For those still trying to gauge where markets will move from here, you needn’t look any further than Clubber Lang’s own expectations for his once forthcoming battle…”pain”. Sadly, need I not remind everyone that performance YTD relative to the markets for Hedge Funds has been as poor as I can remember in the last 20 years. To that point, some managers with both Long/Short and Long-only funds have seen their L/S funds amazingly underperform in aggregate against their Long-only fund underscoring the difficulties felt on both sides. To that degree, while the move downwards most of this week was particularly familiar, the biggest sting came on Friday in the S&P – not a lot of volume, little conviction, no clear sector/thematic trend, and still many unanswered questions on investors’ minds into the long weekend yet the market ripped higher catching many offside. What will happen when China opens next week after the sustained break? Will China devaluate? Most importantly, will OPEC come together and give the production cut many are hoping for - but not necessarily positioned for? No cut and perhaps oil goes to $25, some further hope of a cut (or headlines thereof) and perhaps we see oil into the mid-$30’s. As I have said in the past, while it is hard to pinpoint which of the many Global Debates are driving markets on any particular day, sessions like Friday do point to an interesting phenomenon. Every time oil seems to break near $26, we get a headline or quote from a producing region that drives it higher, and markets follow suit. My view is that the market is yearning for oil to settle at higher levels which would remove a lot of stress from high yield, financials, rates, and the overall equity market. In a world where we have shifted from when $100+ oil was a potential trigger for a recession to a regime where oil below $30 now plays the same part given the amount of capital, capex and overall knock-on effects that have emanated from energy space the last decade. The key question remains however what gets the market to settle at higher levels and helps to break the Wash, Rinse Repeat cycle that we are all so unwelcomely familiar with. Where is Rocky when you need him?
A savvy investor remarked to me recently that there are three things to focus on; the macro, positioning/technicals, and fundamentals. When the macro & positioning/technical are screaming “get out, don’t listen to the fundementals”. The first two have been challenging and the third choppy at best. Positioning is probably around 3/4 of the way there with grosses near 3-year lows while nets have reached their lower point since 2007-08 marks. With Grosses still somewhat elevated around ~15% above the GFC levels, I believe it has been the speed and pace of the downturn that has significantly contributed to the pain. Nowhere has that been truer than in energy, where our Prime Brokerage team notes that Hedge Fund gross and net exposure for global energy is close to 5 year lows. Positioning is now extreme in ETFs as well as on our commodity desk and more balanced across futures. Energy ETF volatility remains high although the recent selloff has been more pronounced in other sectors with energy less of an outlier. In our futures Pain Trade Monitor, we estimate that the net shorts initiated in WTI futures over the past 30 trading days amount to $2.8 billion (5% of total open interest). The momentum trade is being unwound; MS Momentum basket (MSZZMOMO) is down 8% from its January peak (our short momentum basket has 19.5% energy exposure). Furthermore, Friday’s rally in the US is all the more intriguing given what our desk saw on Thursday when funds meaningfully added to shorts, matching January 4th as the year’s top addition day. On a percentage basis, Thursday was the 3rdlargest day of short additions since the beginning of 2015 . The market has shifted from a "love my stocks but hate the market" to "hate the market and have no conviction in my stocks". Lo and behold, Friday was – just as Clubber predicted it – painful as oil squeezed 10% higher and energy stocks were among the top 3 performing sectors to on Friday. Even more frustrating for many was looking up and seeing that Campbell Soup(CPB) has become one of the best performing stocks in the S&P this year ; one of many names in the Consumer Staples sector where not many have been long.
Similar to the difficulty experienced by those trying to forecast oil, US Equity Strategist Adam Parker has been doubtful of the ability of anyone, himself included, to predict the market multiple in any time horizon of less than a few years. There is simply too much volatility in the variable and too many exogenous factors, whether data driven or sentiment driven, to consistently make convicted and ultimately correct calls on the multiple. Among the other major market variables that are difficult to predict are the price of oil, the relative strength of the USD, and the level/slope of the yield curve. When you take four variables you cannot call with certainty and put them at the center of the volatile Wash Rinse Repeat market we have seen, it makes for a difficult setup. Will the next move be up 15% or down 15%? Up 15% puts us just above the August highs on the S&P while down 15 puts us below 1,600. A lot of the focus these past few weeks seemed to be on the scenario that most agree would drive us lower: recession. Looking through various economic indicators and market signals though, it seems like this is as hard to predict as the other market drivers mentioned above. If we look to the credit markets, HY is pricing in a high probability of a recession, but not a 100% probability, and, according to our banks team, the price levels in their coverage are already indicative of a mild recession. If these signals are right then we should continue to brace ourselves for more of the same over these next few weeks as low oil drives fears of slowing global growth, credit defaults, tightening of financial conditions, a move away from risk assets and ultimately a recession.
Not all indicators are flashing red however. The Conference Board’s Coincident Economic Indicator Index (CEI) is trending at about +2% year-over-year with payrolls, personal income, manufacturing and trade sales holding steady, while only the relatively smaller component of industrial production is falling. This week also saw the Federal Reserve Bank of Philadelphia release polling numbers that the probability of negative growth in real GDP are under 16% for this quarter and for each of the following two. Greeting the predictive power of these forecasts with the same incredulity with which Adam Parker greets prognostications of the market multiple might be justified based on history, but those who spend their time trying to make this call are telling markets that recession is not the base case. The message that recession is not the base case seems to be consistent with that from the MS Economics and Equity Strategy teams as well as their work suggests the probability of a recession and a material earnings correction is not as high as what is priced in. This is a judgment call based on the health of the US consumer, the modest fiscal stimulus they expect in 2016, and the importance of the consumer relative to the manufacturing sector, where trends are clearly inferior, but it is not unsupported by recent data from this week: better consumption and residential investment estimates raised MS Q1 GDP tracking to 1.5% from 1.2%, the MS AlphaWise Real Time Indicator of Economic Activity (ARIA), led by housing and employment components, rose 14 bp in January, and we saw a jobless claims number that is trending sideways rather than moving higher. So despite the general feeling of angst in the markets, we might be able to avoid recession after all and stay in line with base case the MS Economics team laid out back in November of a slow slog back to growth. As pointed out by our Consumer Economics team this week in an in depth look on consumer spending trends, on net, real consumer spending accelerated to an average annual growth rate of 3.1% in 2015, the fastest pace of spending since the financial crisis, so maybe we can sit tight and hope that continued strength in consumer spending and some patience and fortitude help turn the tide.
Perhaps the tell is in Credit? Credit markets have grown much faster than the overall economy in part because of Fed policy. In other words, a relentless reach for yield for many years engineered by the Fed. So the risk now is that credit markets are very large, the sell-side and dealer capacity to absorb risk is much smaller, and the need for daily liquidity has gone way up thanks to factors such as increasing mutual fund AUM in fixed income. That sets us up for painful moves and the problematic liquidity environment we are in - as we have seen over the past year. It also sets us up for a big default cycle in terms of the volume of defaults that we will eventually see. In fact, while many Bulls will point to the fact that today’s credit market has better interest coverage and a lower percentage of the market trading at distressed levels than prior recessions in order to try and assuage concerns, Bears will not let us forget that since 2000 and 2007, HY debt outstanding has grown 402% and 139%, respectively. Though corporate credit recessions are typically lighter than asset deflation driven scenarios like we saw in 2008, this statistic still concerns me. In fact, credit is still pricing in greater downside risks than equities. As the Bears argue that the stock market still has more downside to come in order to catch up to our counterparts higher up in the capital structure, I question whether the returns of US IG and HY credit could be more attractive today than those of the S&P – an argument that was presented this week by AdamRichmond who leads our US Credit Strategy Research.
