Cautious Stock-Picking After the ECB Eases
Some banks stocks could be ripe for an upturn, and corporate bonds could rally. One theme: defensive growth.
But the president of the European Central Bank offered nothing to further depreciate the euro, effectively drawing a line in the sand for now in its efforts to devalue the common currency against other major currencies and committing it to trade in a range against the dollar between $1.07 and $1.14.
Draghi on Thursday delivered far more than anticipated. His package included increasing the size of the asset-purchase program from 60 billion euros ($67.15 billion) a month to €80 billion beginning in April, lowering the deposit rate to minus 0.4%, and introducing a new targeted long-term refinancing operation for banks from June, all of which were largely expected.
However, he also trimmed interest rates on the main refinancing operations and the marginal lending facility, and included in the asset-purchase program euro-denominated bonds issued by euro-zone nonbank corporations.
The reaction was muted on Thursday, partly because of Draghi’s blunt message that the ECB doesn’t anticipate cutting rates further. But markets rallied on Friday after investors had a chance to digest the actions. The Stoxx Europe 600 index gained 2.6% on Friday, while the yield on German sovereign bonds with a 10-year maturity fell four basis points, to 0.27%. The euro was trading at $1.11 on Friday, up 2.3% in 2016.
The scale of the measures reflects the ECB’s worry about the health of the euro-zone economy and comes as the central bank cuts its forecast for gross-domestic-product growth to 1.4% in 2016, down from 1.6% in December. Its estimate for inflation this year drops to 0.1% from 1%.
Little wonder the ECB is keen to stimulate bank lending. The ECB has tried to make life easier for banks through the targeted long-term refinancing operation: with negative deposit rates, banks are essentially going to be paid to lend to the real economy.
It could be a good time for investors to re-evaluate the sector. Bank stocks are down some 20% since the start of 2016. Benjamin Segal, who manages the Neuberger Berman International Equity fund (ticker: NBIIX), in recent weeks has purchased shares in Lloyds Banking Group (LLOY.UK) and Barclays (BARC.UK) in anticipation that they were going to rebuild their capital, repair their balance sheets, or make plans to pay dividends.
ECB purchases of corporate bonds will begin in the second half of the year, but the long wait and uncertainty over what will be bought could produce a rally in high-grade spreads. Debt issued by utility, transport, energy, and basic industrial companies could outperform. There could be a positive knock-on effect in high yield, which is ineligible for purchase. The market for investment-grade credit is worth about €1.6 trillion, but the portion that meets the ECB criteria for purchase is just €550 billion.
Details are still to be worked out, but the ECB plan raises numerous issues. With debt prices set to tumble as the ECB buys what it can, it makes sense for European companies to raise debt at close-to-zero interest rates and use the proceeds to buy back their stocks or pay higher dividends, suggests Bill Blain, strategist at Mint Partners. “Perhaps it’s time to buy the shares of European investment-grade corporates,” he says.
STOCKPICKERS ARE TAKING THEIR TIME evaluating the ECB moves and their effect on the markets. Brian Hennessey, the portfolio manager of Alpine’s Dynamic Dividend fund, says future gains won’t be across the board, so stock selection is important. He’s looking for defensive growth companies with good cash-generation in niche markets.
Among his picks is ISS (ISS.Denmark), which provides facility services such as cleaning, catering, security, and property management. The Danish company “is not a very exciting story,” says Hennessey, but it is delivering organic growth of 2% to 4% annually, improving margins, and reducing debt. Its shares, which closed in Copenhagen on Friday at 249.50 Danish kroner ($37.33)—giving it a market value of about $6.93 billion—have climbed 55% since its initial public offering in March 2014.
But at 15 times estimated 2017 earnings and a ratio of enterprise value/earnings before interest, tax, depreciation, and amortization of 10, ISS trades at a discount to peers like Compass Group (CPG.UK), which has a 2017 price/earnings ratio of 19 and a EV/Ebitda multiple of 12. Hennessey believes that the stock could rerate and shareholders could see higher returns. ISS currently offers a 3% dividend yield.
Neuberger Berman’s Segal sees opportunities in the health-care and industrial sectors due to factors like recurring revenues and lower volatility. Among his holdings are SAP (SAP.Germany) and Linde (LIN.Germany).
