On the markets
The IMF has revised down its growth forecasts for 2011 by 0.1% to 4.3% and left 2012 unchanged at 4.5%. The main positive shift was in the euro zone which has been revised up 0.4% to 2% in 2011 because of Germany and France. On the other hand, US growth in 2011has been revised down by 0.3% to 2.5%. Forecasts for the emerging zone have been left unchanged at 6.6% for 2011 and revised down by 0.1% to 6.4% for 2012. However, this week’s European PMI data were less upbeat as the euro zone’s industrial index slipped from 54.6 to 52……
Edmond de Rothschild Group (Market Outlook: 19/05/2011)
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This will have important international consequences. Strong industrial integration in sectors like US autos and Asian electronics meant Japan’s woes were shared. US auto production in April and May fell by 6.6% overall due to supply chain problems. Inventories are low and car builders are now planning to step up production this summer in line with deliveries from Japan. The entire auto supplies sector in the US (steel, chemicals, electronics and electrical material) will return to normal after the sudden breakdown in supplies which hit in March.
Each successive week is like the last. In thin trading, European indices in recent days have been hit by the same concerns over sovereign debt. The confidence of issuers has suffered and Saint Gobain, for example, has postponed the IPO of its subsidiary Verallia. The mood appeared to ease on Friday morning on news that the Greek government had put forward fresh austerity measures. Now these have to be approved by parliament. Fortunately, this week’s Bourget air show was unaffected by gloomy markets. It was a very good show for EADS which booked more than 700 orders for planes. Almost 90% of these were for the new Airbus A320neo and the buyers were mainly Asian (Air Asia). Asia still represents the good news when companies report figures. For example, Intercontinental’s REVPAR in the zone is still doing well and so is the US (+8.8% in May). Porsche expects an increase of more than 30% in sales of its Cayenne model in Asia by 2012 or double the US figure. And the luxury sector as a whole advanced during the week thanks to Swiss watch exports rising 32% YoY in April. There are also reports in the Chinese press that import taxes on imports of luxury goods could fall; that could provide an additional boost to sales.
In company results, H&M Q2 figures were slightly disappointing – sales +12% as expected but the gross margin was down- due to high commodity prices and the currency effect. The company is however upbeat on the outlook mainly because of China’s contribution. Kesa’s figures were in line and there was a strong performance from Darty in France.
Philips, however, had much weaker sales than expected in Western Europe and in lighting. The company has significantly revised down sales and margins for the current year and expects profits to fall 30%. The share tanked on the news.
Asia was still in pride of place in this week’s deals. Zurich is paying USD 115m for MAAB, a small insurance company in Malaysia, further evidence of its move into growth markets. Publicis has bought China’s Genedigi which is specialised in public relations and marketing. The group is looking to raise the emerging market’s contribution to sales to 30% vs.
20% in 2010. Nexans has also agreed to buy a stake in the energy cables business of China’s Shandong Yanggu Cable (for an EV of around EUR 140m). Elsewhere, Total has sold its UK service station network and Alstom has unveiled a series of agreements over electricity production in Russia. Lastly, ING is said to be in talks to sell its car leasing business and fleet for around EUR 4bn. After selling ING Direct USA, this shows the company continuing on its move back to core business.
After seven consecutive weeks in the red, US equity markets reversed the trend. The S&P500 gained 1.25% over the last 5 trading sessions amid persistent concern over sovereign debt and Greece in particular. Ben Bernanke’s speech failed to reassure investors. As expected, the Fed revised down the growth outlook for 2011 and admitted that certain factors weighing on the economy looked set to last. It nevertheless still expects the economy to pick up speed again during the second half. There were no further indications on future interest rate rises or any sign that QE2, which ends in one week, will be replaced by a similar measure. Talks between the White House and congress over raising the debt ceiling were suspended as republicans said there was a stalemate over higher taxes.
In data releases, sales of previously owned homes fell 3.8% in May after slipping 1.8% in April. It was the sixth month down in a row, a sign that the US property market is still mired in difficulties. However, economists had pencilled in an even bigger fall.