While Adam Richmond believes that the macro backdrop has deteriorated and that it seems increasingly likely that the credit cycle has turned, valuations and spreads in these markets are at recessionary levels. Within InvestmentGrade credit, it is worth considering that if growth slows and volatility remains high, we could see the high levels of issuance experienced over the past couple of years subside as the incentive to increase leverage declines – this could provide the kind of downside floor to valuations that many in our world would welcome these days. For investors choosing to upgrade their portfolios due to the rising macro concerns, IG credit could be viewed as one of the only attractively priced, lower-beta opportunities out there. For those reaching for even greater yield, HighYield credit is screening as increasingly inexpensive even under our House HY default assumptions of 5.6% for 2016 and 7.1% for 2017. Though Balance Sheet trends are mixed with elevated HY leverage ratios despite interest coverage at peak levels, the risk premium priced into this market feels too high. On a single name basis, a few credits across IG and HY that have recently been highlighted as compelling buys from our Credit Analytics desk are Ally (ALLY), Tyco (TYC), Zebra (ZBRA), and Cimarex (XEC). Please let me know if I can send along Adam Richmond’s latest note on the topic or connect you with our Cross Asset Desk.
If not oil or credit, perhaps it will be earnings that can help support the multiple. Unfortunately, with already over 75% of the S&P500 having now reported and the aggregate numbers tabulated, earnings may be less supportive than we would need. At a high level, the earnings surprises ratio continues to be positively skewed, with 70% of the S&P 500 coming in above expectations. What does that ratio mean within the context of negative earnings revisions, disappointing earnings growth, and the smaller-than-historical-average amount by which companies have beat consensus? MS research team found that the 1Q16 guidance has so far seen 5.09 negative-to-positive ratio, which is significantly worse than the 11yr average of 2.64. In fact there have been only two other quarters in the past 24 quarters that saw worse ratio than 1Q16. However and to make matters all the more perplexing, neither one of incidents led to an earnings recession as they instead acted merely as a reset opportunity for companies to lower the bar and subsequently beat the quarters thereafter. If only we could be so lucky this time. Nevertheless, with poor guidance dominating this earnings season, the 2016 y/y earnings growth is now down to just 2.9%. Statistics are one thing but hearing actually commentary, especially on the negative side, from companies this week such as KKR (KKR), First Data (FDC), Rush Enterprises (RUSHA), and Cisco (CSCO), really helped to highlight the challenged outlook that many corporates have on the future. On a side note, we continued to see more pain from lower oil to corporates as well as Anadarko (APC) cut their dividend from $0.25 to $0.05/sh. Of course as most fears in oil do, this caused rippling concerns extending to Apache (APA), Marathon (MRO), Enbridge Energy (EEP), Atwood Oceanics (ATW), OMV (OMW AV), Repsol (REP SM), Eni (ENI SM) among many others.
Unlike the US, European earnings are extremely unlikely to provide a possible redemption as the last 4 weeks the breadth of earnings downgrades has been worse than at any point since 2009 and it’s not just due to Europe’s commodity heavy disposition either. As a matter of fact, every sector has seen at least 10% more downgrades than upgrades. Hopes that Europe would be the best performing market this year continued to unravel this week. 4Q GDP came in disappointingly in-line and December industrial production was weaker than expected which now means it has been weeks since we’ve seen a steady stream of positive economic data. With this bleak outlook across both the macro and micro, spreads have widened, Momentum (MSEEMOMO) has sharply reserved, and Europe has quickly become the most heavily shorted region across the globe. There doesn’t appear to be much on the horizon that capable of turning this around other than clarity on a global level or more juice from Mario Draghi and the latter’s promise of doing “whatever it takes” feels like it’s beginning to have a marginally diminishing effect. Nevertheless, with such a concentration of high conviction bears it’s hard to not at least acknowledge the possible pain that a positive reversal of economic factors and earnings could have. Given that any reversal would likely mean we see a lower Euro or better global conditions it feels like the best options are large, multinational companies with proven businesses models and strong balance sheets. Fortunately Europe has an abundance of these names, such as Novo Nordisk (NOVOB DC), Nestle (NESN VX), Assa Abloy (ASSAB SS), and Dassault (DSY GY), among others; please ask for the full list.
For many of us trying to shake the recurring looming nightmares of 2008, the Deutsche Bank(DBK GY) situation – which reached a fever pitch this week – did very little to ease the nerves of investors as many feared this could be mirrored across other financial institutions. In the end and after much fuss, Deutsche Bank appears to have assuaged investor concerns after not only disclosing enough capital to cover their AT1 Coupons but also announcing plans to buy back bonds. Of course, none of this occurred in time for equity investors to save themselves from being forced to become credit experts but at least for now it is worth reminding everyone that a nightmare is only bad dream and we are not on the cusp of a solvency crisis. In conjunction with our positioning data showing that the largest portion of net selling recently has been in EU Financials, it may be worth considering going long the EU Banks and positioning for the upside, particularly when you remember that “financial instability” is something Draghi said in January that would be on the watch list for the ECB. Furthermore, valuations would support a contrarian position in the banks; many European bank stocks are trading ~60-70% of tangible book values, similar to post the GFC and during the European Soveriegn crisis which are both periods where the macro backdrop was far worse. A few of the top names to own include ABN Amro (ABN NA), ING (ING NA), KBC (KBC BB), Natixis (KN FP), RBS (RBS LN), UBS* (UBSN SW). Additionally, I cannot stress how important of an opportunity our March European Financials Conference in London will offer to investors to uncover opportunities and gain clarity around the outlook for many of the markets most global financial institutions. Please be sure to ask for details.
Banks in the US have a similar risk-reward skew. Of course, risks still abound with corporate credit costs rising, global equity markets fragile and currency wars affecting oil prices, however as our MS North American Banks analyst Betsy Graseck points out, it is more crucial to focus on what is already in the price. Looking at the price it is clear that there has been no mercy towards the US financial institutions, the worst performing sector in the US down nearly 15% YTD. At these prices, bank stock valuations are already at recessionary levels and the greater opportunity likely lies to the upside over the next year. Comparing US bank P/BV multiples to the overall market, she finds that banks are at ~40% of the S&P 500 P/BV, in line with prior lows during the recessions of the early 1990s, the TMT bubble in 1999-2000, and the financial crisis in 2008. She sees 27% upside on average to bank stocks under her coverage, with her base case calling for stable rates, 5% growth in revenues, 3% growth in expenses, and provisions that are ~50% above 2015 levels. However, as with much of the bull cases for sectors, regions, assets, etc. we need stabilizing macro data with improving financial conditions. Top picks are Synchrony (SYF), Capital One (COF), Bank of America (BAC) among large caps and BankUnited (BKU), Signature Bank (SBNY), and SVB Financial (SIVB) among midcaps.
Over in Asia, the winter of discontent continues. Despite most markets being closed for the Chinese New Year there has been no lack of activity in the way of newsflow. Concerns over growth, and FX/rates appear unlikely to abate. With the Hang Sang Index down -5% on the week, Asia Strategist Jonathan Garner reiterates his bear case price target of 16,500 despite the extremely low valuation. HSI is trading below 1x trailing PB, the cheapest since July 1984. Further, the trailing dividend yield of the HSI, is now 4.9% (an all-time high premium above the US 10-year yield). The market appears to be discounting, whether on the P/B or dividend yield spread, significant impairment in the earnings and dividend-generating capacity of the HSI going forward. Garner isn’t convinced we find a resolution in the near term. In a note titled, “The JPY Risk Rally”, our FX team expects the RMB to stabilize next week; in part due to the upcoming G20 meeting in Shanghai, but broad USD weakness lessens the pressure for USDCNY to rise. In stock news, Celltrion (068270 KS) was down 12% despite yesterday’s positive FDA approval news. The move sparked widespread capitulation across the retail playground and blamed for dragging the KOSDAQ index down -5% and at one stage hit a circuit breaker after falling 8%. Macau also made headlines with the index up +2.4% on positive earnings and commentary from both Sands (1928 HK) and Wynn (1128 HK).