EDF seeks financial support from French state for Hinkley Point C
EDF will not go ahead with the contentious £18bn Hinkley Point C nuclear project in the UK unless it wins further financial support from the French government, according to a leaked letter by the utility’s chief executive.
Jean-Bernard Lévy, who has come under fire this week for pressing ahead with the project, said in the letter seen by the Financial Times that he was negotiating to “obtain commitments from the state to help secure our financial position”.
He added he would “not engage in the [Hinkley Point] project before these conditions are met”, without going into detail on how this might occur.
Two people close to EDF said the French state could take a stake in the Hinkley Point C project, or possibly participate in a capital raising by the company, although they said that nothing had been finalised. The government has an 85 per cent stake in EDF.
The letter by Mr Lévy was intended to reassure EDF employees amid growing disquiet over its plans to build two new nuclear reactors at the Hinkley Point power station in Somerset for electricity generation. Thomas Piquemal, EDF’s finance director, resigned last week over concerns that the project could threaten the company’s future.
The Cour des Comptes, France’s state audit body, said on Thursday that the “complexity of both funding and carrying out” Hinkley Point should cause EDF to ask itself if it was the right decision.
Critics have raised concerns about the £18bn cost given EDF’s stretched balance sheet. EDF borrows money every year to pay its dividend, and the company’s €37bn of net debt dwarfs its €19bn market capitalisation.
Worries also exist over the ability of EDF to complete the Hinkley Point project on time. Two other projects in France and Finland using the same technology — the so-called European Pressurised Reactor — are both heavily delayed and over budget. Another in China has also experienced slippage, although less severe.
The Big Read
EDF: At breaking point
The French energy group plans to go ahead with the Hinkley Point nuclear project despite the expense
Mr Lévy admitted in the letter to employees, which was sent on Thursday, that “the financial context is tense” and that Hinkley Point had been “the subject of much debate”. The final investment decision is expected as soon as April.
Mr Lévy addressed concerns about the construction risk, saying that EDF had learned from its two EPR projects in France and China. “We will benefit from the experience and the feedback,” he said.
He also said Hinkley Point would ultimately be profitable for EDF, with a return of 9 per cent over 60 years. The price the UK government has guaranteed for the wholesale electricity that Hinkley Point C will produce is three times the current going rate.
The construction will represent 15 per cent of EDF’s investment on average for 10 years, said Mr Lévy, leaving “ample room” for other projects such as extending the life of France 58 nuclear power stations, which is set to cost €55bn.
The French and the British governments came out this week to fend off criticism of Hinkley Point and to publicly renew their support.
For the UK, Hinkley is a key part of plans for low-carbon electricity generation.
France, meanwhile, needs to retain its nuclear expertise through exports as it prepares to renew its own fleet of reactors, which provide two-thirds of the country’s electricity.
They weigh 44 tonnes, travel nose-to-tail in convoys and communicate using a combination of WiFi, cameras and radar. And if you look in the cabin and see a driver without his hands on the wheel do not panic — that is all part of the plan.
The prospect of driverless lorries hurtling along motorways will move closer in the UK next week when George Osborne will use the Budget to announce trials for the automated convoys as part of a sweeping embrace of auto technology.
But a substantive question remains about the lorries: just how much space can the “road trains” safely leave between the vehicles’ bumpers?
Volvo has done tests in Sweden, and found the gap could be as little as four metres, which would leave a breaking time of just 0.2 seconds if the convoy, known as a “platoon”, were travelling at 44mph. If a second’s breaking time were required, that would mean a distance of 22 metres for a platoon travelling at 50mph.
Linked by wireless communication, radar and camera systems the lorries brake simultaneously when the leader of the pack slows. The technology, which has been tested in the US and in other parts of Europe, sees the front truck use lane-sensing technology to stay inside the lines, while others in the convoy follow behind.
Although each lorry will have a driver in the cab, once on the motorway the lorries drive themselves — with the driver taking control to leave the motorway and depart to difference destinations.
Six of the largest European truck brands — Volvo, Scania, Mercedes, Iveco, MAN and DAF — will next month criss-cross Europe as part of an EU programme to trial the platoon approach.
