EDRG: Market Flash – August’s US job data was disappointing

August’s US job data was disappointing. Unemployment was unchanged and job creation was nil overall even if the private sector created 17,000 jobs. Taking the strike at Verizon (telecoms) into account (45,000 people), companies actually created 62,000 jobs. But figures for the previous months were revised down by 58,000. Moreover, the working week was a little shorter and income was only up 1.9% over a year compared to 2.3% in the previous month. The ISM services index recovered slightly to 53.3 vs 52.7 in July.
After the decline in European PMI indices, statistics from Germany were more reassuring. The 2.8% drop in new industrial orders in July was largely due to a fall back in capital goods after an exceptional performance in June. But the trend on intermediary and consumer goods was upbeat.
Industrial production in July rose 4% (4.5% excluding energy) after falling 1.1% in June.

EUROPE
A very erratic week that started with another brutal sell-off before rallying on the ruling from Germany’s constitutional court and the voting of austerity and stimulus measures in France, Spain and Italy. After watering retrenchment down, Italy added EUR 45bn back into its austerity package. These measures, along with much better-than-expected economic data like Germany’s industrial production, which rose 4% in July, have helped dispel concerns over an absolute collapse in the global economy. But investors are increasingly coming to the view that the road to recovery will be long and rocky.
Germany’s finance minister Wolfgang Schaüble reiterated his opposition to eurobonds by claiming that, under existing
European treaties, they would weaken the euro by giving the impression that there was no need for non-virtuous countries to cut spending. At any rate, the market once again ended the week lower with the banking sector still losing the most amid persistent liquidity tensions.
On the currency front, the Swiss National Bank caused surprise by fixing a price floor of CHF 1.20 against the EUR. The move was designed to curb the Swiss franc’s current level which it is feared will damage Switzerland’s competitiveness.
Results from Clariant (chemicals) bore this out. The group has lowered guidance due to currency effects and slowing global demand but has maintained its targets for 2015. Even Richemont, which saw a much better than expected 29% rise in sales over 5 months to the end of August – and +35% like for like- said the Swiss franc’s advance since March would hit translated profits and result in flat first half earnings despite much higher sales and operating profits.
The M&A market remained active. Canal + has bought 60% in Direct 8 and Direct Star, two channels belonging to the
Bolloré group. The EUR 279m deal will be financed by Vivendi shares but still has to receive regulatory approval and Bolloré will as a result hold 1% of Vivendi. Other media sector news concerned Lagardère which is considering using the proceeds from selling its international press division to fund a share buyback or an exceptional dividend. The group will not sell its EADS stake before the A350 programme is technically and commercially on the rails. In defence, the stateappointed mediator is to try to solve the issue of asset swaps between Thales and Safran by pushing for the creation of jointly held companies instead. France’s Sodexo has acquired Puras do Brasil, the country’s second largest on-site services company. The deal represents EUR 525 in enterprise value and will mean Brazil has a new sector leader. SAP has paid an undisclosed amount for the southern Californian company, Right Hemisphere, which designs 3D applications to enhance design functions for SAP’s clients. Alcatel, however, says the Permira fund has walked away from talks to buy the group’s Enterprise division.
Restructuring at Sanofi Aventis is starting to pay off. At an investor presentation, it announced that looking beyond new cost savings, a gradual increase in the dividend payout and targets to increase sales, the company was planning for the period after patent expiry deadlines and expecting to see a fresh surge in growth. Air France KLM has not yet seen a real downturn in business but is planning a further round of cost cutting that could amount to EUR 700-800m a year. This compares with targeted savings of EUR 470m a year under the current Challenge 2012 plan.

US
Despite persistent worries, US equity markets edged higher in a week shortened by the Labour Day holiday. After last week’s disappointing jobs data, non-manufacturing ISM, which represents two thirds of the US economy, came in better than expected at 53.3. The FED’s beige book still shows the economy recovering at a slow pace. The big news of the week was Barack Obama’s USD 447bn stimulus plan focused on jobs. However, the systematic opposition of the Republican majority in Congress amid an extreme polarisation of political views means the package’s eventual contents and implementation are in doubt.
Apart from the departure of Yahoo’s CEO, there was no major company news. Company autumn conferences have not yet reflected market concerns over an economic slowdown. There is in fact optimism among some oil companies and tech stocks Nvidia and Intel have actually raised guidance.
Between September 1 and 8, all sectors lost ground, led by financials, industrials and consumer discretionary.