In Japan, the Risk-Off sentiment continues to persist as the Topix fell over 12% in just four trading days (worst week since 2008), the JPY strengthened to 113 by end of week-, and 10-year JGB yields flipped to negative for the first time ever. As the Negative Interest Rate policy has yet to have its intended positive impact, concerns have been added about bank profitability and the credit cycle. It was only a matter of time until politicians made their presence felt Friday with comments from Finance Minister Taro Aso that he is “watching FX moves closely” and the WSJ reporting that the BoJ may call an emergency meeting. At current Yen levels Japan is fighting for the survival of ‘Abenomics’ and policy action may be more imminent in Japan given dire market conditions. The BoJ has limited its power to affect the Yen in the short run and Chief BOJ Watcher Yamaguchi-san thinks the BoJ’s move to negative interest rates reflects a “policy reaction function change” which means that the BOJ is no longer focused on just deflation but “to encompass considerable emphasis on controlling financial market trends”. Yamaguchi-san calls for at least one more round of additional easing before the Upper House Election in July with his base case expecting the policy rate to be lowered by 20bps from -0.1% currently to -0.3%. In a risk scenario Yamaguchi-san thinks we could see “Three-Dimensional Easing”– combining a rate cut with a modest increase in JGB and ETF purchasing. Our FX team takes a short-term bullish view on USD/JPY, calling to tactically short the JPY and go long AUD, ZAR and USD. Interestingly, as I look at the market reaction to the BoJ’s decision to implement negative rates, while I can’t say it with 100% certainty it is more likely than not looking as if it were a policy error. With that reality now in the history books, I can’t help but think how this might apply domestically given that Janet Yellen indicated this week to Congress that negative rates are not off the table. In fact, seeing the performance of the US stock markets as well as several negative economic data prints following what looks like a not so well-timed December rate hike, should the Fed follow in the BoJ’s footsteps it could be two strikes and you’re out for the their credibility. In fact, the verdict on that optionality which Ms. Yellen has given herself may already be priced in as we watched gold move almost 6% higher on the week even in the face of a deflationary outlook. Indeed…more pain.
Above all else, for markets to move higher it is clear that we simply need clarity and stabilization. Until then we are likely to see investors continue to reduce exposure to risk assets. As with all points in the cycle, this current environment where capital has been moving to the sidelines does not mean that investors have ceased looking for Alpha on the long side. What has turned in this backdrop has been the shifting focus towards quality names that have perhaps suffered unfairly in the recent turmoil. To identify such investment opportunities, the Alpha Team, a group within MS Sales & Trading, ran a screen of North American names under MS Research coverage to look for quality companies with manageable leverage that are trading at a relative discount to peers but that offer a faster growth profile and better profitability than their respective peer sets. The names on the list are MS Overweight, have a market cap in excess of $2.5B USD, Net Debt/EBITDA (T12M) < 2.5x, and a long term EPS growth rate above peers. A few companies are Alaska Air (ALK), Broadcom (BRCM), Cognizant (CTSH), CVS (CVS), Delta (DAL), Skechers (SKX), UnitedHealth (UNH), and Walgreens Boots Alliance (WBA). Please ask for the full list as well as to be connected to the team.
Nevertheless, please find below a selection of this week's data points, charts and research from each region (Europe, US, Latam, Asia, Japan, EEMEA) that I believe points to an inflection or material change for individual sectors, companies and/or the macro environment this week. I have tried to avoid the obvious beats and misses and instead highlight what I thought to be the more significant trends and inflection points.
Have a great weekend,
Nick
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*Included in my 2016 Global Ideas Deck. Please ask for the presentation.
TRENDS & INFLECTION POINTS
Positive
ì Global – FX Strategy – The ‘quasi-bullish JPY’ trade expressed by a rising EURUSD has worked out and FX Strategist Hans Redeker continues to see the BoJ deploying a faster reaction function compared to the ECB. Therefore, in the short term, USDJPY should find it difficult to break below 114.00 at this stage. The BoJ knows that restructured Japanese pension portfolios now deploying 33% of their assets outside JPY bears a larger P&L risk compared to the old JGB over weighted portfolios. Pension funds performed poorly last year and if the BoJ does not step in near current JPY levels, pension funds may – due to P&L pressures – be forced to reduce their foreign FX exposure by hedging long FX positions against JPY (i.e., selling foreign currencies and buying JPY). In this case, JPY would come under lasting appreciation pressures, even exceeding his JPY bullish projections. How much market sentiment has changed is illustrated by his positioning tracker showing moving to long JPY, yet the consensus on Bloomberg still forecasts further JPY weakness. Hence, verbal or even physical BoJ intervention seems immanent and, if executed properly, it could take USDJPY back up to 118.50.
ìJapan – Banks and Insurers – Hideyasu Ban-san, Japan Banks Analyst notes that the Banks’ & Insurers’ share-price correction has gone too far and interest rate reduction and downward pressure on financial firm earnings do not exhibit a linear relationship. Further if future interest rate reduction improves sentiment for the price outlook, encourages currency depreciation, and supports the stock market, stock-related gains could fuel recoveries in earnings outlook and expectations for stable dividend growth. Ban san estimates a 3.2% hit to earnings for SMFG from a 10bp cut and 12% hit at 50bps. For Mizuho the amounts are 4% and 16%. He estimates the limit to the negative interest rate without causing financial contraction is 50bps. On VALUATION adjusted PBs are in the 0.45-0.50x range for SMFG and Mizuho and he doesn’t expect major impact on F3/16 earnings outlooks / dividends. Stocks have room to recover when investors ascertain that expanded fee income sources and steady sales of strategic stock holdings should avoid serious erosion of profit outlooks. Note attached and I’d be happy to connect you with Ban san.
ì US – Natural Gas – US Commodity Strategist, Adam Longson, reports that while natural gas supply levels remain high, he is encouraged by evidence of slowing growth. Per the latest EIA production data, US dry gas production totaled 74.3 Bcf/d in November 15, 1.2 Bcf/d lower than October levels and 1.5 Bcf/d above equivalent 2014 levels. Judging by pipeline data, it appears supply growth has turned less robust since November, falling 1.3 Bcf/d YoY in December and increasing just 0.5 Bcf/d in January. Winter-to-date dry production growth has slowed by ~5.8 Bcf/d YoY according to pipeline data which significantly improves the probability that balances and prices can recover by YE16 in his view.
ì Europe – Telecom Services – MS European Telecoms analyst Emmet Kelly and team take an in-depth look at the European Towers industry and the scope for Telcos to unlock value. <20% of towers are owned by Tower Cos in Europe vs 90% in the US. European Towers differ from the US in terms of tenancy ratios (US: 2.6x, Europe: 1.4), revenue escalators (fewer in Europe), secondary tenancy discounts (as high as 60% in Europe) and tax status. Euro Telcos could sell more towers - to realise high valuations (TI trades at 5x 17e EBITDA vs Inwit trading at 18x, based on their & Bloomberg estimates), while freeing up capital for deleveraging, 4G etc. DT (>40k Telco sites in Germany, Austria, NL &Poland) and Telefonica have indicated a willingness to explore strategic options for their towers. Vodafone owns ~100k Telco tower sites. Given their valuation of €100-250k a tower, they could account for 12-20% of Euro wireless NAVs. Theoretically, selling towers could see implied wireless valuations fall from 6.5x EBITDA (with towers) to 5.9x EBITDA (post towers sale). They believe that concerns are overdone that selling towers has a detrimental impact on network quality - as exemplified by Verizon's continued Best Network, despite tower disposals. US TowerCos enjoy low tax rates due to REIT status. Euro TowerCos are not REITs - but can use several tax shields.