Mr Osborne will use his Budget speech to accelerate Britain’s embrace of such technology, pledging to overhaul regulation to allow driverless cars to run on motorways by 2020.
“Driverless cars could represent the most fundamental change to transport since the invention of the internal combustion engine,” he said.
Nissan has announced plans to introduce fully autonomous vehicles by 2020, while others companies, such as BMW and Mercedes, already have some “lane control” abilities in existing cars. The industry says driverless cars could eliminate the vast majority of road accidents because machines do not get distracted or fall asleep.
“At a time of great uncertainty in the global economy, Britain must take bold decisions now to ensure it leads the world when it comes to new technologies and infrastructure,” said Mr Osborne.
Driverless lorries have been touted as having the potential to transform the haulage and logistics industry, cutting workforce costs and fuel bills while improving productivity.
Driving in platoons would not necessarily initially save haulers money, cautioned Malcolm Bingham, a director at the UK’s Freight Transport Association, as the cost of the technology would outweigh the likely fuel cost savings.
But, he added, the technology was “a useful stepping stone to full autonomy”, which would allow haulage groups to run trucks continuously, avoiding the costs of driver breaks or restrictions on working hours.
Under Department for Transport plans seen by the Financial Times, truck manufacturers, engineering companies and haulage groups will be invited to tender for testing licences from as early as next month.
A £19m scheme that is likely to be extended in Wednesday’s Budget has seen test centres set up for driverless cars in Coventry, Bristol, Greenwich and Milton Keynes. A further £100m was pledged from public funds last year towards research and development into the technology.
Mr Bingham said the trial phase was important to test the suitability for UK roads.
A key issue for the tests is how to prevent lines of lorries from blocking other motorists from joining or leaving the motorway. This is why it has been suggested that the M6 in Cumbria could be a test area.
“On that part of the M6 the junctions are very widely spaced apart,” said Mr Bingham. “You couldn’t do it on the elevated M6 in Birmingham, where junctions are close together and motorists cross two lanes to leave the motorway.”
It is also expected that the first convoys will travel at night, when the chance of disrupting other motorists is minimised. “You can’t replicate these sorts of problems on test tracks,” said Mr Bingham. “You have to be on the road.”
Driving trucks close together is not only safer but also more fuel efficient, according to industry estimates. Savings range between 5 per cent and 20 per cent from lower fuel use by trucks at the back of the convoy, because they encounter less wind resistance.
The Department for Transport said: “We are planning trials of HGV platoons — which enable vehicles to move in a group so they use less fuel — and will be in a position to say more in due course.”
Weekly Market Update: From Beijing to Frankfurt
China and the ECB set the tone for global markets this week. Last weekend, the Chinese leadership disclosed their economic projections for 2016 at the National People's Congress (NPC), unveiling a GDP target range of 6.5-7.0%, as well as a higher fiscal deficit level. China left its CPI target at +3%, and cut its fixed asset investment growth to 10.5% from 15% prior. The changes were largely in line with expectations, although enthusiasm was tempered by the very weak February China trade report out later in the week. On Thursday, the ECB launched another round of monetary policy stimulus, cutting all three of its key policy rates and adding to its monthly QE bond buying scheme. Mario Draghi warned markets that there would not be much more easing on tap from the ECB, while simultaneously claiming that the ECB was not out of ammo. Thursday was the seventh anniversary of the current bull market, as measured from the Monday following the S&P500's ominous bottom at 666 on Friday, March 6th 2009. US markets were flattish and devoid of much major news (beyond the continuing political circus of the presidential nominating contest) until Friday, when stocks surged higher. For the week, the DJIA added 1.2%, the S&P500 gained 1.1%, and the Nasdaq rose 0.7%.
Markets eyed the February China trade report with concern. China's trade balance sank to a 10-month low in yuan terms and an 11-month low in dollar terms, while yuan exports fell 20.6% y/y, their biggest annualized decline since May 2009. Chinese exports have now fallen for eight months in a row, while imports have contracted for 16 straight months. Shipments to the US, Europe and Japan were all down about 20% y/y, racking up bigger declines than high-single/low-double digit slippage seen last month. The data also explain why last weekend Premier Li decided to skip 2016 projections for the trade component of the economy. After the trade numbers, HSBC suggested that recent hopes for a global rebound need to be tempered, as the figures clearly show the downturn in global demand is not getting any better.
