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EDRG: European leading indicators were a pleasant surprise

On the market : European leading indicators were a pleasant surprise. The provisional eurozone PMI index rose to 50.4 vs. 48.3, moving back above the key 50 level which indicates a recovery in the economy. This was largely due to Germany where the IFO index gained more ground, rising to 108.3 from 107.3…..


Edmond de Rothschild Group (Market Outlook: 30/01/2012) 


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Germany’s consumer confidence is also continuing to improve and the GfK index is slated to come in at 5.9 in February vs. 5.7 (it peaked at 6 in March 2011).   

US housing data might look disappointing but has to be seen in the context of previous figures. Pending home sales dropped 3.5% in December but this was after two months which saw strong rises of 10.4% and 7.3% respectively. Similarly, lower sales of new homes were essentially due to falls in the south, the biggest single family home market, which had risen sharply in the previous month. The property market is still improving, albeit in a very modest way, despite these figures but the trend remains irregular and fragile.
In contrast, durable goods orders remained upbeat in December, rising 3% and 2.1% excluding transport. Stripping out defence and aeronautics, they rose 2.9%.  
Shifts in central bank stances in emerging countries were confirmed this week with rate cuts in Israel and Thailand which both moved from 3.25% to 3%. India, meanwhile, reduced minimum capital requirements for banks from 6 to 5.5%.      

EUROPE
The January effect is still alive and well. The week saw further gains especially for the laggards of 2011: four of the five top sector performances for 2012 so far were among the worst performers in 2011 (and vice versa)! And yet macroeconomic news is mixed as Greece struggles to reach an agreement with private creditors over a new haircut on the bonds they hold.
Fourth quarter results have kicked off with few grounds for enthusiasm. Profit warnings are still frequent and many cyclicals have missed expectations. Siemens, for example, turned in satisfactory performance in lighting alone while its industrial, healthcare and energy divisions disappointed. Thyssenkrupp used its AGM to deliver a rather bleak message on the chances of its US steel business recovering. However, it confirmed reports that it was in talks to sell its stainless steel division to Outokumpu. That would reassure investors that the group was pressing ahead with restructuring. In technology, Logitech revised down sales and profit forecasts for the second time in 6 months while Ericsson’s margins were sharply below consensus expectations. In telecoms, Holland’s KPN has decided to scrap its share buyback programme after revising down prospects for cash flow generation.   
ST Microelectronics released full year results. Despite a favourable currency effect in the fourth quarter as the USD rose against the EUR, and the company’s reassuring comments on order book trends –which echo sentiments at  Texas Instruments- the stock is still burdened by the worrying situation in its mobile joint venture with ST Ericsson (USD 207m in fourth quarter operating losses). Trading is also expected to suffer significantly in the first quarter of 2012: clients will be reducing inventories, old products are declining and deliveries of new products to Nokia are seen lower.    

The only good news came from Nokia which has sold more smartphones and at higher average prices than expected and
Sweden’s SCA (paper) which, unlike its US rival Kimberly Clark, is not seeing any slowdown in demand or indications that clients are trading down.
Switzerland’s Roche (healthcare) launched a hostile USD 5.7bn bid on US diagnostics company Illumina to build up its
presence in this sector.
Carrefour’s stock price jumped on Thursday on as-yet unconfirmed rumours that its CEO Lars Olfsson would be replaced by Serge Plassat. .The group’s operating challenges are still daunting but Plassat’s arrival would please the market He has spent his entire career in retail and has an excellent track record after restoring Vivarte to profitability. He still owns 10% of Vivarte and the Charterhouse private equity firm is also a shareholder.

US
US equity markets edged higher in a week marked by FED statements and fourth quarter company earnings.  At the FOMC, the FED reaffirmed its intention of leaving benchmark rates at current levels of 0.25% and also gave forecasts on growth, jobs and inflation in coming years. It expects to see growth of around 2.5% in 2012. Durable goods orders rose more than expected by 3% due to stronger demand for transport equipment. The earnings season is in full swing and more than 40% of companies by market cap have now reported. Positive surprises are running at 56% which is lower than in previous quarters. There are many companies issuing lacklustre guidance for the first quarter of 2012 including tech sector firms Sandisk and Juniper which fell by more than 6%. Boeing helped the aeronautics sector perform with results that easily beat expectations and Delta, whose earnings surprised on the upside, is confident on the outlook for the first quarter. Earnings from companies viewed as heavily defensive like Verizon, MacDonald and Johnson & Johnson were in line and their guidance for the coming quarter was also as expected.
Over the last 5 trading sessions, the best performing sectors were utilities, materials, and technology. The telecom sector
fell sharply.

