On the markets
US jobless data for May provided confirmation of the slowdown suggested by recent indicators. The unemployment rate, which is the most visible indication but not ….
Edmond de Rothschild Group (Market Outlook: 19/05/2011)
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necessarily the most significant, edged up from 9% to 9.1% but the really disappointing news came from job creations (83,000). Other statistics like working hours, income and overtime were more or less stable.
Recent performance might explain why the job creations figure was the lowest since June 2010 as this follows three good months. Companies are perhaps entitled to wait and see before hiring further.
Elsewhere, US industry was hit by supply problems in areas like autos and electronics where Japan is an important player. The jobs situation was also impacted by poor weather in May due to tornadoes and flooding.
European PMI data fell slightly in May. The euro zone composite index slipped to 55.8 compared to 57.8 in April and the February high of 58.2. Germany is still playing a decisive role in Europe’s economy and industrial orders there rose 2.8% in April but it is interesting to note that retail sales for the euro zone as a whole improved (+ 0.9% in April) after several disappointing months.
European markets lost ground. Investors are focusing on worries over US growth despite reassurances from central banks that current difficulties are only temporary. At the same time, Germany’s position on any Greek debt restructuring has revived worries and highlighted the divergence with the ECB which reiterated its opposition to the proposal. After surging 12% in March, Germany’s industrial production fell 0.6% in April m/m, the first dip since December.
Germany also validated the main measures in its energy bill which should go through before the summer. As far as the nuclear sector is concerned, the radical option has won out. Seven reactors which are currently idle will be closed down for good, all agreements to extend a unit’s life will be cancelled and the nuclear tax will be maintained at 15/MWh i.e. EUR 1.3bn in 2011-2016 (down from EUR 2.3bn as seven reactors will have been closed). The news was better in the UK: Scottish Power has announced that gas prices to private individuals will rise by 19% and electricity by 10% from August 1st. In financials, the Spanish government is to levy a tax on lending institutions (banks/cajas) which charge interest rates significantly above those of the market. ING has received bids from GE and Capital One Financial Corp for its on-line affiliate ING Direct USA. The price tag could be around USD 9bn.
There were few results: Ahold’s margins disappointed especially in the Netherlands while Home Retail Group’s sales and gross margin were sharply lower than expected. In contrast, although Rémy Cointreau operating profits were merely in line, net gearing fell 34% to take Net debt/Ebitda to 2.19, which was much better than expected. Swiss chemicals group Clariant has significantly raised guidance and now expects an Ebitda margin of 13.5% to 14.5% in 2011 instead of 12.7% and above 17% by 2015. Alstom has won a EUR 500m contract to build a gas-fired electric power station in Israel. It is also working with its Russian partner, Transmashholding, on developing a new regional electric train for the Russian market. The first prototype is expected to be unveiled at the end of 2012.
In M&A news, Schneider has paid USD 650m to acquire Leader & Harvest Power Technologies, a leading China-based manufacturer of medium voltage drives. The price represents an EV/EBITDA multiple of 22.5. Aegis has confirmed that it is in preliminary talks with IPSOS to buy its market research affiliate Synovate for GBP 500m.
Markets consolidated and the S&P500 slid 1.8%. Investors were unmoved by Fed Chairman Ben Bernanke’s speech on the state of the US economy. He argued for accommodating monetary policy given the desperately slow pace of the economic recovery and promised to maintain the Fed’s benchmark rate close to zero as long as inflation remained unthreatening. The Fed’s much-awaited Beige Book said that the economy was overall continuing to grow but that a small number of regions had noticed a certain slowing.
On the macroeconomic front, consumer credit unexpectedly rose in April by USD 6.25bn after 4.82bn in March. This was primarily due to student and car purchase loans. The trade deficit contracted sharply in April to USD 43.7bn vs USD 46.8bn in March due to higher exports helped by the weak dollar and lower imports.
In company news, Ford Motor revised up guidance and said it expects 50% growth in global sales to around 8 million vehicles by 2015 thanks to a recovery on the US market and rising demand in India and China. However, Texas Instruments, the second largest US maker of semiconductors, revised down forecasts for Q2 results due to less business from troubled Nokia.
All sectors declined in the last five trading sessions. Technology led the field by losing 3.2% while telecoms fell 2.8%.
Industrials, financials and the consumer discretionary sector also lost more than 2%. Banks were hit by fears that capital adequacy ratios might be made more stringent and by the Senate’s rejection of a bill to postpone the reform on credit card charges by six months. This reform is expected to eat into banks’ revenues.