ì US – Consumer Spending – Paula Campbell Roberts, US Economist, is highlighting categories of spending that carry the most momentum going forward and is outlining the benefits of lower gasoline prices. On net, real consumer spending accelerated to an average annual growth rate of 3.1% in 2015, the fastest pace of spending since the financial crisis. She believes the benefit of lower oil prices was quite obvious in some categories and estimates that consumers spent roughly 70% of their incremental disposable income and savings from lower gas prices. In her corresponding note, she introduces a new microanalysis to reveal spending categories that had the highest momentum in 2H15 vs 1H15 and where consumers may continue to spend — including hotels, home healthcare, truck leasing, video equipment, watches and pork.
ì Global – Tech – The shift of spend to "change" vs. "run" is accelerating. The Indian vendor cost advantage has narrowed and they continue to gain share, but more slowly. MS European Tech analyst Adam Wood, Indian Tech analyst Parag Gupta, and US Tech analyst Brian Essex believe the cost of running IT infrastructure is falling – driven by low cost cloud services and hardware commoditization. Meanwhile, consumers are demanding better access to data & services and a better customer experience. Companies are taking the infrastructure savings and accelerating investments in Digital or SMAC (social, mobile, analytics, cloud) initiatives. they see three key implications for IT Services vendors: 1) Advantage shifts to the "change" experts: they believe vendors that focus on Consulting & Systems Integration ("change") will gain share as spending accelerates in their area. 2) Indian Heritage vendors likely to see share gains moderate: Global vendors have been building out global delivery models. 3) Infrastructure vendors to continue to suffer: they see IBM, HPE, Atos and CSC as most at risk in this area. A shift to cloud (like Amazon's AWS) puts pressure on “run the business” spend and they prefer vendors with relatively high exposure to “change the business” or consulting spend. Downgrade India Technology sector (to In-Line), Atos (to UW) and Wipro (to EW).
ì LatAm – Chile – Chile may be experiencing the beginning of the end of highflation, which is good news for Chile inflation watchers frustrated by stubbornly high inflation over the past two years. The combination of a difficult base effect and tax changes conspired to push annual inflation higher at the start of the year, but this is likely to mark the peak for 2016. With greater signs that slack is building up, coupled with more limited scope for future peso depreciation as the economy has undergone the bulk of its adjustment, our LatAm economics team suspect that highflation will become a thing of the past. And that will be a welcome set of news for Chile’s economy, where deep pessimism among consumers and business alike has become the norm.
ì US – Housing – Home price appreciation continued in November for the 10th consecutive month, according to Case-Shiller’s National Index. James Egan, US Securitized Products Strategist, thinks this increase highlights two important messages: (1) this marks the longest streak of consecutive months of appreciation since home prices bottomed in 2012, and (2) it’s the first time we’ve seen non-seasonally adjusted home prices increase in November since 2005. James was optimistic on US housing formations in his 2016 year-ahead outlook published in November, and he remains positive noting household formations are likely to be driven largely by 1) demographic (millennials) and 2) income.
Negative
î Cross Asset – Implications of Lower for Longer – On the back of Adam Longson’s oil price forecast takedown, their Cross-Asset Strategy team took a deep dive into the implications of lower oil across asset classes. Despite a diversity of fundamentals, price action across risk assets reflects persistently high correlation, each asset adjusting to a ‘lower for longer’ path of oil. Surveying for opportunity, Andrew Sheets, Chief Cross-Asset Strategist, likes exposure to high yield credit ex-energy and large-cap banks which have largely priced in their ‘lower for longer’ oil forecast. On the short side, energy and mid-cap bank equities face the most downside from lower oil. These topics and more will be addressed at their upcoming Global Investment & Asset Allocation Forum held in NYC on February 24th. In addition to their latest collaborative efforts from research, the forum will host Morgan Stanley product desk heads to address best practices of implementation across a spectrum of instruments given cost and liquidity constraints, in addition to accessing alternative risk premia. Marty Leibowitz will lead a lunch keynote on Portfolio Construction in a Correlated World, with additional insight from Andrew Sheets, their Cross-Asset Strategist, and Boris Lerner, their head of Quantitative and Derivatives Strategy. Please ask us to see the details of this event or to be connected with their Asset Allocation team.
î Global – ETFs – their Prime Brokerage team notes that Hedge Fund gross and net exposure for global energy is close to 5 year lows. Positioning is not extreme in ETFs as well as on their commodity desk and more balanced across futures (although they think a high percent of new longs are caught offside). Energy ETF volatility remains high although the recent selloff has been more pronounced in other sectors with energy less of an outlier. In their futures Pain Trade Monitor, they estimate that the net shorts initiated in WTI futures over the past 30 trading days amount to $2.8 billion (5% of total open interest) – 1.2 z-scores greater than the average 30-day net short build we’ve observed over the past year. The momentum trade is being unwound; MS momentum basket (MSZZMOMO) is down 8% from its January peak (our short momentum basket has 19.5% energy exposure)
î US – Freight Transportation – US Freight Transportation analyst, Alex Vecchio, reports that over the past two weeks his Truckload Freight Index (TLFI) decreased sequentially and trended below the historical average at this time of the year. The truckload (TL) demand component of the index decreased sequentially and underperformed the historical average at this time of the year for the second consecutive update, while TL supply increased sequentially and was above normal seasonality. While TL management teams continue to expect capacity to meaningfully tighten up as 2016 progresses and support 2-3% core rate increases on contract renewals, Alex remains more cautious in his outlook as inventory levels across the supply chain remain elevated and his TLFI straight-line forecast now remains below 2015 levels for the entire year and substantially below the long-term trend line for the entire year. He believes most TL carriers will find it difficult to expand margins in 2016 considering the prospect for pricing to decelerate to ~0-2% from mid-single digits increases in 2015, together with continued inflationary pressures and headwinds from lower gains on sale. His reefer and flatbed indices both declined sequentially versus his prior updated and underperformed seasonality.
î Australia – Macro – Chris Nicol, Australia Equity Strategist, following the logic of his 2016 Outlook, “Tell Them They're Dreaming” notes the 'condition' of Australian business indeed looks to be softening. This week’s NAB survey was weaker across the board, industrial EPS is still slipping, and the tax reform debate is getting trickier. The political difficulty of a mooted increase in the GST from 10% to 15% highlights the perhaps unavoidable shorter-term risk that a genuine tax reform debate poses to both consumer and business confidence. He maintains his view that the government has fiscal scope of around 5% of GDP under a AAA-rating threshold, and should use this to pair targeted infrastructure stimulus with the medium-term tax reform agenda.
î EEMEA – SA Banks – Elan Levy, our SA banks analyst, reiterates his OW for Firstrand, downgrades Standard Bank to UW, and cuts his FY16 EPS by between 3% and 18% on all four stocks under his coverage (SBK, BGA, FSR, NED). Elan’s new estimates include the risk of a further sovereign ratings downgrade (and impact on bank borrowing costs). Government yields already appear to be factoring this in alongside a sharper cyclical slowdown in domestic and regional growth expectations. Elan adjusts his CoE estimates across the sector, raising risk-free rates by 135bps to 9.5%, concluding that bank discount rates, remarkably stable over the past 5 years, have moved to a new normal level above 10 year means.