JAPAN
The Topix surged 4.4% in JPY but against the stronger euro edged up only 0.4%. The index reached a 3-month high after rallying for 7 days in a row for the first time since early July. Investors turned to mainstream stocks as the yen weakened to levels seen one month ago while the impact of the eurozone crisis abated. Active trading lifted average daily volume to above JPY1tn, a level not seen since mid-December. The yen weakened against the dollar by 0.6% and the euro by 1.5%, or levels seen about a month ago, due partly to the fact that Japan’s CY2011 trade balance of JPY-2.5tn recorded the first deficit in 31 years.
Financials and bellwether exporters were particularly strong. Financial firms dominated the top gainer list with 7 stocks jumping by 10% or more, led by Daiwa Securities, up 15%, while Tokio Marine and Nomura  both jumped 12%. The weaker yen bolstered Toshiba and Sony, both surging 12% and they were also lifted by strong results from Apple, and Toyota and Suzuki, together gaining 11%. Fuji Film rose 8% after its arch-rival Kodak filed for Chapter 11 bankruptcy and also on a report it was mulling investing in the troubled endoscope maker Olympus which had barely staved off delisting from the TSE1. Komatsu, up 4%, extended its winning streak to an impressive 12 days as buyers anticipated China would take more accommodative monetary action.
Downbeat performance was mainly among defensive stocks. TEPCO, which will most likely be under government control next year, plunged 9%. Japan Tobacco and Eisai both dropped 3%, JR East lost 2% and Seven & I Holdings slipped 1%.

ASIA
Asia had a short week as most stock markets in the  region closed for several days to celebrate the Chinese New Year. They reopened in thin trading and focused on cyclicals and financials. China’s central bank said nothing during the holiday but the market still expects to see gradual easing as China is the only BRIC country not to have deviated significantly from its fight against inflation and property speculation. All eyes will be on Shanghai when it reopens for business on Monday. In company news, South Korea’s Hyundai and Kia (autos) unexpectedly missed expectations in the fourth quarter. Both referred to delays in stock deliveries which should be corrected in this first quarter and cause volumes to rebound smartly.
And both are still winning market share in the US and Europe while trading on a reasonable 7 times 2012 earnings. Apple’s sales should have a positive impact on Taiwan-based suppliers including Honhai, Largan and TPK. Oil company CNOOC has released very low forecasts of production growth for 2012 of between zero and +3% maximum compared to consensus expectations of at least 5%. The stock did not fall further due to the strong crude price but it now looks both relatively expensive and also more volatile as it will now be mainly geared to oil price fluctuations. In coming years, four new wells should help improve volume growth but in the absence of M&A deals, it will be difficult to achieve much more.
Even so, the stock could hold onto its premium status as it is one of the very rare oil proxy plays in the region if we exclude Australia. In India, blue chip companies like ITC,  Larsen & Toubro and HDFC Bank posted good results. The market bounced sharply led by the most cyclical stocks and helped by a 50bp cut in minimum capital requirements for banks to 5.5%.  

OTHER EMERGING MARKETS
The week’s headline event was the Reserve Bank of India’s decision to cut minimum capital requirements for banks to 5.5% from 6%. This makes it the last central bank in the emerging zone to make the move. We can expect the trend to continue but the bank may well wait until the budget is voted through so as to measure the extent of the fiscal deficit which is inflationary by nature. Around one third of company results are in. Excluding Reliance Industries (the largest index weighting at 10.3%), earnings growth is running at 15%. About 65% of companies which have already released results have beaten expectations. Despite the troubled environment –significant delays in electricity generation and financial problems at Kingfisher Airlines and GTL (telecom infrastructure) – private sector banks have the cost of risk under control.

Axis Bank, for example, saw earnings rise 36%. But  the cost of risk rose for state-held banks and Canara Bank saw annualised results fall 21%.  Petronet LNG posted results up by an annualised 73%, higher than expected.     

India has enormous infrastructure needs and a largely low-income population so it is the most capital intensive country in the emerging zone. Falling rates should therefore benefit infrastructure financing, which is 70/80% debt financed, in full as well as consumer sectors like cars which are 70% financed through loans. European developments could fuel volatility in coming weeks but we would advise investors to return to the Indian market: valuations are reasonable, the cost of capital is low, the Reserve Bank of India could cushion any global liquidity crisis by injecting liquidity and company results are encouraging.
The Brazilian market rallied 2.52% this week (14.9% YTD), on signs of growth in the US and China and renewed optimism in Europe. On the macro side, the highlight event came from the Central Bank of Brazil which signalled further interest rate cuts to below 10%, or more than expected. Unemployment decreased again to a new historical low of 4.7%. As a result, homebuilders benefited from a more positive outlook for domestic demand. But inflation in January was above consensus in MoM terms – 0.65% vs. 0.56%- driven by higher food prices due to the drought in South Brazil. This week, we held a conference call with shoe-producer Arezzo which indicated that January’s sales, usually a slow month, were doing well this year. Santos do Brasil (port) posted good volume growth in December, after a sharp deceleration between August and November. Furthermore,  Petrobras’ CEO Mr. Gabrielli resigned and will be replaced by Mrs. Das Graças Foster –this was expected but not so soon. Ms. Das Graças is a very  knowledgeable technician, who has spent all her working life at Petrobras.
Other LatAm news included higher-than-expected retail sales of 7.5% YoY, in Mexico, during November, up from 3% in October. This was due to a successful government-sponsored discounted sales programme.   Colombia had  higher results on business confidence, increasing by 4.2 points MoM and 7.5 YoY to 4.2, in November. On the other hand, retail sales for the month grew 1.3% YoY, below consensus expectations of 5.9%. Peru also posted positive numbers: GDP grew 5% YoY, in November, above expectations of 4.7%, driven by the restaurant, hotel and financial sectors; the weakest sector was mining (down 1% YoY)

