On the markets
Industrial activity in the euro zone rose 0.2% in April which was better than expected…..
Edmond de Rothschild Group (Market Outlook: 19/05/2011)
Sign up for our free newsletter to receive weekly news from BONDWorld
Click here to register for your free copy
Manpower’s quarterly hiring intentions survey, which polls 63,000 companies throughout the world, reveals that in 35 out of the 39 countries covered, employers intend to take on staff in the third quarter of 2011. In the US, positive replies represent a net 12% compared to 10% in the previous quarter.
US retail sales for May showed a slowdown in spending but excluding autos and petrol, they rose 0.3%, proof that households are still making a decisive contribution to growth. Lower credit card default rates, which for companies like Capital One Financial returned to pre-crisis levels, show that personal financial situations are gradually improving. The FED estimates net household worth at USD 58 trillion, which is one trillion more than in the first quarter. This means that half the losses registered during the crisis -when it fell from 66 trillion in 2007- have been recouped.
Once again, the unresolved Greek crisis undermined markets. European leaders have still not agreed on an aid programme and the country is confronted with mass demonstrations against its austerity measures. Greece is the focus of concern and the only economic indicator to emerge was industrial production in the euro zone which was in line with
Banks suffered the most from the climate, dragging down leading market indices. Moody’s has put three French banks -BNP Paribas, Société Générale and Crédit Agricole- on negative watch due to their exposure to Greek debt and, for the last two, their stakes in Greek affiliates. In addition, the Financial Times says new, more demanding capital ratios are in the offing, notably a core Tier one which will be higher than the existing 7%. More positive news came from Capital One which has paid USD 9bn for ING Direct USA (two-thirds in cash and the balance in shares). This will help ING to continue reimbursing state aid. This is one of the sector’s biggest acquisitions since the crisis. The few results announced this week were at best in line with expectations. Inditex (distribution) had generally satisfactory Q1 sales and expects Q2 to be more of the same. Margins, however, contracted. H&M saw sales rise 12% in May when the consensus estimate was for +15%. Tesco said demand was still soft in the UK but rather good in Asia and the US, so no change to annual guidance. Carrefour, however, issued a profit warning on trading in France. Investors expect management changes and a downward revision in guidance. In contrast, Zodiac’s Q3 sales rose 14.8% like for like, driven by cabin interiors. The company has revised up its targeted increase in annual sales to 20% vs.15/20% previously.
On the deal front, press reports claim Thyssen Krupp would prefer to sell its stainless steel division through an IPO. There were also suggestions in the press that Renault-Nissan, which already owns 25% of Russia’s Avtovaz, was about to take control of the company. That would push the new group into third place in world rankings. Vinci has confirmed that is in interested in buying Hochtief’s airport concessions for more than EUR 1.3bn. Cap Gemini is said to be in exclusive talks to buy Prosodie for EUR 382m and expects the deal to enhance earnings by 3-4%.
US equity markets had their seventh down week in a row. The S&P 500 lost 1.66% over 5 days. Macroeconomic indicators were mixed and failed to assuage fears of an economic slowdown. Retail sales in May fell less than expected and housing starts and permits started to recover, but the Philly Fed came in at -7.7 vs. 3.9 the previous month, a sharp reminder that manufacturing was ailing. What’s more, the consensus had been expecting a rebound to 6.8. In company new, Kroger (food distribution) posted quarterly results that were better than expected due to tight cost controls and higher sales. Department store chain JC Penney has appointed Ron Johnson as its new CEO. He had previously developed Apple’s store network. The market saw this as a sign the trademark would be reinvented and sent the stock price higher. Trading was also boosted by a new crop of mergers and acquisitions. Energy Transfer Equity has agreed to buy Southern Union Company in an all-share deal representing a total of USD 7.9bn. US textile group VF Corporation (The North Face and Eastpak backpacks and Wrangler and Lee jeans) has paid USD 2bn to acquire Timberland, a 43% premium on the last quoted price. Lastly, Allied World Assurance is paying USD 3.2bn for Transatlantic Holdings (reinsurance) a 16% premium.
All sectors declined over the week. Due to the falling oil price, energy and commodities led declines by losing 3.2%. In
contrast, utilities and consumer staples proved resilient by only falling 0.2% and 0.5% respectively.