î Europe – Banks – With AT1 YTCs generally at 10%+ and some c.13%, the sector undoubtedly looks cheap to MS European Banks Credit analyst Greg Case and team. Deutsche hasn't been far from the minds of investors over the course of the last two weeks, with the sell-off implying a significant part of the investor community believed a coupon skip is near. This fear has been a large component of the negative sentiment driving the AT1 market weaker. Greg and team have seen continued credit selection in the AT1 market, with the bonds they previously highlighted as having a high risk of coupon skip underperforming materially. These are names such as UniCredit and Deutsche, who are down around 20pts on the year so far. At this point, coupon risk feels priced in to them and they’d now like to add some of the more beaten-up names to ride any rally back up and clip early teens carry in the meantime. Bank credit fundamentals haven't changed, in their view. If anything, credit profiles are continuing to improve. From their conversations over recent days they get the sense that credit investors feel much the same way. Technicals continue to dominate, with 'lower prices begetting selling' and conviction to step in and 'catch a falling knife' incredibly low. So far, investors fail to see any near-term catalyst beyond capitulation in the equity market. Sadly, the equity market also seems to be looking to the credit market for reassurance.
î Japan – Economics – Japan Economist, Takeshi Yamaguchi-san thinks the BoJ’s introduction of negative interest rates at the January MPM signals a change in its policy reaction function. Yamaguchi-san is his main monetary policy now calls for additional easing before the Upper House election in July (no date yet). There are three monetary policy meetings (MPM) in the interim – March 14-15, April 27-28, June 15-16 – and he thinks the likeliest timing for additional easing would be the April MPM, when the BoJ’s Outlook Report will be released. Depending on how markets fare, however, he sees some risk alternatively of a move at the March MPM. He expects the policy rate to be lowered by 20bp from -0.1% currently to -0.3%. In his base-case scenario, he expects a rate cut without ‘quantitative and qualitative’ expansion. As a risk scenario, however, he does not rule out the possibility that Governor Kuroda may attempt to promote 'three-dimensional easing', by combining a rate cut with an modest increase in JGB and ETF purchasing (e.g., by \5trn from \80trn to \85trn a year for JGBs, by \2trn from \3trn to \5trn for ETFs), with indications of willingness to increase these amounts further as needs dictate, in order to counter the market’s view that ’QQE is approaching its limits’.
î EEMEA – Greek Banks – Sam Goodacre, our Greek banks analyst, has conducted an Alphawise study that shows over 90% of deposit outflows are unlikely to return, indicating funding risks lingers for the longer-term. Low macro hopes, stress around income and finances, and concerns on indebtedness are key bear case trends Sam continues to track. The financial situation of households has deteriorated over the last 3 months, at a greater pace than Sam’s previous surveys suggested, and more survey respondents now see further deterioration ahead. Greek banks stocks are now testing new lows, amidst continued delays to first review negotiations. Pending progress on the third bailout, Greece's economic recovery and any signs that bank ROE rebuild is steeper than Sam’s base case implies, he stays Equal-weight.
î India – Economics – With The Union Budget for F2017 due on Feb 29th Chetan Ahya, Chief Asia Economist believes the government will continue with its commitment to maintain fiscal consolidation path, but the pace of fiscal consolidation will be slower than what was planned earlier. So, for instance, F2017 budget target could be 3.7% of GDP vs. government's stated target of 3.5% of GDP. The pace of fiscal consolidation will probably be slower than expected mainly due to impact of seventh pay commission recommendation for central government employees. He believes that the key to track in the budget is government’s commitment to the fiscal consolidation path. In this respect, he will be closely tracking the overall fiscal deficit target for F2017 along with the details of expenditure management and revenue receipts. Given that the government has a higher outlay on seventh pay commission awards, one rank one pension and higher food subsidy, he believes the focus will be on government commitment to fiscal consolidation and quality of the same.
î Europe – Diversified Financials – MS European Diversified Financials analyst Anil Sharma and team explore a bear case Brexit scenario, where the UK / EU fail to negotiate a replacement trade arrangement. They believe investors assume that, if Britain were to leave the EU, a deal would be struck allowing investment management to be delegated back to the UK. But their economists argue that the chances of a 'friendly' split in which the UK maintains full access to the single market are low. On the UK side, there could be limited appetite to pay the price of accepting EU regulations in return for the prize of market access. The EU, in turn, could be reluctant to allow the UK preferential treatment (versus Norway and Switzerland) given financial stability concerns around prospects of an ‘offshore’ EU financial center, and a risk that others might follow the UK if exit was too easy. Across their global asset manager coverage, exposure is highest for BTT, Franklin Resources, Henderson, Invesco and Schroders, with15-40% of AUM held in UCITS format. This could also be a major risk to growth and earnings for insurers’ captive asset managers, given their reliance on European inflows in recent years. Prudential's M&G Optimal Income Fund is in a UCITS structure, as is Standard Life's GARS. They estimate that Optimal Income accounts for ~18% of M&G's pre-tax earnings – but only ~3% of Pru's group earnings. GARS is more material, they think, at ~50% of pre-tax earnings for Standard Life Investment Management and ~20% of group PBT.
î US – Gaming & Lodging – Tom Allen, US Gaming and Lodging analyst, analyzed consumer spending data for reads into Gaming & Lodging trends. Contrary to consensus, recent economic data suggests some potential momentum in travel spending (though leisure and not corporate), but a slowdown in US gaming spend. Tom highlights four key themes in his report: (1) US casino spending has slowed over the last 6 months; (2) Since the US recession, domestic gambling spend has become much more elastic, suggesting a real shift in consumer behavior; (3) Spectator sports momentum continues to increase - potentially a bi-product of increasing sports betting and daily fantasy sports (DFS) penetration; (4) While most believe that a stronger dollar is continuing to impact the US lodging industry, data suggests improving foreign travel spending in the US. This data is encouraging, but Tom notes that commentary on several earnings calls suggest more headwinds than tailwinds. Several companies cited issues such as reductions in international demand and declining international inbound revenue.
î India – Technology – Parag Gupta, India Technology Analysts downgrades Indian IT Services to “In-Line” based on key findings in MS Global Insight note on the changes in the industry. The cost of running IT infrastructure is falling, driven by low cost cloud services and hardware commoditization. Meanwhile, consumers are demanding better access to data & services and a better customer experience. Indian Heritage (IH) vendors' cost advantage has also narrowed and while they are still gaining share, it will be at a slower pace. MS have put together a scenario analysis to provide a quantitative framework of how the industry might evolve over the next 5 years, and believe 1) IH vendors growth should slow over the next cycle, 2) infrastructure outsourcing (ITO) vendors will continue to cede market share and 3) "change the business" digital spending will dominate growth over the next cycle. Parag has thus lowered his revenue estimates by 1-5%, and margins and EPS by 1-10% in 2015-17. MS Global picks are now Capgemini, Cognizant & Infosys (for company specific productivity improvements). In this note, he downgrades Atos to U-Weight and Wipro to E-Weight.
î US – Industrials – US Multi-Industrials analyst, Nigel Coe, thinks that positive January sales momentum from FAST is likely not a much heralded positive inflection in the industrial cycle. The likely cause of this renewed optimism in the industrial cycle was positive January commentary from companies such as FAST, GWW and HUBB, which has manifested in sequentially better January sales trends from FAST. He also points to definitive optimism from Emerson CEO Dave Farr in his commentary that organic sales and orders will break back into positive growth in April. The final factor is the weakening of the USD, which is currently sitting at 3 month lows and is undoubtedly helping to stoke a risk-on appetite. Nigel sees evidence for continued caution, however. Factors supporting a bearish view include: (1) US durable goods orders - extremely weak in December, suggesting continued pressure on US capex and industrial production; (2) US railcar loadings – a very predictable lead for the industrial sector – remain very weak with January down 5.9%; (3) US durable inventory levels - remain at stubbornly high rates indicating that production likely dips below end market demand over the next 3-6 months; and (4) Sharp drop in oil and gas spending in the US - likely leads to another drop-off in general industrial markets.