In contrast, healthcare and energy proved resilient by only falling 0.3% and 0.5% respectively. The energy sector was cheered up when ExxonMobil announced new deep-water discoveries off the Mexican coast, the group’s first discoveries in a long time.
Japan was generally stable this week. Unhedged euro-denominated funds benefited as the yen gained 1.1% against the EUR. Companies continue to make efforts to restructure. The prime example this week was the giant Olympus group under its new chairman Michael Woodford. The group has 70% of the global endoscope market and could be an interesting turnaround company to follow over coming quarters.
Volumes on Asian markets are still anaemic and this means huge price swings. China’s upcoming macroeconomic data for May should help reassure investors that the domestic Chinese economy is doing well. Record sales in May for flagship companies like China Overseas Land showed that natural demand for property in China is still strong. In these circumstances, a property crisis is probably not in the offing. That said, large residential projects that the central government is intending to launch are running late due to bad weather and delays over providing the funding, so competition in the property sector will heat up from Q2. But that will not douse strong demand in the mid and up-market segments. China’s property sector has posted abysmal performance. Valuations are now close to the lows seen in the 2008 crisis even though the environment in China is not as bad.
South Korea’s central bank took investors by surprise Friday morning by raising its benchmark rate by 25bp. The market was expecting no change. The move reflects the dilemma confronting quite a few countries where inflation remains high and growth is slowing down. The Bank of Korea had postponed the hike several times and the market had eventually stopped believing it would happen. It is however, good news for the Korean banking sector which for several years has been unable to raise lending rates. The move should have little impact on loan volumes as Korean rates are still low and the benchmark rate is now 3.25%.
Shipbuilder Hyundai Heavy has upset the markets by showing in interest in buying a stake in Hynix that is currently held by creditor banks. Hynix is a leading manufacturer of RAM memory chips and was part of the Hyundai conglomerate which was broken up in the 1990s into several different international companies. The Chung family, which used to own all these assets, is manoeuvring to force Hyundai Heavy, which is financially solid, to buy a company that has strictly no synergies with its main business. Obviously, minority shareholders reacted badly to the news and both stocks fell sharply last week.
We would not be surprised to see the deal eventually going ahead. A few months ago, the Chung family forced auto maker Hyundai Motors to buy a stake in Hyundai E&C (construction) although there were no synergies to warrant the acquisition. Clearly, the Chung family is attempting to rebuild its former empire. This sort of affair never ends well so we are maintaining our cautious stance towards all the companies in the group.
Indonesia’s annualised inflation continued to decelerate for the 4th month in a row to 5.98%. This leaves real interest rates at 78bp and explains why the central bank left its rates unchanged. The won has risen 5% against the USD year to date which is one reason why inflation has started to calm down. The environment is therefore still positive for domestic consumption. Due to its investments in the auto industry (Astra International) the Jardine group is one of the companies which stands to gain from this structural trend. Moreover, the won’s appreciation against the USD is also a plus as the USD is the group’s accounting currency.
OTHER EMERGING MARKETS
In India, as expected, industrial production continued to grow at a slower pace, rising 6.3% in April vs the restated advance of 8.8% in March. This is good news for inflation which is the principal drag on the equity market. The social unrest that erupted at the beginning of the month at the largest auto maker Maruti seems to be spreading to the rest of the sector.
This will cause production problems. A circular letter has advised the government to open up the mass distribution sector to foreigners by allowing them to invest a maximum of 51% in a joint venture.
Over the next 6 m onths, investors will be torn between the positive news of a soft landing for India’s economy and the less exciting prospect of weak earnings growth. This is why we recommend investors should start to return very gradually to the Indian market as it will be the first to benefit from lower commodity prices.
In Brazil, the market fell 1.58% in USD due to worse-than-expected US figures and political volatility in the local market following Antonio Palocci’s resignation as head of Staff. Macroeconomics stole the limelight: Brazil’s central bank raised its benchmark rate by 25bp to 12.25%; May IPCA inflation fell to 0.47% from 0.77% in April, in line with market forecasts. On a yoy basis, IPCA inflation rose marginally to 6.55% from 6.51% in April. Therefore, for a second month in a row, it stayed above the ceiling of the targeted band (6.50%); the national association of vehicle manufacturers (ANFAVEA) reported that auto production rebounded strongly in May, which suggests a pickup in industrial activity in May, after a strong, seasonally adjusted 2.1% mom contraction in April. In other news, ONS reported that in May total electricity generation declined by a seasonally adjusted 0.12% (mom) from 0.6% in April. All in all, most economic indicators so far, with the exception of May car production and sales and growth in bank loans, suggest that the economy is gradually slowing down. This is positive news as it should bring down inflation. We remain cautiously optimistic as most of the market adjustment is already behind us.
