Activity slowing in the US and Asia
Companies are still struggling to secure supplies
The Fed and ECB are in no hurry to get monetary policy back to normal
The most recent economic data show activity slowing in the US and Asia. In the US, ISM fell 4 points to 60.1 in June as jobs and new orders data declined. China’s drop was much more pronounced with PMI flirting with the 50-watershed dividing expansion and contraction. In Europe, meanwhile, reopening and the summer season have led to activity accelerating although the sanitary situation is still fragile. Markets are worried about the rapid resurgence in Covid cases from the Delta variant. Government bond yields fell sharply as a result. Yields on US 10-year Treasuries retreated to 1.24% while equity markets sold off towards the end of the week. The Delta variant is highly contagious, especially among young people, but vaccinations, even if they do not provide full protection, seem to have kept hospitalizations low. The question now for countries is whether to go for a new lockdown or wait to see if the Delta variant spread, along with vaccinations, helps achieve herd immunity while preventing hospitals being overrun. Elsewhere, companies are still struggling to secure supplies and, in the US, recruit staff so prices are still under pressure. Inflation is particularly evident in emerging countries like Turkey where prices have risen 17.5% over a year. In Russia, they are up 6.8%. And the failure of the OPEC+ talks on gradually increasing oil production has made things even more complicated. High oil prices act as a consumer tax in developed countries where they effectively reduce purchasing power. Against this backdrop, the Fed and ECB are in no hurry to get monetary policy back to normal. The ECB’s strategic monetary review has changed from aiming for inflation “near to but less than 2%” to a new target of 2% in “symmetric inflation”. This means following the Fed's lead in allowing inflation to go above this level before considering action. We are maintaining our neutral stance on equities with a preference for Europe and China. In fixed income, we are still underweight duration and prefer corporate bonds.
EUROPEAN EQUITIES
Risk aversion moved a step higher, denting bullish sentiment on equity markets. Sanitary concerns resurfaced, fueling worries overgrowth as the latest economic data seemed to be faltering. This was bad news for the reflation trade. And yet the European Commission once again revised its growth forecasts higher after Europe’s economies enjoyed better-than-expected rebounds. The €750bn stimulus package, which will start paying out its first instalments from July 13, should also play a key role. Cyclicals overall naturally underperformed in this environment. In company news, Royal Dutch Shell said it would be returning more to shareholders through higher dividends or share buybacks. The strong recovery in the oil price has helped the group slash its debt and the group is upbeat on prospects. However, management stressed that oil companies have to focus on being disciplined with shareholders instead of going all out for volume as was the norm only a few years ago. Elsewhere, autos group Stellantis said it had managed to offset higher supply prices with persistent cost-cutting efforts as well as relatively strong pricing power as its sales moved more up market. Daimler, however, warned on falling sales due to ongoing semiconductor shortages. Jaguar delivered the same message and shares in its parent company Tata Motors fell. The groups said there was a lack of visibility on when the situation might improve. They expect the picture to remain difficult up to the end of this year. Some trends, however, remained resilient. In the UK, Ocado (automated logistics for online retailers), said demand was still strong and announced new partnerships. Trading is still conditional on higher costs, but the group left its annual guidance unchanged. Management feels that the Covid crisis has changed consumption patterns for good and that e-commerce will continue to gain market share. On the Covid news front, a clinical study showed that antibodies developed by Roche help reduce deaths.
US EQUITIES
Over the last five trading sessions up to Thursday, the Dow slipped 0.23% while the S&P500 gained 0.54% and the Nasdaq 0.38%. Services ISM came in at a disappointing 60.1, or below the 63.5 expected, pushing 10-year Treasury yields lower to 1.37% and spoiling the fun for cyclicals which shed 2.5% compared to defensives. Concerns over the Delta strain persisted even if the impact on the economy has so far been limited. The OPEC+ summit failed to agree on concerted action and its last session was even cancelled. Divergences between Saudi Arabia/Russia and the UAE on output levels were unresolved. The cartel was planning to increase monthly production by 400,000 barrels between August and December, the equivalent of 2 million barrels a day by end 2021. The UAE wanted to dispose of a bigger quota. The FOMC minutes failed to provide conclusive evidence when a tapering schedule might be announced. Instead, committee members said there was much uncertainty over the pace of the economic recovery and the inflation trajectory. Elsewhere, US job offers hit an all-time high of 9.2 million in May, triggering fears that labor shortages could slam the brakes on the recovery. Transport stocks fell 3% on Thursday after the Wall Street Journal said Joe Biden might insist on regulatory action to get maritime and rail transport costs lower. The government feels that the sector’s relatively small number of players had helped companies to charge unreasonable amounts to transport goods. The US-China diplomatic stand-off continued. Citing human rights violations in the Xinjiang region, Washington added at least 10 Chinese companies to its trading ban list. Amazon jumped 4.7% last Thursday after the Pentagon cancelled the $10bn Joint Enterprise Defense Infrastructure (JEDI) contract awarded to Microsoft in October 2019. A court had suspended the cloud infrastructure contract after Amazon claimed it had been sidelined in the bidding process due to poor relations between Donald Trump and Jeff Bezos. The contract will now be subject to a new tender. Bezos, meanwhile, retired from his position as Amazon CEO on July 5. During his reign, the stock had risen 234,000%. Pfizer said it was going to ask for emergency approval for a third dose of its vaccine to counter the effects of the Delta strain.