î Europe – Food Retail – Asda looks set to post its worst quarterly LFL sales decline in 50 years for 4Q and, so far, 2016 points to an even bigger contraction. Asda's top-line performance has suffered over the past 18months due to the company's under exposure to the two fastest growing channels in UK grocery, convenience and online. At the same time, its positioning and geographic footprint make Asda particularly vulnerable to rapid expansion of the hard discounters. However, the main reason why they expect Asda to post its worst sales performance in 50 years in 4Q is that the company has been protecting its P&L at the expense of market share (a case in point is the 500+bps LFL sales divergence with Morrisons in 4Q). While it would be simplistic to say that Asda's problems are simply down to pricing (improving quality of fresh food, range of private label, etc. are also areas to work on), they do believe that Asda needs to significantly improve its pricing vs. conventional competitors (the gap with Tesco stood at only 0.5% on national brand items last month, per their Alphawise survey), as well as the hard discounters. This may imply a significant reset of Asda's industry high EBIT margin, and could in a bearish scenario mean a profit pool moving from~£3bn currently to £1.5bn in the medium term.
CHARTS
US Activity Falling Fast – Unconventional Permits (3-Mo. Moving Avg.)
Source: MS Research
The US rig count fell 31 last week highlighting the precipitous drop in activity. (Largest weekly decline for 10 months); lowering BHI to E/W on deal risk. On oil the USD remains the key driver to oil prices; see Adam’s note. Download the complete report
Emerging Markets in No EMan’s Land?
What do economies and tennis players have in common? It seems both struggle when in ‘no man’s land’. EM cycles, which are already greatly out of sync with DM, are also in the most delicate phases of their cycles – the business cycle equivalent of tennis’s no man’s land. Take growth, for instance. These cycles are clustering near the trough of the curve where headwinds are plentiful. Inflation? Polarised into highflation and lowflation for some time now and likely to show asymmetric normalisation going forward. Monetary policy is also splitting into a pro-cyclical way in EM-like EM economies (so against the growth cycle needs) and a counter-cyclical way in EM economies with DM characteristics (in line with both growth and lowflation objectives, but not yet likely to outmuscle oil and structural forces). Download the Complete Report
More Than 50% of Respondents Want Greece to Stay in the EU
Sam Goodacre’s (our Greek banks analyst) AlphaWise survey shows over 90% of deposit outflows are unlikely to return, indicating funding risks lingers for the longer-term. Low macro hopes, stress around income and finances, and concerns on indebtedness are key bear case trends Sam continues to track. Download the Complete Report
Market returns and changes in the yen's exchange rate have a high explanatory power with regard to stockreturns
Our Global Quantitative Research team notes market returns and changes in the yen's exchange rate currently have a high explanatory power with regard to stock returns in Japan, in the 71st percentile relative to the past 15 years. Image shows the historical cap weighted R-square of regressions of stock returns vs. market returns and changes in the yen's exchange rate. Note that while the market is the dominant explanatory variable, the incremental contribution from currency fluctuations is sizeable. Download the Complete Report
The correlation between monthly changes in the Japanese yen and the MSCI Japan has become substantially negative since 2006
While the correlation between the yen and the MSCI Japan has been modest between 1988 and 2005, it has become substantially negative since 2006 (-0.67 on average), as shown in image above. Given this material regime shift, our Global Quantitative Research team ran their sensitivity analysis on two sub-periods: 1988-2005 and 2006-2015. For the latter period, the high magnitude correlation makes it more questionable to interpret the regression coefficients in a bivariate regression as the "true" sensitivities. Therefore, they used a two-step process in order to mitigate such multi-collinearity issues: first they ran a regression of cohort returns vs. the MSCI Japan's returns to estimate the market betas, then they ran a regression of the residuals obtained in the first step vs. changes in the yen's exchange rate. Download the Complete Report
Global IT Services Market Share
Our Global Technology team believes the cost of running IT infrastructure is falling – driven by low cost cloud services and hardware commoditization. Meanwhile, consumers are demanding better access to data & services and a better customer experience. Companies are taking the infrastructure savings and accelerating investments in Digital or SMAC (social, mobile, analytics, cloud) initiatives. Our tech team sees three key implications for IT Services vendors: Download the Complete Report
January ARIA: Limited Momentum
Ellen Zentner, Head US Economist, saw improving data from her January AlphaWise real-time indicator of economic activity (ARIA). ARIA rose 14bp in January, only partially reversing December’s large decline of 0.33%. The modest increase in January is consistent with better, but limited economic momentum in 1Q. Download the Complete Report
Focus Shifting Towards Aligning CEO Pay More Towards Longer-Term Incentives, 2012-14
Morgan Stanley’s Sustainable + Responsible (S+R) team examined how 25 EU and US consumer staples CEOs are paid, observing executive pay structures and disclosures, to gauge how closely CEO and shareholder interests are aligned. On average, EU CEOs have to invest ~1x (ex Reckitt and Heineken) of their base salary in company shares. In the US, CEOs must invest ~8x their base salary in company shares – firmly tying their interests to shareholders'. US CEOs also hold a higher stake in their companies: Estee's owns the most, with a ~0.5% stake. The S+R team noticed a shift in pay composition, with >60% of the analyzed companies increasing the equity component (long term) as a percentage of total comp (2012-14), while 60% have reduced their annual payout (short term). Moreover, fewer CEOs were rewarded with high short-term incentives in 2014 than in 2012. Download the Complete Report
US Banks: Valuations Rarely So Attractive - P/B at Just 39% of S&P 500 P/B
US Large Cap Banks analyst, Betsy Graseck, sees 27% average upside to the banks as bank stocks price in a modest recession despite Morgan Stanley’s more optimistic macro outlook. Stocks should work if stabilization is seen in credit spreads, job growth, oil price, and currencies. She is lowering beta by downgrading RF to a neutral rating and SNV to bearish, and thinks the risk/reward has improved. She sees stocks +27% in her modest growth base case vs. -17% in a deep recession. Her base case calls for stable rates, 5% growth in revenues, 3% growth in expenses, and provisions that are ~50% above 2015 levels. Even with a conservative credit outlook, she sees 27% average upside to the banks. On a book basis, banks are trading at just 40% of the S&P 500 multiple, equal to prior cycle lows. Betsy’s top picks in a no-recession scenario are SYF, COF, and BAC among large caps; and BKU, SBNY, and SIVB among midcaps. Download the Complete Report
Lowering 2016 PC Market Growth: Improvement Not Expected Until 2H16
US IT Hardware analyst, Katy Huberty, reduces her 2016 PC unit growth estimate from 5% declines Y/Y to 7% declines. IDC 4Q15 PC shipments were down 11% Y/Y (vs MS -9%) and up 1% Q/Q, in line with normal seasonality. The delta versus her estimate for the quarter was largely driven by weakness in developed market commercial demand for both desktops and notebooks. Given channel inventory remains elevated and macro concerns, she is cautious on PC sell-in in early 2016 but expect headwinds to lessen towards the second half of the year. Companies with the highest PC revenue expose include NVDA (76%), HPQ (63%), and INTC (57%). Download the Complete Report
RESEARCH
Positive