The oil price jumped 3% when OPEC disappointed expectations by failing to agree on increased production quotas. Saudi Arabia, Kuwait, Qatar and the UAE were all in favour of increasing OPEC production by 1.5 million b/d but Libya, Angola, Ecuador, Algeria, Iran and Venezuela opposed the move on the grounds that the price might collapse. The decision to leave quotas unchanged is bad news but the open dissension within the cartel is worse as it will do nothing to sooth oil markets and the global economy. Even so, Saudi Arabia decided to increase production by 500,000 b/d if needed. This is good news but bear in mind that the country produces heavy crude whereas refineries prefer the sort of light crude that Libya produces. US demand continues to slide and lost 3.9% compared to the same period last year. But unless more supply comes on stream, only weakening demand could put a brake on prices let alone get them to fall.
Base metals gained 2% this week amid fears that Ollanta Hulama might win Peru’s presidential elections. Hulama has always promised to tax mining companies more heavily and numerous projects could be postponed or even shelved.
Reminder: investment in Peruvian mining projects up to 2017 is expected to amount to USD 41bn. Peru is the 3rd largest producer of copper in the world (1.3m tonnes a year) and the second largest zinc producer (1.7m tonnes). In unlisted metals, iron ore prices for Q3 2011 have been confirmed at USD 170/t (no change) and Australia’s Iluka has just raised its zircon prices by 35%. Lastly, maize prices keep on rising. The latest statistics from the US Agriculture department show global stocks are expected to meet a mere 12.8% of demand compared to an average of 16.6% over the 5 last years. The situation is also tight in wheat, soya beans but it is by no means as serious. It is about time people started to query the use of maize-based biofuels in the US and the rest of the world.
The week was dominated by resurging risk aversion which dragged emerging equity markets lower. Convertible bond prices held up well but we have even so started to see selling appear. Chinese equities are under suspicion due to the Sino-Forest affair. The company was in recent years a real success story that raised money through its Canadian listing.
The investment fund Muddy Waters has filed a complaint against the company for fraudulent accounting. The fund claims Sino-Forest’s assets have been artificially inflated. The recent market correction seems to us to have gone too far on certain stocks and we are starting levels where it would make sense to reinforce positions. We took part in a new issue this week. OSIM is a Singapore company which makes massage chairs.
Equity markets are still suffering from weaker economic indicators. Between June 2 and 9, the major indices performed as follows in local currency:
– Standard&Poor’s 500 -1.8%
– Euro Stoxx 50 -0.2%
– TOPIX -1.5%
– MSCI Emerging markets -1.8% (in EUR)
Yields on bond markets fell back to levels seen at the beginning of the year with 10-year government bonds in both the US and Germany yielding close to 3%. As Greece’s debt crisis worsened, yields on Irish debt rose to 10.6%, while in Portugal they hit a new high of 9.88% and ended at 5.4% in Spain.
The dollar lost ground across the board. It moved back above 1.46 to the EUR before rallying to 1.44 and quoted 80 against the yen. The Chinese renminbi hit an all –time high during the week of 6.47 to the USD.
In the circumstances, we are sticking with an overall neutral rating and continuing to make tactical trades as opportunities arise. We recently moved to a tactical + on euro zone equities and raised exposure to the zone. Because of the absolute and relative decline of European equities compared to other markets, we feel it is time to gradually return to the zone. In the emerging zone, we are maintaining a + score and focusing on Asia and particularly China which is well ahead in its monetary tightening cycle. In currencies, we turned neutral on the USD at the attractive levels of 1.41 and 1.42. Elsewhere, on fixed income markets, our shorts on German and US bonds are suffering as yields fall. Europe Flexible: we have raised exposure to 67% due to the recent decline in European indices. We think current levels on the DJ Eurostoxx 50 represent the opportunity we were waiting for to add to positions. Hedging is focused on options, especially against the UK index which remains expensive in relative terms.
Written on Friday June 10, 2011
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