On the markets: Slovakia’s parliament was the last of the euro zone’s 17 countries to ratify the EFSF. Set up in 2010, the fund is now open for business with country members after helping out with Portugal and Ireland. US jobless data for September were more encouraging than August’s disappointing figures. 103,000 jobs were created which was not enough to lower the unemployment rate from 9.1%. However, the private sector, which created 137,000 jobs, is picking up. Figures for the previous two months were revised up by 99,000 as wages and the weekly working week were also revised higher to modestly positive levels…….
Edmond de Rothschild Group (Market Outlook: 07/10/2011)
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Consumers will continue to pay down debt but the situation is less urgent. Moreover, monthly debt payments are still falling and the overall corporate payroll is rising. A little more than 2 million jobs have been created since February 2009. Germany’s industrial orders fell 1.4% in August after losing 2.6% in July. This was mainly due to lower exports of consumer goods. But in the same month, exports were 3.5% up on July.
EUROPE
The equity market rally continued on news that European banks would be recapitalised shortly and the likelihood of a partial Greek default. Investors are now expecting a haircut of 60-75%. Meanwhile, the troika has approved the disbursement of the fifth EUR 8bn tranche to Greece. It will be paid at the beginning of November after approval by the EUROGROUP and the IMF’s board. Slovakia finally voted through the new-look EFSF which will now have a war chest of EUR 440bn. We should now hear how the fund will effectively operate. Even if the rally was driven more by hopes of imminent progress in settling the European banking crisis rather than hard facts, it still helped European indices to rebound by close to 14% from its September 23 low while euro indices gained almost 20% over the same period.
Banks eventually advanced little during this week’s rally due to S&P and Fitch downgrading Spanish banks including Santander and BBVA. Both agencies said gloomier economic prospects and the persistently depressed property market had led to their decision. Fitch also announced that it was overhauling its bank ratings. Fewer banks in the world will in future be rated AA or above and most will be in the A category. Universal banking models and investment banks with higher exposure to capital markets and which depend on short term financing, have been particularly badly hit. As a result, long term and viability ratings for Barclays, BNP Paribas, Crédit Agricole, Credit Suisse, Danske Bank, and Deutsche Bank are now on negative watch.
In company results, Burberry’s Q1 sales jumped 23% to GDP 830m. This represented organic growth of 28% after +32% in Q1. CEO Angela Ahrendts said that brand momentum was still strong across all zones and products. In technology, ASML beat expectations and Q3 orders were slightly above guidance.
Roche (pharmaceuticals), however, missed sales expectations due to the strength of the Swiss franc and the impact of Avastin. But the company maintained 2011 guidance for low single-digit growth due to US healthcare reform and European austerity measures. Elsewhere in Switzerland, Givaudan’s sales rose 5.4% in CHF but suffered a negative 16.3% currency impact. Fragrances recovered, rising 1.3% over 9 months vs. -0.4% in H1). Syngenta’s Q3 results beat the consensus by 7%, rising 21% (and 16% on a like-for-like currency basis). The 3% rise in prices was also a very pleasant surprise.
Carrefour released its Q3 sales and also issued its 5th profit warning in a year. The company says operating profits for 2011 will fall 15-20% instead of the 15% decline previously expected. This looks particularly poor compared to Casino, both in France where Casino’s hypermarket sales only dipped 1.5% compared to a fall of 4.4% for Carrefour, and abroad, especially in Latin America. Carrefour says this is due to deteriorating consumer sentiment in most European countries – non-food, for example, fell by a very disappointing 10%- and the negative impact of the group’s new sales strategy in France. The group refused to comment on the performance of its new hypermarket concept Carrefour Planet but it will take time to meet targets as will restoring its price image.
M&A is also picking up a little. Some private equity funds are still active. Permira is reported to be on the verge paying USD 1.5bn for Alcatel’s Genesys Laboratories (software for call centres and video conference calls). Permira was already in talks with Alcatel to buy the entire enterprise division which includes Genesys. Alcatel rose on the news as the deal could improve its balance sheet which is viewed as risky.
Unilever has paid EUR 604m for 82% of Concern Kalina, a Russian maker and distributor of cosmetics. The price tag represents around two times the company’s sales.
GDF Suez’s decision to appeal against the government’s decision to freeze gas prices for households from October 1st 2011 is another reminder of political interference in the utilities sector.