The Japanese market continued to stabilise this week as the yen moved higher against the EUR. Sentiment seems to be turning gradually according to polls carried out by Merrill Lynch Bank of America. In June, 18% of multi-asset investors were overweight cash compared to 6% in May, the highest level since June 2010. And 27% were overweight equities vs. 41% in May. That could represent a low if optimism over earnings expectations continues to recover. 54% think companies overall will see higher earnings in the next 12 months.
Hino Motors, which has a big presence in the emerging zone, has released its forecasts on operating profit for March 2012. It expects JPY 35bn, an increase of 21.1% on March 2011. This is even higher than estimated by some analysts.
Our markets too were hit by the Greek crisis but the raise in the dollar, and consequently Asian currencies against the EUR, eased the decline. The fallback in oil prices is good news for the region and India in particular. For the time being, monetary conditions are still being tightened -as we saw last week in India and Korea- and China continues to be hit by a flow of bad news such as constraints in the property sector, hikes in the RRR (reserve requirement ratio for banks) and benchmark rates, price controls and possible taxes on dividends and on commodities. Investors feel as if they are being strangled. And yet indicators show China is still expanding: industrial production has been over 50 since the beginning of the year, domestic consumption was up 16.9% YoY in May and even the property sector has seen its earnings growth revised up for 2011. Tighter conditions for banks are intended to neutralise high capital inflows as well as to rein in domestic liquidity. The figures speak for themselves: China is one of the countries which is seeing earnings growth revised higher and it should now see +20% for 2011 and +17% for 2012. And yet it is on a PE for 201 of only 11. Shanghai is now trading at the same level as in October 2008. This is excessive in our view and it offers an historically low entry point.
SAMSONITE’s first day of trading on Thursday was difficult as the stock fell 6%. And yet the company had been careful to pitch the price at a reasonable KD 14.5 or a PE 2011 of 17 with annual average earnings growth of 25% over the next 3 years. At this level – 13 times 2012 earnings- the stock is a good buy. We are impressed by the restructuring carried out by the group across all its business zones. That includes the US where the operating margin is above 13% as in Latin America. But clearly the group’s growth engine is Asia where operating margins are flirting with 20% and demand is growing sharply for strong, good quality luggage. We view Samsonite as a good proxy play for rising purchasing power in Asia, and India in particular where the group’s sales are just behind China. In both countries, the company is the leader in the mid to up market segment with a market share of 10%.
Another aspect of the Asian luxury sector is the impressive jump in the price of goods. Take Prada for example which is about to be listed in Hong Kong. A pair of Prada shoes, which retails for EUR 490 in Milan, sells for EUR 505/510 in New York and 515/520 in London but shoots up to EUR 580 in Hong Kong and even EUR 640 in Shanghai, almost as much as the EUR 647 shoppers pay in Tokyo (Source CLSA, not taking VAT and currency impact into account). This is a massive price multiplier effect; with the potential, unparalleled volume in Chinese sales, the stakes are obvious. The same pattern will also come into full play for Samsonite as a new consumer class in Asia can now pay premium prices to buy well-known trademarks. Hence, such high margins in Asia. And we also have to take into account the sharp increase in travelling in the region. China is about to spend almost as much as the US (USD 1,400bn vs. 1,600 according to Morgan Stanley) on transport and tourism over the next 10 years.
OTHER EMERGING MARKETS
With inflation running at 9.1%, the Reserve Bank of India unsurprisingly increased its financing rate by 25bp to 7.5%. Investor worries over certain State Electricity Boards (SEB) are taking shape: this week the Tamil Nuda SEB asked the central state for USD 9bn to bale it out. Other SEBs are expected to do the same in coming weeks. The anti-corruption drive has produced proof that the cement industry is run by a cartel. The sector has excess capacity yet prices kept rising. Lastly, investors are keeping a close eye on developments in the developed world’s sovereign debt saga. This is why Indian IT services companies have underperformed the market since the beginning of the month. We expect volatility to remain high in coming weeks. But if lower economic growth were to lead to less inflationary pressure, India’s macroeconomic outlook would improve (except, of course, if a global liquidity crisis were to erupt). In Brazil, the market fell 4.12% in USD, driven by increasing uncertainties on the Greek economy and fears of a US slowdown. As expected, the utility sector had the best performance. On the macro side, the Central Bank of Brazil published the minutes of its latest monetary policy meeting. The tone was more benign towards inflation. The attention is now focused on the Petrobras capex plan, which could be announced this week. We expect a total amount close to US$220 billion for 2010-14. The amount will be in the spot light, but so will investment in refineries. Moreover, the Brazilian market has approximately USD 6.5billion in IPOs and follow-ons being offered, in sectors ranging from Consumer Discretionary to Energy and Utilities.