In company news, Oracle (data base software) reported disappointing quarterly figures as IT equipment sales fell 6%, a division inherited from its merger with Sun Microsystems. In contrast, economic bellwether FedEx reported quarterly figures in the black due mainly to introducing an operational efficiency drive. Lastly, airlines led by Delta Air Lines advanced due to lower oil prices. Over the last 5 trading sessions, all sectors rose apart from utilities and consumer staples which lost less than 0.5%. The energy sector posted the most timid rise due to plummeting oil prices and the IAE’s surprise announcement that its member states would be selling strategic stocks onto the market. The consumer discretionary and materials sectors stood out with gains of 3.2% and 2.9% respectively.
The Topix ended with a 0.5% rise in JPY and 0.8% in EUR after seesawing in a narrow range. The 1.5% decline due to concerns over Greece, the US economy and inflation in Asia late last week was mostly offset by the 1.6% rise after the new Greek cabinet was formed. The Forex market was also quiet with the yen firming slightly against the USD by 0.5% and by 0.3% against the EUR.
China-related stocks were mixed as worries about inflation and power shortages worsened. Komatsu rallied after the strong CPI report while Fanuc was largely unchanged. On the technology front, Sony’s market cap last Friday sank below JPY 2 trillion for the first time in more than two years, hit by the personal information leakage issue and loss-making TV operations. Chipmakers like Toshiba and Elpida also performed poorly due to softer demand. The Diet’s session was extended by 70 days without any guarantees of Mr. Kan’s resignation and investors are now wondering if this may cause further delays in restoring the Tohoku areas and Fukushima nuclear power plants as well. The good news was that power demand in TEPCO’s territory was still 15% below peak capacity on the hottest day this year.
The Chinese market bounced sharply on Friday after a tricky month. This was set off by Premier Wen Jiabao’s comments to the Financial Times that inflation would wane in coming months. This might mean that June represents a peak level.
This official statement confirmed that China’s economic growth had been slowing since Q1. This also suggests that drastic anti-inflation measures like strict controls on bank lending, commodity prices and market liquidity will probably ease and help the Chinese market emerge from a period of underperformance. Current valuations in Shanghai and on Chinese stocks quoted in Hong Kong are an additional incentive for investors to get back into the market. True, monetary policy will not change radically in coming months but we should start to see good news on tax, especially on infrastructure and social housing projects.
Premier Wen’s statement came the day after HSBC’s PMI data for June which showed a contraction from 51.5 in May to 50.1. This is not the official industrial production index but it is generally a reliable indication of the trend. (A reading below 50 indicates economic contraction). Clearly, the economy is slowing. The task now is to avoid a contraction. If inflation has effectively peaked in June, then the second half of the year should be better for growth. Investors are generally underweight the market so a catch-up period is more than likely.
Sun Art Retail, China’s leading hypermarket group which is owned by Auchan (51%) and the Taiwanese conglomerate Ruentex (49%) will be listed in coming weeks. It has 196 hypermarkets under the Auchan and RT Mart banners throughout China, 12% market share and very aggressive plans for expansion. 122 sites have already been obtained and the group plans to open an average of 50 hypermarkets a year up to 2013. The market cap could be close to USD 10bn and the offer price will represent a PE of above 20 on 2011 earnings. The group had the same market share as Carrefour China (9.5%) in 2007 but has since progressed while Carrefour has slipped to below 8.5%. The other big player is Walmart which has 11% market share. Note that these three leaders only represent 30% of China’s hypermarkets compared to 90% in developed countries so all there is room for them to grow. Note also that 90% of staff will receive shares, an indication that profit sharing in China is not an empty word.
Lastly, there is an interesting example of how Europe’s woes are increasingly driving funds into emerging markets.
Hungary is to cut its reliance on government bonds and reduce its debt by using private pension fund assets. This will result in the country’s weighting in bond indices falling in favour of countries which have low sovereign debt but a growing appetite for bond issuance. Countries where ratings are improving like Thailand and especially Indonesia should see their index weightings increase as a result. Is the giant China Mobile about to stir?
OTHER EMERGING MARKETS
In India, the market was disrupted at the beginning of the week by the renegotiation of the fiscal treaty with Mauritius which worried Participation Note holders that they might be subject to capital gains tax. The discussions over the treaty will take place in the next 3 months but it is so far impossible to guess which details might be changed. Larsen & Toubro, India’s largest construction company has won an Rs 55bn (EUR 860m) contract. Investors are still glued to renegotiations over Greece’s debt as any contagion could hit global liquidity and thus Indian growth rates.
