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EDR: Market Flash – Japan’s industrial production rose 5.7% in May

12 GIAPPONE

On the markets
Japan’s industrial production rose 5.7% in May, proof that the recovery is gaining traction. June should see a further rise of more than 5%. In the auto sector, Toyota says production should be back at February’s level from July. This news is not only good for Japan as production in sectors like autos is characterised by high international integration….


Edmond de Rothschild Group (Market Outlook: 01/07/2011) 


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This advance means that one of the factors that impacted the global economy in Q2, especially in the US, will be on the wane in Q3. European consumption was disappointing in May. Clearly, consumer sentiment was hit by oil prices which peaked during the month. In Germany, despite the favourable trend on the jobs market where unemployment is at 7%, retail sales fell 2.8% while French consumer spending dipped 1.5%. In contrast, the IFO survey of business sentiment in Germany is still hovering around record highs. In the US, durable goods orders ex defence and aeronautics rose 1.6% compared to a revised -0.8% in the previous month (initially reported as -2.6%). Companies continue to increase investment and May was only 4% off the highs recorded in the previous  economic cycle. Following a series of negative monthly readings from regional Federal banks, the Chicago purchasing managers survey for June rose to 61.1 vs. 56.6 in May. Even so, it is still lower than February’s exceptional performance of 71.2.

EUROPE
The Greek parliament’s green light to a EUR 28bn austerity plan has lifted some of the uncertainties on European markets. But for the solution to work, we will have to wait for the vote on its practical applications and the IMF aid package to be unlocked. News this week focused on banks. Within the Basel III framework, regulators are apparently looking for systemically important banks to increase their tier one capital  base by 1-2.5% to between 8-9.5% (vs. 7% previously) by 2016-19. Elsewhere, if the suggestion from France’s banks to rollover Greece’s debt goes through, banks exposed to Greece would win out.
Company results were dominated by profit warnings. Holland’s Akzo Nobel said it had not been able to pass on higher commodity price to its clients. The group is also said to be suffering from soft demand in mature countries and Q2 EBITDA is now expected to be EUR 550m rather than EUR 640m. Similarly, Colruyt earned EUR 338m for the year, 5% below expectations due to wage inflation and commodity prices. Tomtom and Teleperformance, have both reduced 2011 guidance on sales and margins due to lower volumes in Europe and the US.   
But there was good news from Fiat which has confirmed 2011 targets of EUR 300m in net profits and Alstom is still on track for a full-year operating margin of 7-8%. And Rhodia says it can raise prices to compensate for higher costs. Lastly, BG Group has doubled its estimate of reserves in the Santos basin to 6 billion barrels.
Advertising agencies are on the acquisition trail. WPP could be interested in some of Aegis’ assets and Publicis has raised its acquisition budget for this year by 50% to EUR 700m. Casino and Carrefour are about to confront each other in court over control of CBD in Brazil. Casino has strongly criticised an attempt by its partner in CBD, the Brazilian family Diniz, to merge its CBD stake with Carrefour’s Brazilian operations, a deal put forward by the Brazilian investment bank BTG Pactual. The plan is for the trio to take full control of CBD, which is a jewel in Casino’s crown.  

US
Equity markets rose in USD terms as the international mood improved on news that IMF aid for Greece would go through. In addition, economic data in the US was on the whole encouraging. Consumer confidence came in below expectations but failed to dent good news in the property sector. According to the National Association of Realtors, home sales rose 8.2% in May which was much better than estimates of 3%. The new orders component in Chicago’s industrial barometer also rose sharply.   
In company news, Nike’s quarterly results trounced  expectations as trading picked up speed in North America and emerging Asian countries. Bank of America said it had reached an agreement to settle subprime mortgage claims. At their analysts’ day, Dell and Netapp said the outlook for corporate investment in the second half was encouraging. Over the last 5 trading sessions, all S&P500 sectors advanced, led by energy and commodities.    