JAPAN
The Topix hit another year low following a six day rally before ending lower by 2.2% in JPY and 0.4% in EUR. No job growth in the US and rising tensions over Greek debt combined to send investors into risk-off mode again. Softness in Asian markets in the wake of tighter monetary policies also depressed sentiment. The JPY/USD rose by 0.9% while the JPY/EUR lost 1.8% to below 109, the lowest in a month.
The weaker euro and China’s stagnant PMI reading dragged down key exporters. Toshiba nosedived by 9% and hit a year low after agreeing to buy back a 20% stake in the leading nuclear power plant builder Westinghouse from US engineering company Shaw. Among dozens posting year lows in the week were Panasonic, Komatsu, Sony, Mitsubishi Electric, and SMC, all of which declined by 5-8%. A move of one yen against the EUR affects operating profits at Sony and Toshiba by JPY6bn and 3bn respectively. Financials were also weak. Three mega banks fell about 4%, and non-life insurance firms such as Tokio Marine and MS&AD plunged 6% on concerns that their payments to cover damages caused by the Typhoon 12, where more than 50 people died, would balloon. Nomura HD lost nearly 6% as it was in a group of firms being sued by the US Federal Housing Finance Agency. The stock traded lower than its rival Daiwa for the first time on record.
The new Cabinet formed on September 2 was generally welcomed with a support rate of 60-70%, about triple that of Kan’s at the July end. But the impact on the stock market was insignificant as PM Noda would appear to have put “unity” in his Democratic Party before individual ability. Many of the appointees were unfamiliar to electorates and untested as ministers.

ASIA
As the earnings season comes to an end, the picture is rather good as close to 3 out of 4 companies matched or beat the consensus. China, Hong Kong, Thailand and the Philippines led the field. On the other hand, Taiwan’s tech sector was the most disappointing. Downward revisions for 2011 are stabilising after falling sharply over recent months. Growth is now estimated at 11.5% this year and 12.9% in 2012, revised down from +13.3% in July. Estimates have, however, been revised up for both years in Thailand and the Philippines. Estimates for Indonesia and Malaysia are unchanged which is a positive factor in the current global environment and we continue to recommend being exposed to these countries.
Chinese coal prices could rise ahead of their usual seasonal lift. Electricity generation companies are already interested due to (i) poor hydro-electric yields due to drought, (ii) large scale maintenance work in October on the Daishin Railways lines which carry coal transports and (iii) the news that China’s electricity production rose 12% in July compared to July 2010, a sign that underlying demand is high.
Indonesia’s Astra Intl has bought 95% of PT Marga Hanurata Intrinsic and thus the licence to build 40.5km of motorways in the east of Java. Even if the contribution to profits will be no higher than 4%, it is still a first step in an extremely promising sector given Indonesia’s relatively fledgling transport infrastructure. Indonesia is ranked 94th out of 133 countries in the World Economic Forum’s road infrastructure survey. Its road network is 0.6km per km² compared to 1km, 1.7km and 2.5km respectively for India, China and Singapore. There is an urgent need for infrastructure investment to match rising consumption in a population of 250 million people. The fact that Indonesia’s largest conglomerate has invested in a road-building project is a good sign.