US
US equity markets moved higher as worries over the US economy abated and the first Q3 results started to appear. In the political arena, the Senate unsurprisingly threw out Barack Obama’s USD 447bn stimulus plan which targeted infrastructure and lower taxes for the middle classes and small and medium companies. Elsewhere, the minutes of the last FOMC meeting suggest FED members are increasingly likely to introduce extra measures to boost the economy.
In company news, Alcoa kicked off the earnings season with lower than expected figures due to rising costs and a slight fall in deliveries. However, the group is still forecasting a rise in global demand for aluminium. In technology, Google posted excellent figures driven by strong sales growth. Google+, which is supposed to counter facebook, is reported to have more than 40 million users. In banks, JP Morgan reported in line and there were encouraging signs that credit quality was improving while corporate lending grew by a modest but constant sequential rate of 3.4%. The bank is, however, still cautious on the outlook for the 4th quarter. Over the last five trading session, all sectors advanced led by tech and consumer discretionary stocks.
JAPAN
The Topix has just made up for last week’s steep loss, gaining 3.7% in JPY and 0.8% in EUR. Euro-zone efforts to contain its debt crisis largely relieved investors. Although Slovakia’s intial vote against the EFSF enhancement plan and flood damage to Japanese production facilities in Thailand weighed on later in the week, the Tokyo market rose on the back of steady Asian stocks and better-than-expected machinery orders in Japan. Trading volume was 18% less than last week as investors showed caution ahead of the earnings season which kicks off later this month. The JPY/USD rate was little changed at mid JPY 76 while JPY/EUR, up 2.9%, stabilised after hitting a 10 year low last week.
Economically sensitive stocks recovered sharply from their nadir while defensive sectors were largely snubbed. Tokyo Electron surged 17% on strong rallies in equivalent US stocks and was one of the best gainers in the TSE1, despite third quarter orders in its chip making division hitting a 2-year low. Komatsu and Fanuc jumped by around 15% encouraged by rallies in Chinese stock markets. Major trading houses rose by more than 9% after plunging some 20% in the past two weeks.
In contrast, the flood in Thailand has raised serious concerns over Japanese firms with critical manufacturing sites. Nikon, down 4% and among the worst decliners, makes 90% of its most profitable high-end cameras in Thailand, and said it had no idea if it could resume shipments in time for Christmas sales. Most automakers are suspending local production.
Honda’s plants were also submerged while Toyota and Nissan, with no direct damage, are suffering from supply chain disruptions. The flood is expected to last at least another month and this could potentially leads to sizable opportunity losses.
ASIA
All sectors rebounded this week boosted by macroeconomic news in the region. Chinese inflation for September dipped a little to 6.1% which suggest the situation is under control. And Thailand announced an average 30% cut in corporation tax which is an indication of strong government finances. Indonesia has followed on from Brazil and cut its benchmark rate from 6.75% to 6.5% which should underpin economic growth and household consumption. Lastly, the Philippines is to spend USD 1.5bn on infrastructure. As high quality infrastructure is lacking, this money will really create additional economic value.
As far as companies are concerned, the 4th quarter will be tricky for cyclical businesses like steel makers and petrochemical groups. Margins will struggle to remain at the already depressed levels seen in the last quarter. In contrast, some domestic consumption segments are seeing strong growth in demand. Smartphones in China are a good example: a new generation of handsets sold at less than UER 130 could send annual volume up by more than 150% next year.
Mediatek, the low cost rival to Qualcomm, supplies processors for these phones and stands to benefit from this development.
OTHER EMERGING MARKETS
The market rose 6.8% (in USD ) on news on the outlook for Euro-banks capitalisation plan and better US figures. Moreover, we have observed a important downturn in food inflation in the EM. Brazil should not be different. However, September inflation continued to rise in Brazil (7.31% versus 7.23% in August). On the other hand retail sales came down significantly from 7.1% in August to 6.2% in September. All attention is on the Central Bank’s decision on interest rates next week (on October 19th). We expect it to lower interest rates by 50bps. The third quarter season has started with consumer companies Localiza, Hering and CBD. All results showed that the deceleration is underway. Even though this was expected, the results were still a little below expectations. As in the second quarter, we expect Q3 sales and ebitda margins to disappoint. We are increasing exposure to growth stocks.
