suzuki’s production is expected to return to 80-85% in December, vs 40% in September and 60% in October, thanks to easing chip shortages.

Turkey’s central bank dipped into its dwindling foreign exchange reserves for the first time in seven years to shore up the lira.

Brazil’s third-quarter GDP disappointed (-0.4%), meaning Brazil is in technical recession. Markets are now expecting a 150bp hike at the next central bank meeting on December 8. The Senate approved the Precatorios bill and raised monthly Auxilio Brasil aid payments to R$400. Anima sold 25% of its medical business at an attractive valuation.

CORPORATE DEBT

CREDIT

Market agitation continued as fears mounted over global economic prospects following the emergence of the new Omicron Covid variant and its possible resistance to existing vaccines. Bond yields moved lower with yields on 10-year US Treasuries down 5bp to 1.44%. Yields on the equivalent German Bund shed 4bp. But credit spreads showed some resilience with the Main only widening by 1bp and the Xover by 2bp. This left high yield credit 0.25% better over the period while investment grade gained 0.41% thanks to its structurally longer duration.

Auto equipment supplier Adler Pelzer reported a 4% rise in sales over a year to €340m. However, EBITDA shrank by 16% to €27m while net leverage rose from €447m at end 2020 to €525m.

Troubled Adler Real Estate had a very disappointing third quarter. As part of its deleveraging programme, it sold its stake of around 7% in Brack Capital Properties N.V. for €75m to a LEG IMMOBILIEN subsidiary. It also undertook to tender its remaining BCP share to LEG in any IPO providing that the price per share was not below €157. This would bring in €765m for Adler RE. 

Balta agreed to sell its polypropylene division (rugs and residential flooring) as well as its non-woven carpeting business to Victoria PLC for €225m. The deal should complete in the second quarter of 2022. The proceeds will go on paying off a good deal of Balta’s debt even though management has not said exactly how much.
 
In financial debt, Austria’s Uniqa (insurance) raised the equivalent of €375m to buy in its 2023/2026 maturity.

CONVERTIBLES

New issuance continued apace despite market tension over rising Covid cases. Taiwan Cement, which supplies to the building sector, raised $800m due December 2026 to invest in its foreign subsidiaries, notably NHAO (formerly Engie EPS) which it bought over the summer. Some of the proceeds could also be used to buy commodities in foreign currency, a move that could reduce interest payments and reduce exposure to forex volatility. Japan’s Koei Tecmo raised $405m with a December 2024 maturity. Koei Tecmo results from the merger of video game companies Koei and Tecmo (Dead or Alive, Ninja Gaiden and Project Zero). In the US, Array Technologies (solar tracker technology) raised $375m at 1% with a 2028 maturity.

Two US tech companies reported third quarter results. Okta had another excellent quarter with revenues jumping 40% over a year to $304.7m. Losses were contained to 7 cents a share, or much less than the 24 cents expected. 

Splunk also saw strong like-for-like growth. Sales rose 19% over a year to $665m but the big news was the company's statement that it was targeting $2bn in cloud sales next year. The company is now looking for a new CEO after Doug Merritt stepped down in November.

For the second time, Jack Dorsey stood down as CEO of Twitter, the social media giant he founded 15 years ago. He will now focus on developing his fintech Square under its new name Block. The name change suggests the company will now be concentrating more on blockchain technology and cryptocurrencies.

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
03/12/2021
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