In its decision on Thursday, the ECB cut all three of its key rates, and expanded the QE bond buying program by €20B to €80B a month. In something of a surprise move the central bank also said that non-bank investment-grade corporate bonds will now qualify for the buying program, vastly expanding the universe of debt the ECB can choose from. Fears about the perilous state of some banks remain a big problem for the euro zone recovery. While bonds issued by banks still don't qualify for ECB buying, falling yields on other corporate debt due to ECB buying will likely inspire investors to turn to bank debt for yield. The ECB also eased bank funding costs by unveiling a new four-year TLTRO loan program, which could carry interest rates as low as the deposit rate (now cut to -0.4%). In the press conference, President Draghi suggested that there would be no further easing (unless things got much worse), which somewhat dampened the immediate response to the decisions. Draghi also took pains to reiterate that the ECB is by no means out of tools or out of ammo. Buyers snapped up Greek and Portuguese government bonds after the announcement, while most other sovereigns sold off, sending yields higher.
The final reading of the fourth quarter GDP report confirmed Japan's economy has dipped into contraction for the second time in three quarters. The final reading was a bit less bad than the preliminary data, thanks to slightly better corporate capex spending. There was more talk that the government would again push back the second round of sales tax increase from the current April 2017 target date, with a key cabinet meeting scheduled for March 16th.
Commodity prices see-sawed through the week, following the ups and downs of the Chinese economy. Chinese iron ore futures gained 19% on Monday, to multi-month highs, topping an eight week rally, after Beijing set its 2016 GDP target range, then reversed around half this rally on Wednesday after the brutal February trade report - but then reversed higher through week's end. Other major industrial commodities followed a similar trajectory. After following the run-up in commodity prices over recent weeks, mining stocks saw steep losses mid-week, although many of the global mining majors closed out the week flat, with the exception of Vale, which is down 13% thanks in part to the chaos devouring the Brazilian political leadership. Goldman Sachs published a note on Wednesday arguing that deflation, divergence and de-leveraging would reapply downward pressure on commodity prices in the near term.
The rally in crude oil prices slowed but did not stop, as WTI tested YTD highs just shy of $39 and Brent equaled November highs above $40. Maneuvering ahead of a potential oil production freeze summit continued. There had been talk that OPEC and some non-OPEC nations would meet on March 20th in Moscow to seal the deal, but officials said the inability to get Iran on board meant the meeting would most likely take place in April. Sources say Iran is demanding to be allowed to freeze production at its pre-sanctions production level of 4.0M bpd, rather than current levels, which were just over 2.9M bpd in January. The Kuwait Oil Minister said they would only join the freeze if "all major producers" signed on, and threatened to sell "every barrel Kuwait produces" if there is no deal.
Global banking giants Deutsche Bank and Citigroup both made cautious comments at industry conferences about the business environment for banks in the first quarter. Citigroup's CFO warned that revenue from equity and fixed-income trading would fall 15% y/y in the first quarter, while investment banking revenue would fall 25% y/y. Deutsche Bank's CEO said the seasonally strong first quarter might turn out to be challenging for the sector overall, given the heightened volatility in global markets.
United Continental CEO Oscar Munoz said he would return to work just two months after heart transplant, and was welcomed back by a big push by two funds to take control of the board. Holders PAR Capital (3.8% stake) and Altimeter (3.1% stake) said they would launch their own slate of six board members and nominate former Continental CEO Gordon Bethune as chairman, claiming the current board is not holding management accountable. United said they had been engaged in talks with the two firms, and also said they were disappointed the firms could not reach a deal with management.
There was talk that BASF was mulling a rival bid for DuPont, which is in a pending deal with Dow Chemical. According to reports, BASF had contacted DuPont last year, before announcing a $130 billion merger agreement with Dow. Deutsche Boerse is expected to formally announce a merger agreement with London Stock Exchange next week. TransCanda disclosed that it was discussing a "potential transaction" with an unnamed third party, following press reports that a $10B merger with Columbia Pipeline Group was under consideration.