JAPAN

In the week up to June 29, the Topix rose 1.8% in yen and 0.8% in euros helped by US rallies. Weaker yen and strongerthan-expected industrial production in May, at 90% of the pre-quake February level, also sent Topix to some 45-day high since mid-May. EUR/USD was eventually flattish while EUR/JPY rose 1.0% as the Greece issue eased somewhat. This week’s best performers in Topix 100 include real estate stocks like Sumitomo and Mitsui. Fanuc also jumped following its chairman’s note that the firm will boost sales to JPY1 trillion in 3 years. Nikon was sold off most after profit taking. Topix now seems more volatile as futures trading reached a 2 month high in value against TSE1 where trading for the week was lightest in June due possibly to lengthened political vacuum and worries about power shortages in the coming months.  Nikkei’s poll conducted on weekend revealed 26%, down 2pp from May, where 893 respondents were supportive of PM Kan while 42%, nearly double that of May, urged him to resign as soon as possible. Against restarts of nuclear power plants were 69% and 45% said yes to tax hikes for reconstruction budgets, of which 52% preferred consumption tax to income/corporate taxes.
This week was dense with shareholders’ meetings for fiscal year March. TEPCO’s chairman on Tuesday deeply bowed
and apologized to some 9,300 attendants, nearly tripled from a year ago, who condemned management on how they take responsibilities for the world’s worst nuclear crisis, while the anti-nuclear resolution was rejected at the meeting.

ASIA  
Markets moved higher in the last week of the quarter. The Greek parliament’s vote has provided a short term breather. But the more interesting news for the region could  come from China which might have turned a corner judging from Premier Wen’s statements. He said the fight against inflation was producing results. The market interpreted this as suggesting inflation which was above 6% in June represented a peak and that the pace will now slow. That should allow
the government to ease its monetary policy after 18 months of tightening. As we have already pointed out, China is trading at historically low levels and the outlook for growth is still upbeat.
IPOs in Hong Kong are seeing a revival. Prada gained 10% on its first day of trading despite being pitched at a rather generous valuation and Samsonite has moved back above its offer price after a few days of weakness. There is also robust demand for Auchan’s subsidiary Sun Art Retail which seems to be in favour with investors.
The US hedge fund Muddy Waters which hit the headlines when it published a detailed report attacking Sinoforest’s dubious accounting practices – the stock subsequently lost 85%- has failed to damage its latest target, Spreadtrum, a Chinese tech stock with a US listing. Spreadtrum reacted vigorously to the fund’s claims and the stock rapidly made up its losses. This should dent the recent campaign against Chinese stocks quoted in New York.  Indonesia’s inflation rose by an annualised 5.5% in June, an indication that it is still under control. Real interest rates in Indonesia are running at 1.2% so from the monetary  and liquidity point of view, the country is still a very interesting investment. Bank Rakyat, a microcredit giant, is particularly well placed to benefit from this benign environment and its lending growth should still grow by 20-25% this year. Another winner should be United Tractors. It is  the exclusive distributor of Komatsu diggers and tractors which are essentially bought on credit and the country is also enjoying a mining and agricultural boom.

OTHER EMERGING MARKETS
In India, despite high inflation (9.1%), the government has courageously decided to reduce oil subsidies, good news for
the country’s finances. This will economise around Rs 500bn (EUR 7.7bn). Annualised deposit growth has moved back up to 18.2% which is in line with loan growth of 20.7%. This will help improve liquidity in the banking system. As we have already said, after 6 months of India underperforming emerging markets, it is now time to move back into the Indian market because
–          inflation is stabilising or even falling thanks to lower commodity prices,   
–          liquidity is improving in India’s banking system
This positive macroeconomic data will, however, be offset over the short term by rather modest company results over the next 2 quarters.
In Brazil, the market rebounded by 3.8% this week.  Fears of a Greek default diminished and US economic leading indicators improved, pointing to a better second half. In the local market, the highlight was on the retail sector, on Pao de Açucar’s transaction. Mr. Diniz, Carrefour, BTG and BNDES put forward a plan which would create the the largest Brazilian retailer.  The new entity would integrate CBD and Carrefour Brazilian assets plus 11% stake  on Carrefour France. The deal, however, still needs approval of Casino, the future controlling shareholder of CBD. Moreover, the 12
months inflation continued to rise (in line with expectations). We attended a conference with Brazilian companies, and the overall expectations for 2Q results are quite positive, except for steel makers, which have been hit by higher commodities prices (iron ore and coal) and by higher volumes of imported steel. Brazil is trading on a 12-month forward PE of 9.6 which is below its historical level.