In Brazil, increasing concerns on Greece raised volatility across the board. On the domestic market, as expected, monthly inflation for the first 15 days in June declined to 0.23% (slightly above consensus) from 0.70% in May. Food and transportation prices fell the most. Also, unemployment remained at 6.4% in May (a record low). The real wage bill grew 6.9% yoy. We believe that higher wage bills combined with abundant credit will continue to boost domestic demand growth. In particular, the labour market remains tight, which continues to put pressure on wages and service industry inflation. Moreover, Petrobras delayed its capex plan announcement. There were some discussions about increasing royalties and introducing a special participation tax on the iron ore sector. We remain cautiously optimistic.
Another volatile week on markets. As expected, the Fed left its interest rates unchanged but said they would remain low for an extended period. With real interest rates below 2%, this environment is ideal for the gold price. It was little changed over the week but is now solidly established at over USD 1,500/oz with little chance of falling. As a result, gold mines, which had been seriously lagging since the beginning of the year, started to catch up. Elsewhere, the IEA (International Energy Agency) surprised markets by putting 60 million barrels of oil on the market. Set up in 1974 after the first oil shock, this body represents 28 OECD countries and is in charge of tracking oil demand. It also owns inventories equivalent to 90 days of imports by its members so as to be able to react to crises. In all, it holds 1.6 billion barrels. This is the third time since it was set up that it has sold stocks on the market. The previous occasions were in 1990 when Iraq invaded Kuwait and in 2005 following the devastating hurricanes that crippled production in the Gulf of Mexico. Bear in mind (see June 10 Flash) that OPEC members failed to reach agreement on increasing production quotas although oil markets were moving into a period of high consumption and Libyan production was still out of action. The IAE’s move reflects its desire to prevent a price surge at the beginning of summer and higher political tension in many countries. The IEA stocks will give markets chance to breathe over the short term. The news triggered a 5% fall in the oil price. We should, however, put the 60 million barrels into perspective as they represent a mere 1.5 days of OECD consumption or 45 days of Libyan production. And in time, the stocks will have to be replenished so we do not expect to see the oil price fall much further.
The US equity market was choppy during the week, with initial gains after the Greek government won the confidence vote, but down following Wednesday’s FOMC meeting statement; the Fed said that the economic recovery was slower than the committee had expected, but that it was not yet considering QE3. US convertibles traded lower, with Telecom and Materials convertibles outperforming. There were two new issues, Nuvasive USD 325m (2.75% coupon and 30% premium) which closed barely above par on its first day of trading and Insulet Corp (USD 110m) which will be priced before the market opening today.
The uncertain economic and financial environment led to very nervous trading on equity markets. Volatility rebounded, almost hitting 25 before falling back but was still some way from levels see in March when the index broke through 30.
Between June 16 and 23, the major indices performed as follows in local currency:
– Standard&Poor’s 500 +1.3%
– Euro Stoxx 50 no change
– TOPIX +1.6%
– MSCI Emerging markets -0.4% (in EUR)
Bond yields were either stable (2.9% in the US) or slightly lower as in Germany where they edged lower to 2.87%.
Spain’s yields remained unchanged at 5.6% but yields in Portugal and Ireland continued to rise. In Greece, however, they eased slightly.
Currencies were largely unchanged: 1.42 for the USD vs. EUR (1.44 briefly during the week), and 80-81 for the JPY. The RMB hit a new record of 6.47 vs. the USD, taking its rise over 12 months to 5.5%.
We have maintained our overall neutral rating on equities. Our main portfolio changes consisted of reinforcing positions on European dividends and taking some profits on our relative UK equity short against the Eurostoxx50. As far as geographical allocation is concerned, we still prefer Asian markets and China in particular.
In German debt, the fall in 2 year yields in the past few days has encouraged us to continue shorting them against the 10 year bond.
Europe Flexible’s current exposure is 67% with most hedging concentrated in options. Hedging is still focused on the UK market which looks expensive relative to other European indices.
Written on Friday June 10, 2011
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