Closing Market Summary: Financials and Energy Lead Indices to Weekly GainThe stock market ended an upbeat week on a higher note as investors backpedaled from yesterday's initial response to the European Central Bank's latest policy statement and remarks from ECB President Draghi. Meanwhile, supportive conditions from the oil patch and leadership from the heavyweight financial (+2.7%) sector expanded the stock markets winning-streak to four weeks. The Nasdaq Composite (+1.9%) finished ahead of the S&P 500 (+1.6%) and the Dow Jones Industrial Average (+1.3%).
Equity indices jumped out of the gate, as global equity markets rebounded after yesterday's muddled trade. Yesterday's flat performance followed remarks from ECB President Draghi indicating that he does not anticipate that rates will need to be lowered further. Today, investors focused on the ECB's policy statement itself, which expanded asset purchases and lowered the interest rate corridor. As a result, European bourses rallied with financials at the forefront. To that point, Deutsche Bank (DB 20.62, +1.35) jumped 7.0%.
The heavyweight financial sector (+2.7%) displayed strength from the start as it traded higher in sympathy with European banks. The group entered positive territory for the week (week-to-date +1.0%) and extended its March advance to 6.6%. Strength in the financial sector was broad based with money center banks, asset management names, and insurance companies all helping to push the economically-sensitive sector higher.
Meanwhile, a rally in crude oil enabled commodity-sensitive energy (+2.2%) and materials (+1.8%) to top the leaderboard. WTI crude benefited from a report from the International Energy Agency, which contended that production declines from the U.S. and other non-OPEC members may be signaling a bottom in oil. To be fair though, the report also pointed to largely flat demand from the United States. The energy component ended its day higher by 2.4% at $38.67/bbl.
Heavily-weighted health care (+1.9%) was able to swing from a week-to-date loss to a 1.7% gain as biotechnology outperformed. The iShares Nasdaq Biotechnology ETF (IBB 261.94, +6.86) climbed 2.7% today as the ETF moves off a year-to-date loss of 20.9%. The broader health care sector is down 5.1% over that period. Separately, Dow component Pfizer (PFE 30.50, +0.91) climbed 3.1% after receiving FDA approval for expanded use of XALKORI to treat patients with metastatic non-small cell lung cancer. Pfizer topped the price-weighted index.
The Dow Jones Transportation Average (+2.3%) displayed relative strength today as rail names outperformed in the index. Meanwhile, Avis Budget (CAR 27.47, +1.60) jumped 6.2% as it traded higher in sympathy with Hertz Global (HTZ 11.09, +1.22), which surged 12.4 % after receiving an upgrade at Morgan Stanley to "Overweight."
The dollar pared early gains against the euro. The euro/dollar pair ended lower by 0.2% (1.1151) after slipping from a high of 1.1189. Meanwhile, the dollar/yen pair ended near its intra-day high (113.81).
The Treasury complex moved to session lows as the equity market extended its rally. All in all, the yield on the 10-yr note began the day at 1.94% before moving to a session high of 1.98% (+4 bps) and drifting there until the close.
Today's participation fell below the recent average with fewer than 974 million shares changing hands at the NYSE floor.
Today's economic data was limited to February Import/Export Prices:
- We saw in today's Import/Export Price Index report that declining fuel prices again acted as a major drag on import prices, which fell 0.3% in February after a 1.0% drop in January. That left import prices down 6.1% year-over-year.
- Excluding fuel, import prices edged down 0.1% month-over-month and are down 2.7% year-over-year. Translation: price declines aren't just energy driven. For the record, nonfuel import prices haven't recorded a monthly increase sine July 2014.
- Export prices, meanwhile, declined 0.4% with declining nonagricultural prices more than offsetting rising agricultural prices. Export prices are down 6.0% year-over-year.
- Excluding agriculture, export prices declined 0.4% in February and are down 5.6% year-over-year.
There are no economic releases of note scheduled for Monday.
- Nasdaq Composite 5.2% YTD
- Russell 2000 -4.3% YTD
- Dow Jones -1.2% YTD
- S&P 500 -1.1% YTD