CONVERTIBLES  

It took the second vote by Greece’s parliament approving austerity measures to bring the Xover index back below 400bp. This revived all high-yield names. The convertibles market had, in fact, proved very resilient in June by losing only 0.2% vs. a decline of 3.25% in the MSCI in local currency. Fixed interest markets absorbed most of the impact from rising risk aversion and worries over Greece defaulting. On July 3, Europe is set to validate the 2nd bailout which it is hoped will prevent contagion in other peripheral countries.

COMMODITIES
Commodities rallied sharply as fears over the sustainability of the economic recovery waned following  the Greek parliament’s approval of austerity and privatisation plans. Oil and base metals traded on the LME gained around 4%. Brent even moved back above USD 110 with additional support from OPEC’s secretary general Abdullah al-Badri who called for an immediate end to the IAE’s use of inventories to push down prices. Any friction between producer and consumer countries tends to send the oil price higher. Note that Arlene, the first tropical hurricane, is taking shape over the Atlantic. Oil markets are getting worried due to the damage Rita and Katrina did in the Gulf of Mexico in 2005.
Gold slipped by around 1% and even fell back below USD 1,500 an ounce. We would simply point out that the gold price has risen for 11 quarters in a row. Quantitative Easing 2 may be over but the FED will continue to buy US debt by
reinvesting the coupons from the bonds it already holds. So monetary easing in the US is far from over! Rating agencies
are starting to focus on the US where Congress has to vote through plans to raise the debt ceiling to USD 14,300bn by the end of July. After insisting that Greece reduce its debt, rating agencies are ironically now threatening to downgrade the US if it does not increase borrowings! Gold is still very attractive for investors who are disappointed with risky monetary and budgetary policies.
Moreover, a Reuters survey shows that US pension funds have less than 1% of their assets in commodities (including gold) so there is still considerable room for more money to flow into the asset class.

ASSET ALLOCATION
Markets are still obsessed with short term considerations. Sovereign risk continues to unnerve investors but they were reassured by the Greek parliament’s approval for the austerity plan. Between June 23 and 30, the major indices
performed as follows in local currency:

Standard & Poor’s 500   +2.9%
Euro Stoxx 50      +4.3%
TOPIX      +2.9%
MSCI Emerging markets     +1.4% (in EUR)
First half performance for the same indices was as follows:
Standard&Poor’s 500      +5%
Euro Stoxx 50                                 +2%
TOPIX                                               -5.5%
MSCI Emerging markets          -8.6% (in EUR)
Bond market yields moved higher at the end of the month. After flirting with 2.85%, the yield on the 10-year Treasury bond moved back to 3.17%. The yield on the equivalent Bund followed suit by returning to around 3% after going as low as 2.83%. But yields eased on peripheral country debt.
The EUR rallied to 1.45 vs. the USD after the Greek austerity plan was voted through. Year to date, the USD has lost about 8.2% against the EUR – it was trading at 1.34 at the end of 2010- and 5.9% against a basket of trading partner currencies. The yen continued to trade between 80 and 81. The RMB once again moved closes to its peak levels of 6.46
against the USD.
On the eve of the Q2 earnings seasons and due to more cautious market expectations, we upped our confidence levels in equities overall at the beginning of the week. This led us to turn positive (+) on Japanese equities. We believe the ostFukushima recovery could be faster than initially expected and the market could consequently reduce some of its underperformance.
We have also taken advantage of temporary relief over the Greek crisis to cut our underweight on German bonds and return to neutral (i.e. = vs. -) Fixed income markets will remain nervous and Germany will act as a safe haven if tension resurfaces even if its real interest rates are very low.



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.

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