JAPANESE EQUITIES
The NIKKEI 225 fell 2.05% and the TOPIX 0.97%. Vaccination progress and yen depreciation continued but the market was hit by increasing Covid-19 cases, political uncertainty following the outcome of the Tokyo Metropolitan Assembly Election on July 4th, a possible slowing of the global economy on the back of weak economic indicators and stricter Chinese regulations on listing companies overseas. In addition, there was a concentration of ETF ex-dividend dates during the week, prompting selling afterwards. Air Transportation (1.95%) and Land Transportation (0.88%) rose on vaccination progress. On the other hand, cyclical sectors fell, including Mining (-4.93%), Securities & Commodities (-4.66%) and Iron & Steel (-3.47%). Murata Manufacturing jumped 5.69% on expectations of solid earnings growth. Nissan Motor gained 5.62% on news it was investing £1bn in the carbon neutral “EV36Zero” project. Daiwa Securities plunged 8.53% as US bond yields declined. The government decided to reintroduce a state of emergency in the Tokyo metropolitan area from July 8th. The Olympic games will be held without spectators in four prefectures in the area including Tokyo. The Prime Minister said the government was aiming to get 40% of the population vaccinated by the end of July.
EMERGING MARKET
The MSCI Emerging Market index was down 2.75% as of Thursday’s close. India outperformed other regions, slipping 0.38%. China led losses, down 5.55%, as tech stocks fell amid regulatory fears. Brazil underperformed, falling 5.85% in USD on political tensions. In China, inflation edged down sequentially: CPI rose 1.1% YoY in June, vs. consensus estimations of 1.2% while PPI surged 8.8%, or slightly more than market expectations of 8.5%. Credit expansion in June started to reaccelerate with new renminbi loans reaching 2.1 trillion and aggregate financing going above 3.6 trillion. On Friday, the PBoC cut its Reserve Requirement Ratio by 50bp to 12% to release the equivalent of RMB 1 trillion in long-term liquidity. Elsewhere, the US will add at least 10 Chinese companies to its economic blacklist over alleged human rights abuses and high-tech surveillance in Xinjiang. Interventionism was all over the headlines this week: Drug regulators released a draft guideline on clinical oncology drug trials. The Cyberspace Administration launched a cybersecurity review of Didi, 2 days after its IPO on the NYSE. The antitrust regulator blocked the merger between DouYu and Huya, two Tencent-backed game streaming companies. Bytedance, Tiktok’s parent company, was reportedly pushing back its Hong Kong IPO to 2022. Due to a resurgence in COVID cases in southern regions along with chip shortages, June’s passenger vehicle retail sales were down 8% YoY while wholesale was down 15% June excavator sales volume was down 6% YoY, taking volume growth in the first half to 31%. Flat Glass made a positive profit alert for its first half: net income is now forecast to surge 152/174% YoY thanks to higher solar glass product sales. In Taiwan, exports continued to decelerate in June to +35.1% YoY vs. +38.6% in May. In Korea, Samsung Electronics reported better-than-expected profits as memory prices and shipments rose on strong server demand and its foundry business bounced back from disruptions at its Austin plant. In India, Prime Minister Narendra Modi made the first cabinet reshuffle since his reelection in 2019. There were no significant changes in core ministries, so it was essentially a case of more continuity. Strong numbers from HDFC Bank and a Bajaj Finance pre-quarterly update revealed a milder impact on loan demand from the second Covid wave than originally feared. Tata Motors forecast a negative EBIT margin in the first quarter of FY 2022, vs. earlier guidance of 4%, due to the chip shortage. The group also warned the shortage would get worse in the second quarter and would hit 50% of production. Tata Consultancy Services reported better results for its first quarter of FY 2022 but the topline was slightly below estimates due to India’s second Covid wave, with signs of margin pressure as discretionary spending picks up. In Brazil, May industrial production index made a strong recovery from -1.3% in April to +1.5%. PMI in June jumped to 54.6 from 49.2, its highest level since October, as growth in the dominant services sector ran at its fastest pace in more than eight years. Petrobras announced gasoline and diesel price increases, cutting discounts to international parity to only 5% and 3%, respectively.
CORPORATE DEBT
CREDIT Risk aversion trended higher as the Delta variant gained ground and some countries reintroduced restrictions. Equities and credit spreads built on the previous week’s downward move. The Eurostoxx 50 lost 1.5% while the Main gained 1.5bp and the Xover 9bp in a choppy market. German and US government bond yields fell 9bp, allowing IG bonds to return 0.5% and HY 0.03% in spite of IG and HY spreads widening by 1bp and 5bp. The ECB’s new monetary strategy is to aim for 2% in symmetric inflation. Previously, the target was “close to but under 2%”. In financials, BCP’s Polish affiliate Millenium provisioned an extra €101m for the conversion or compensation of Swiss-franc denominated loans. Bloomberg said UniCredit was about to securitize €2bn in NPLs by using the Italian government's guarantee for the senior tranches. In insurance news, NN Group, which is to acquire Metlife’s Greek and Polish business, said it was paying €85m for the Dutch broker Heinenoord. There will be a 4% impact on NNs solvency ratio. Banca popolare di Sondrio raised €500m in green senior preferred 6NC5 bonds at MS+160bp. Banco BPM raised €500m in sustainable senior preferred bonds over 5 years at MS+130bp. Air France raised €800m in senior bonds in two tranches, one for €300m over 3 years at 3% and the other for €500m over 5 years at 3.875%.
CONVERTIBLES
After a record number of issues year to date, the primary market paused for breath. Over the first half of this year, new issuance totaled $95.9bn, a 4.4% increase compared to 2020 as a whole and +149.8% vs. the first six months of 2019. The convertible universe expanded from $317bn at the end of 2019 to $524bn on June 30 this year. At the same time, sector and style diversification has risen, helping multiply performance drivers for investors. The week did, however, see the first convertible issue from Vietnam’s residential property group Novaland Investment Group JSC. It raised $300m over 5 years at 5.25%. The proceeds will go on buying land and developing projects to reach the company’s 3-year profits target.
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