Infosys kicked off the earnings season with better-than-expected results. Quarterly sales rose 4.5% in USD and the operating margin improved by 200bp compared to the previous quarter which had seen wage increases. Analysts were going for 100bp. Due to the Rupee’s depreciation, the company has sharply upped EPS guidance for 2011 from Rs 128/131 to 143/145.
The government has reacted to coal shortages by asking Coal India to channel all this month’s production to electricity companies rather than auctioning some of the production off to other industries. September inflation was still running at a very high 9.72% vs. 9.6% expected. This suggests the Reserve Bank of India could raise rates further.
CONVERTIBLES
Good US macroeconomic data provided some relief for equity markets. This led to buying on convertibles, mainly in Europe and Asia. Convertibles issued by Chinese developers soared by between 20-30% and the same sort of moves were seen on credit markets. Some oversold European convertibles were sought after by opportunistic buyers and prices gradually rose. We benefited from SAP’s good figures released two weeks ahead of schedule and rumours that Alcatel’s call centre division had been sold for USD 1.5bn.
COMMODITIES
Commodities bounced across the board this week. Brent crude led the field, rising 7% and moving back above USD 110. The IEA has revised down overall estimations of oil demand for 2011 by 50,000 barrels to 89.2 million b/d and for by 50,000 barrels to 90.5 million b/d. The market shrugged this off as demand is still expected to rise and OECD inventories only represent 58.4 days which is below the average over the last 5 years. The oil market is still tight despite the (very) gradual return of Libyan production (400,000 b/d currently vs. 1.6 million b/d pre-war and an estimated 600,000 b/d for the end of this year). And Royal Dutch Shell has declared force majeure on part of its Nigerian production (200,000 b/d).
In other energy commodities, we note that thermal coal stocks are much too low in India, only 9 days of stocks instead of the 22 days required by the government. With winter approaching, the return of El Nino which forced many Australian mines to close last year, efforts to replace nuclear power by coal in Japan and low inventories in India and China, coal is likely to rise even further in coming months.
China’s commodity imports in September showed the uptrend was still intact. Iron ore imports rose 3% to 60.57 million tonnes and copper jumped 12% to 380,500 tonnes. Premiums for physical copper deliveries in China continue to rise. This suggests demand is still strong there in spite of current worries.
M&A deals are hotting up in commodities. China’s Sinopec has paid USD 2bn, a premium of 120% on the last quoted price, for Daylight Energy (oil and gas in Canada). China Guangdong Nuclear Power has admitted returning to the table to discuss a tie-up with Kalahari Minerals (uranium in Namibia), the UK’s Ophir Energy is paying a 64% premium to acquire Dominion Petroleum (oil in Eastern Africa) and B2Gold is buying Canada’s Auryx, which has a project development in Namibia, for a 74% premium.
ASSET ALLOCATION
Volatility abated, allowing equity markets to continue rallying. Between October 6 and 13, the major indices performed as follows in local currency:
– Standard Poor’s 500 +3.3%
– Euro Styx 50 +3.7%
– TOPIX +3%
– MSCI Emerging markets +4.9% (in EUR)
Bond markets retreated further and yields returned to levels close to those seen in August. The yield on US 10-year treasuries rose from 1.71% in September to 2.15% and the Bund added 40bp to 2.1% compared to 1.6% in September.
The euro rebounded from 1.34 to 1.37 against the USD while the JPY stayed around the 77 level. After flirting with 6.36, the RMB ended at around 6.38.
Given the sharp bounce on developed country indices and the fact that investors have very high expectations that the next Euro group meeting will result in hard and fast measures, we have continued to lighten equity market positions. In EdR Croissance Globale, we are reducing emerging country exposure and channelling the proceeds into emerging market debt and Japanese equities. In Europe, we have taken advantage of underperformance in countries like the UK and Switzerland to close some of our hedging. In currencies, the Bank of England’s decision to continue with QE led us to take profits on long sterling positions. At the same time, tensions on German bonds are helping us to rebuild positive exposure to the bond market. Exposure in EdR Europe Flexible has been between 33%-40% with hedging mainly through options.
Despite lower exposure, our choice of index hedges and our use of options are proving efficient at capturing the current market rebound.
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.
Source: ETFWorld – La Compagnie Financière EDMOND DE ROTHSCHILD Banque
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