OTHER EMERGING MARKETS
India’s Comptroller and Auditor-General has made 3 main criticisms of how gas blocks were allocated to Reliance
Industries:
– the regulator was too complacent over breaches of spending limits on gas field projects. This diminished profitability for the government which has a 50% share of profits once the company has recovered two times its capex.
– Reliance did not return exploration zones declared as non-commercial by the regulator to the government.
– There is some question as to how one company was granted so many development projects.
Auto sales fell by an annualised 6% in August whereas motorbike sales rose 16%. This is probably due to food inflation
which benefits rural areas where motorbikes are very popular.
The Reserve Bank of India meets next week to discuss monetary policy. We believe that, unlike other countries in the emerging zone, it will keep rates where they are due to persistently high inflation.
The market took some profits after last week’s strong rally, shedding 3.8% in USD. This was partly due to the currency
which depreciated by 2.5%. After the unexpected 50bp cut in Selic to 12%, the currency fell to R$1.65/USD, a level not
seen since March. Despite looking more attractive at this level (we remain structurally positive for the long run), monetary policy and inflation concerns are likely to weaken the BRL further in the short term. Nevertheless, we believe the market has exaggerated by pricing in 160bp cuts in the next 12 months. On the microeconomic front, companies are still reporting good figures across the board: Ecorodovias (toll roads) reported 10% traffic growth in August; car production rose 4.4% YTD (versus 2% expected for the full year), car sales were 8% higher YTD, Hering (apparel) said that low income consumption remains strong. Banks’ loans are up 22% yoy.

CONVERTIBLES
After 4 becalmed months, the convertible market saw a USD 800m secondary placing of the USD 2.3bn Glencore convertible held by a small number of institutional investors. The placing, albeit secondary, created some action in a pool which was suffering from the absence of new issues. The corporate bond market also showed some signs of life thanks to France Telecom issuing USD 2bn and KPN EUR 500m. But markets will have to stabilise before the primary market sees a lasting recovery. The Xover index failed to move under 700, an indication of strong tension on credit and concerns over a double dip in many countries. The ECB left its rates unchanged despite its view that the economic climate is more and more worrying. Jean-Claude Trichet even looked quite irritable when a journalist sought explanations over the ECB’s approach to inflation. Greece unsurprisingly is the main cause of increased uncertainty over the debt crisis. The results on its debt refinancing will be out on Friday. Since the end of August, European equity and convertible markets have fallen 2.8% and 1.2% respectively.

COMMODITIES
The key event was the Swiss National Bank’s decision to stop the Swiss France moving above 1.20 against the EUR. This effectively removes a rival to gold which is now more than ever a rampart against doubts on currencies. After Kazakhstan and Venezuela last week, Romania and Bolivia have joined the list of countries looking to hold more gold as reserves by buying in their domestic production. Neither country is a big producer but the amount of available gold will still be reduced.
ArcelorMittal is to close temporarily two blast furnaces in Europe, one in Germany and one in France, due to lacklustre demand. But there was some good news amid the gloom. Maritime freight rates are still recovering fast which shows China is stepping up commodity purchases after a year of destocking. Iron ore exports from Port Hedland in Australia rose 15% between July and August. In metals, AngloAmerican and Rio Tinto are to sell their stakes in the South African copper mine Palabora. Mining companies seem to be less and less keen on investing in South Africa due to costs rising 15% a year and the increasing threat of nationalisation.
Brent ended the week 1% higher despite US demand slipping 0.2% after six up weeks. Close to 60% of oil production in the Gulf of Mexico is currently idle (2 million b/d at full speed) due to high cyclone incidence.

ASSET ALLOCATION
Markets are still very nervous and volatility remains close to 35. Between September 1 and 8, the major indices performed as follows in local currency:
Standard&Poor’s 500 -1.5%
Euro Stoxx 50 – 6.2%
TOPIX -2.7%
MSCI Emerging markets +0.2% (in EUR)
The yield on US 10-year Treasuries briefly touched a 60-year low of around 1.9% but ended the week above 2%. The equivalent Bund yield also finished above its lows at 1.9%.
The dollar was strong against the EUR (below 1.39 vs. 1.43 last week) and to a lesser extent against the JPY (77.6). The
RMB remained in a narrow 6.38-6.39 trading range.
We continue to prefer emerging markets to the US and, in Europe, the Dax to the Swiss and UK markets. We have
reinforced the Canadian dollar and started to take the top off GBP positions after the Bank of England’s decision to leave rates unchanged caused it to rise. Europe Flexible: ahead of important central bank meetings in this month, we are gradually reinforcing equity exposure in Europe and positioning portfolios for a technical bounce. After reaching the bottom end of our exposure range at the end of August, we have raised exposure by buying back DJ Eurostoxx 50 calls and buying futures.

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