CONVERTIBLES
It was a busy week for macroeconomic data and news on convertible issuers. Markets focused on the handling of Greece’s budget and the final stages of PSI (Private Sector Involvement) discussions. The talks centre on the possible participation of the public sector, notably the ECB, the coupon on new bonds and the size of the haircut on existing holdings. Investors are  also worried that Portugal might need a rescue plan too. Yields on Portugal’s 10-year bonds widened by 40bp over the week. But European credit indices continued to reflect the easing that started at the beginning of the year. For example, the Xover finished the week 30bp lower.
There was lots of news on companies with convertibles: traders were disappointed by guidance from STM Electronics which sees Q1 sales falling 10%. And poor figures from its ST-Ericsson joint venture sent the stock lower. SAP’s upbeat results were in line with its preannouncement. The entire market in subordinated banking issues picked up when Unicredit made a tender offer on a series of Tier 1 and Upper Tier 2 issues. BNP offered to buy convertibles issued by Fortis Bank which can be exchanged for shares in Ageas.  
IN the US, Illumina jumped on news of a hostile bid from Roche. Sandisk fell on guidance over disappointing sales due to lower electronic chip prices.  
Asia was relatively calm due to the Chinese New Year.  But India’s central bank cut its minimum reserve requirements for banks by 50bp.  

COMMODITIES
Metals jumped on news that the FED was to extend its monetary easing stance. Rates should stay close to zero in the US until the end of 2014.  We also note that the US debt mountain is about to break through its authorised ceiling and nobody seems to care. True, the ceiling will be raised almost automatically by the president.  Given this ongoing slide into further debt and the absence of positive interest rates, gold rallied above USD 1,700/oz.  The maritime freight market continues to sink: so far this year it is down 53% and we are close to the 2008 trough. Note that this steep plunge is not due to demand collapsing in maritime transport but to record numbers of ships (249) coming onto the market in 2011. Unfortunately, this record will be beaten in 2012 when 293 ships are delivered. The recycling of old ships will pick up more speed but we can expect no positive news from the freight sector. The oil price was little changed this week. Yet supplies are still under threat from, for example, South Sudan which intends to stop producing 350,000 b/d on the grounds that Sudan to the north is diverting its production. Natural gas prices in the US enjoyed a 19% bounce this week to USD 2.69 mmcf but they are still 24% lower than on January 1st.  
The rebound was triggered by news that certain high-cost producers would be winding down capacity. We can expect the bounce to fizzle out soon as there is still far too much natural gas being produced in North America and the mild winter is also stopping inventories falling. For the record, natural gas is three times more expensive in Europe.

ASSET ALLOCATION
Equity markets pushed higher as interest rates fell in Europe and more positive economic data emerged. On the US market, volatility as measured by the VIX index, fell below 20 after a recent high above 45 (August 2011). Between January 19 and 26, the major indices performed as follows in local currency:

– Standard&Poor’s 500   +0.3%
– Euro Stoxx 50    +1%
– TOPIX    +3.2%
– MSCI Emerging markets  +0.7% (in EUR)

Yields on Spanish and Italian debt fell sharply. In Italy, they returned to around 6%, close to levels seen at the beginning of November ahead of a peak at 7.3%. Spain’s yields hovered close to 5.1% lows compared to peak levels of 6.7% in November. In both countries, the short part of the  yield curve outperformed significantly. In the US,  yields on 10-year Treasuries fell back to 1.94% after moving above 2.05%.  
The euro rose to 1.31 vs. the USD compared to 1.29. The yen initially lost ground on news of Japan’s first trade deficit in 30 years but ended the period unchanged (77).  China’s RMB once again moved through 6.31 vs. the USD.  Equity markets were underpinned by the Fed’s promise to extend the period of low interest rates in the US and its decision to leave the door open for a fresh wave of QE. We nevertheless still think it is too early to declare a genuine trend change in risk assets: there is still substantial economic risk even if it has abated. This respite is good news and has led us to maintain exposure at the low end of our range. This corresponds to a neutral score. In our geographical plays, we have skimmed exposure to Japanese equities but maintained a positive score on emerging countries, especially those in Asia.
On forex markets, we have taken some profits on the Canadian dollar and the Norwegian krone. We have also started to
reduce our US dollar hedging. Edmond de Rothshild Europe Flexible: market exposure is currently between 40-46%. The slight pullback at the beginning of the week led us to increase exposure by buying calls; currently low levels of equity volatility mean options strategies are quite cheap.


Source: ETFWorld – La Compagnie Financière EDMOND DE ROTHSCHILD Banque

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