ì Europe – Whitbread – MS European Leisure and Hotels analyst Jamie Rollo and team look at Costa lifts the lid on 50% EBIT upside via innovations like Pay & Collect, improved food, differential pricing, and untapped demand. A detailed examination highlights multiple levers not on investors' radar. For example, there is scope for positive surprises at Costa Coffee via CostaCollect, a pay & collect app which could be transformational (less queuing, more loyalty, extra sales, improved productivity) and an improved food offer. The food capture rate is 60-70% at its Fresco trial site vs. the 42% Costa estate average, and a fresher/healthier range could boost lunch trade where Costa is weak. It also recently put through a price increase and is considering differential pricing, an opportunity to price up in London / travel hubs. Costa also has untapped demand, as c. 20% of its UK stores are at full capacity, suggesting upside from additional sites. They estimate ~£80m EBIT from these, +50% to Costa's EBIT, with their forecasts only capturing expansion and 3% LfL sales. Remain Overweight. They trim FY17-19 EPS forecasts c. 5% due to weak London hotel trading (post Paris attacks), dull high street trading for Costa, and they assume £10m extra operating costs / D&A with the new CEO's focus here. They assume c. 2% LfL sales and RevPAR in 4Q16 and FY17, with expansion driving all of their forecast EPS growth. Their PT moves from £56 to £51. Download the Complete Report
ì LatAm – Credicorp – Recurring net income was P$755 million, up 1% q/q and 52% y/y, and 9% above MSe of P$693 million. Bloomberg consensus was P$739 million. Recurring ROE was 20.1%, down from 21.2% in 3Q15 and up from 15.0% in 4Q14. MSe was 18.7%. There were a couple of one-time items, goodwill impairment and non-recurring gains from subsidiaries, amounting to negative P$56 million. All said, reported net income was R$731 million, yielding an ROE of 19.4%. Jorge Kuri, our LatAm banks analyst, stays OW with U$150 price target. Download the Complete Report
ì Australia – Ansell – Sean Laaman, Australia Healthcare Analyst recently lowered and upgraded Ansell from EW to OW after the company provided transparency in 2H16. It recently lowered F16 guidance by ~8% despite favorable FX movements & falling input costs leading us to believe there was an underlying flaw. Furthermore, guidance demands strong 2H16 uplift & potential for ongoing deterioration in IP numbers left his skeptical such a 2H jump could be achieved. However, delivery of 1H16 provides 2H16 transparency & his confidence in the long-term outlook has increased. The large part of the downgrade was adverse FX hedging & one-time restructuring charges & does not indicate deterioration in ANN's long-term fundamentals. Management assuring strong growth in core brands & establishment of new distribution partnerships make us now more confident with his forecasts in F17 & beyond. Download the Complete Report
ì US – Level 3 Communications, Inc. – US Telecom Services analyst, Simon Flannery, upgrades Level 3 from to a bullish rating with a price target of $60, offering 31% upside. The recent pullback creates an attractive opportunity to enter the stock at a time when its growth profile is inflecting upwards, and its financial strength has never been better. His upgrade is driven by: (1) attractive risk/reward on pullback; and (2) Solid growth outlook driven by secular forces, and reported revenue growth set to reaccelerate. Additionally, there is an opportunity for capital returns or further M&A by the end of the year as Level 3 nears its leverage target. Download the Complete Report
ì Europe – ITV – MS European Media and Internet analyst Patrick Wellington and team have been talking to media buyers about the outlook for the UK TV advertising market in 2016. The summary feedback from media buyers is: 1. ITV NAR growth seen at 3.5%-4% for 2016 (MSe 3.5%) after 5% plus in2015 (MSe 5.3%) 2. Q1 looks to be up c1.5%-2% on a LfL basis (MSe 0.9%) against the toughest comp of the year (+12%). 3. Advertisers robust - no meaningful move from TV to digital – buyers see marketers reluctant to move away from TV, buyers not put off by ITV inflation of c10% pa. On a like for like basis the media buyers to whom they speak see the UK TV advertising market up c3%-3.5% this year. There is robust demand across categories, new advertisers expected to come in around Euro 2016 and good growth expected in telecom and digital advertisers. Media buyers are focused on retail as a potentially vulnerable category but see no signs of weakness as yet. This is getting more difficult to measure. Broadly ITV is expected up c3.5-4% versus a TV market up 3-3.5%. Channel 4 benefitted in 2015 from including VoD in its numbers and from recovering from being dropped by Omnicom in 2014.Buyers expect its LfL advertising to be broadly flat this year. Five, now being sold by Sky, is expected to outperform the market, up c5-10%. Underlying Skysales house advertising, ex Five, is also expected be up 5-10%. Download the Complete Report
ì EEMEA– Jarir – With the stock falling 47% from its July highs, de-rating to 13.4x 2015 EPS, free of net debt and offering a sustainable yield of 6-7%, Saul Rans (our MENA Consumer analyst) upgraded Jarir to OW (PT SAR 145). His new PT of SAR 145 (17% implied upside) equates to 14.8x 2017e EPS, 5.8% 2017e yield. Jarir’s balance sheet is free of net debt, the business is strongly FCF positive and Jarir’s Board own 43% of the shares, lending support to Saul’s forecast of a continued c85% dividend payout. After a second year of better execution, Saul models 4 stores p.a. and a 2015-20 space CAGR of 10. Download the Complete Report
ì US – PepsiCo Inc. – US Beverages analyst, Dara Mohsenian, believes PEP is the most attractive stock among the mega-caps, and he expects PEP's relative valuation discount to improve near-term driven by superior topline and EPS growth. Post Q4, he is raising his FY16 EPS forecast by 3 cents to $4.68, with his organic sales forecast increasing from +3.5% to +3.8% as PEP increases its investment behind the business. Positive characteristics of the company include: (1) Superior Fundamental Performance: anchored by favorable snacks category exposure. (2) Strategic Options: While PEP has indicated it is not splitting up or pursuing structural changes in NAm beverages, strategic options could re-emerge at some point if Pepsi’s recent turnaround stalls, and shareholder activism should help prop the stock up. (3) Valuation Looks Compelling: Pepsi’s valuation of 19.3x 2017e EPS and 12.6x EV/EBITDA does not fully reflect the probability for either a continued fundamental turnaround and/or strategic action with the stock trading at a -22% EV/EBITDA discount to KO. Dara’s $110 price target is unchanged (22x 2017e EPS) and offers 14% upside including a 3% dividend yield. Download the Complete Report
ì Asia – IRPC – Mayank Maheshwari reiterates his O-Weight call on IRPC, PT 5.09THB, as he believes while 2015 already showed a turnaround in refining and select chemicals cycles, earnings this year will continue to be driven by improvements in in operational performance. In 4Q15, refining margins continued to be strong, offsetting the weakness in chemicals, and this was driven by a four ther turnaround in the refining and select chemicals. Mayank is still 15% above consensus earnings for 2016. It is one of his key picks in ASEAN O&G trading at 7.7x FY16 P/E, 1x FY16 P/B, 15% ROE and 14% EPS CAGR over the next 2 years. Download the Complete Report
ì Europe – LafargeHolcim – Current stock market turmoil and EM/US growth fears (~85% of LHN's attributable EBITDA) have left LHN shares trading below their bear case scenario. MS European Building & Construction analyst Alejandra Pereda and team reduce their forecasts and price target. This reflects their updated bottom-up global cement assumptions, the worsened FX scenario and higher internal eliminations in the merged group than they were initially assuming. Their estimated EBITDA falls by 6%/ 8%, net profit by 15%/25% and fair value by17% to SFr60, well ahead of the current trading price. However, the Cement outlook set to improve from 2017. They have lowered their global cement growth excluding China for 2016 to +3.1% (vs 3.9% before) with India, South East Asia, Mexico and US the main positive drivers for growth. Demand is still growing slightly below supply and price cost balance is now worse at -0.9% in 2016 and only +0.2% positive in 2017. This results in3.2% and 3.8% cement volume growth for Lafarge Holcim in 2016 and 2017 respectively, which coupled with cost savings and a positive price cost balance from 2017, should allow for a progressive earnings recovery ahead. Download the Complete Report