Commodities fell across the board this week amid worries of a double dip in the developed zone, slower Chinese growth and, of course, the sovereign debt crisis. Brent lost 4% despite an IEA report which slightly revised up its overall demand estimates for 2011 and 2012. The report also said global demand by 2016 would amount to 95.3 million b/d (vs. 89.3 million currently) with 75% of demand coming from Asia and the Middle East. Growth in demand over the long term is certain but the market is worried about the situation in coming months as global economic growth has, for the time being, hit a wall. Demand in the US (which is the largest user in the world and accounts for 25% of total demand) is still disappointing and down on last year’s levels.
Base metals lost 2% on average this week for the same reasons. But the news is not all bad: in China, electricity demand grew by an annualised 10.8% in May, steel production hit an all-time high of 60.25m tonnes and industrial production jumped 13.3%.
Gold ended the week practically unchanged The World Gold Council said that Treaty of Washington signatories (who have to respect quotas when selling gold) had only sold a single tonne since September 2010 (compared to an annual 500 tonnes a few years ago). Central banks in heavily indebted countries like Spain and Greece are no longer sellers and are instead using their gold as collateral when borrowing. Meanwhile, in countries like China which have high currency reserves, central banks are buying gold to diversify their reserves and lower USD exposure.
There were two new issues this week, one of which was South Korea’s Lotte Shopping, a new Jumbo deal for almost USD 1bn in two tranches. The group, a large distributor, is very popular with Korean investors as it is one of the blue chips with the highest exposure to domestic demand in China and the ASEAN zone. Successive acquisitions have helped the company build substantial market share in these countries.
The second issue was from Japan’s Sekisui House for JPY 50bn. The company is specialised in prefabricated houses which means it should play a role in post-quake reconstruction. We took part in both issues amid a very volatile market amid a stalemate in the Greek crisis (CDS on Greek debt hit a spread of about 1,800bp over 5 years). As a result, some convertibles have become less expensive in terms of implied volatility, making our universe more and more attractive.
Uncertainty continues to dominate sentiment on equity markets as the Greek debt issue and economic data disrupt investor sentiment. Between June 9 and 16, the leading global indices performed as follows in local currency:
– Standard&Poor’s 500 -1.7%
– Euro Stoxx 50 -1.7%
– TOPIX -0.1%
– MSCI Emerging markets -0.6% (in EUR)
Bond markets were relatively stable: 10 year yields in the US and Germany ended the week close to recent lows of 2.9%. 10 year yields on peripheral country debt continued to rise, reaching record highs in Greece (17.4%), Portugal (10.4%), Ireland (11.2%) and Spain (5.6%).
On currency markets, the dollar rallied from 1.45 to 1.41 vs. the EUR while the JPY hovered between 80 and 81. The RMB held firm at its highs (6.47).
As a result, we are staying with our overall neutral rating on equities and maintaining current exposure. But we have taken profits on our Swiss SMI index vs. Eurostoxx 50 short. As far as geographical allocation is concerned, we still prefer Asian markets and China in particular.
After turning neutral on the USD, we continue to make gradual purchases of the EUR when the dollar rallies. As the EUR has fallen against most currencies, we have also taken some profits on our long Sterling position.
In German debt, we have switched from 2-year to 10-year Bunds as the former have fallen more sharply.
Europe Flexible’s current exposure is 68% with most hedging concentrated in options. The UK market looks expensive relative to other European indices and that is where most of the portfolio’s hedges are.
Written on Friday June 10, 2011
Saint-Honoré Chinagora is more lightly regulated UCITS that avoid leverage. It is not subject to the same rules as UCITS that are open to all investors and may as a result be riskier. Only persons mentioned under the section “subscribers concerned” in the simplified prospectus may subscribe to shares in this UCITS. The subscription to, or acquisition of, shares in this UCITS either directly or through any third party, is reserved to investors listed in article 413-2 in the General Regulations of the French Market Authority (AMF). When subscribing for the first time to one of this UCITS, investors must state in writing that they have been duly forewarned.
Edmond de Rothschild Group and its subsidiaries therefore recommend that all interested parties ensure that they are legally authorized to subscribe to the products and/or services before any investment is made.