ì US – Newell Rubbermaid Inc. – US Household and Personal Care analyst, Dara Mohsenian, is bullish on NWL, as valuation does not appropriately reflect accelerating organic sales/EPS growth, and EPS accretion with the JAH acquisition. The announced NWL/JAH merger should generate almost 30% pro-forma FY16 EPS accretion using the full $500M synergy run-rate, or 4%/18% 2016/17 EPS accretion using partial synergies. He also sees upside to NWL's expected $500M synergy target (~5% of JAH sales) given NWL is usually conservative, and the target is toward the lower-end of historical CPG transactions in the ~8% range. Valuation looks attractive with the stock trading at only a 11.7x 2017 P/E and 10.0x EV/EBITDA (or assuming fully synergized numbers, 10.3 times P/E and 9.3 times EV/EBITDA), relatively in-line with ENR at 15.6x 2017 P/E and 9.5x EV/EBITDA, despite a strong management team and much better organic sales growth at both NWL and JAH than ENR. Download the Complete Report
ì Australia – Alacer – Stefan Hansen and Brendan Fitzpatrick, Australia Materials Analysts upgrade Alacer from EW to OW as AQG has ~US$360m in cash and optionality around its expansion plans in Turkey, a large, low-cost resource base at Cöpler, which can support long-lived production, its Acreage position could yield more ‘Cöplers’. Near-term multiples are elevated at ~14x 2016e EV/EBITDA vs 3x gold peer average; however, this is largely due to long-term expansion project value. He thinks that a key value driver is longevity: This is predicated on the view that group resources can continue to grow from exploration and resource definition drilling. Download the Complete Report
Negative
î Australia – Newcrest – Stefan Hansen and Brendan Fitzpatrick, Australia Materials Analysts downgrade Newcrest from EW to UW. Despite having an attractive near-term earnings growth profile under his base-case, the profile flattens substantially over the medium-term. There are also persistent operational issues at key assets, Lihir, Telfer and now Cadia, reduce their confidence in Newcrest's ability to deliver the production profile they expect. The company is working through the issues, and clear operational stability could make us more positive. Newcrest is trading in-line within 1 std deviation of its 3 year average 1yr forward PE ratio (~30x vs. Avg of ~13.5x), suggesting the equity is currently overpriced. Download the Complete Report
î US – Tableau Software – Tableau Software’s steep investment ramp against sharply decelerating top-line growth, drives US Software analyst, Keith Weiss, to cut his FCF estimates by ~75% and downgrade the name from a bullish rating. Recent results showed a top line growth profile far less durable than previously thought, with license growth decelerating from 57% YoY in Q3 to 31% in Q4 and guidance implying a further step-down to single digit growth in Q1. With new transaction volumes holding up well, it appears the slower growth stems more from a reduced ability to up sell existing customers – speaking more to macro or saturation concerns versus competitive issues. Download the Complete Report
î Europe – HSBC – After nearly 20% outperformance vs SX7P banks index since July 15, MS UK Banks analyst Chris Manners and team downgrade HSBC to UW. With a headline divi yield of 7.5%, investors have gravitated to HSBC in a tough market, as US rate hikes offered margin upside and cost discipline is being shown. They are more cautious on revenues, BoCom and hence dividends. BoCom now trades at 4x 2016e consensus P/E, so investors clearly question earnings sustainability and with the market value of the stake at $8bn vs carrying value of $15bn, they see increasing risk of derecognition of the non-cash income of BoCom (-11% to 2017e EPS). The recent HIBOR spike is also a risk to asset growth. they still expect HSBC to build to a 13.5% 'steady state' CET1 ratio over time (vs guidance 12-13%, 11.6% FY15e) and this is again likely to reduce appetite for distributions >100% reported payout ratio. Further they still expect significant legacy conduct charges ($8bn) / restructuring costs ($4bn) over the next three years reducing capital accretion (c.70bps drag). Valuation not compelling relative with HSBC trading at 10.4x 2017e P/E, c.20% premium to EU peers on 8.7x they see valuation as uncompelling. Price target/EPS changes: they cut 2017/18e US$ EPS c.-20% (weaker topline, lower BoCom income) and cut PT -12% in-line with GBP earnings. Download the Complete Report
î LatAm – Southern Copper – SCCO missed EBITDA and EPS estimates by a wide margin on unexpectedly high costs. Carlos de Alba, our LatAm materials analyst, believes the poor performance is a blip, but management has a lot to explain. Despite a weakening balance sheet, share buybacks inexplicably continued. Carlos cuts his PT to $22.1 from $22.7; prefer GMexico. Download the Complete Report
î Australia – Supermarkets – Thomas Kierath, Australia Consumer Analyst notes that the Australian supermarkets have never been as levered to the AUD as they are currently. He thinks the lower AUD will pressure supermarket margins at a time when dry grocery prices are declining. While bulls will argue a lower AUD is a tailwind, he would argue to the contrary. Food imports by value have risen at an 8.4% CAGR since 1988 with an acceleration to 10.2% since 2008 as the supermarkets look overseas for 'cheap' private brand products. Growth in imported food has outstripped Australian F&L sales growth such that he estimates that food imports now represent c.19% of supermarket industry sales at retail. Download the Complete Report
î US – Baker Hughes – US Oil Services, Drilling, and Equipment analyst, Ole Slorer, is downgrading BHI from a bullish to more neutral rating on heightened deal risk and poor execution. He is concerned about BHI's deteriorating performance, as seen in 4Q15, when the company's profitability was meaningfully below all of its peers’. If the deal fails, BHI could trade into the low $30s before rebounding to what he sees as fair value in the high $30s, based on its relative valuation in the last downturn and his SoTP analysis. Ole estimates that the market-implied probability of the deal closing has recently increased from ~25% to ~55%, and this could be a good entry point to take a negative view on BHI relative to HAL. Download the Complete Report
î Europe – Deutsche Bank – Challenges to profitability (trading, negative rates), litigation/ legacy issues & starting point mean DB is the bank farthest from its go-to capital requirements by 18e and why MS EU Banks analyst Huw Van Steenis and team modelled zero cash divis to18. DB is ~2.5% cT1 below MSe 18e go-to ratios prior to capital raising (e.g. announced Postbank sale). Their base case is for only modest capital generation over the next 2 years, as they are cautious on litigation, RWA inflation, restructuring charges, as well as core earnings, non-core run off and the value of the stakes. But why have investors become more bearish? Their base case already includes a (19) % fall in FICC/Equity trading in 2016, although could be better/worse. Deflationary concerns have increased nerves on NII. At Davos one policy maker posed to me whether the lower bound was (1)%.Despite their long held concerns on negative rates, they note NII at Danske & the Swiss banks has held up through aggressive repricing on the asset side. Their new PT is mainly due to lower assumed returns, higher CoE and greater dilution in the bear case to reflect these prospects. DB trades at 0.4x 2015e TNAV vs. underlying ~9% ROTE in 18e. With unresolved litigation, which the market struggles to book-end, weak capital generation & need for capital raising actions, they think valuation is not enough to warrant an Overweight. Next catalysts: CEO Cryan to speak at MS conference March 16th, 2016. ECB decision 10/3 on negative rates & actions will also be key. Download the Complete Report
î EEMEA – Norilsk Nickel – Neri Tollardo, our EEMEA M7M analyst, downgraded Norilsk Nickel to UW on a lower margin of safety, with an uncovered dividend even with a 40% cut. He sees higher-than-expected capital locked up for downstream reconfiguration pushing leverage closer to the 2.0x ND/EBITDA threshold, and increases his net debt estimates for YE15 from $3.8bn to $4.4bn. The dividend safety margin is now small as a result, and raises considerably the risk of a dividend cut under the shareholder agreement. NLMK and Severstal dividend stories appeal more. On spot, steel companies offer an average 6% DY on 11% FCFY and just ~0.5x ND/EBITDA in 2016-17e. That is a better risk-reward than Norilsk's spot 11% DY with 3.5% FCFY. Also, unlike the last two years, Norilsk now has less scope to sell assets or release working capital. Download the Complete Report
î US – Regions Financial Corp. – US Large Cap Banks analyst, Betsy Graseck, downgrades RF from a bullish to neutral rating based on four key concerns: (1) higher exposure to energy loans; (2) riskier energy assets; (3) lower earnings power to counter tougher energy credit; and 4) slower tangible book value growth. She sees more risk to her base case outlook for RF as EPS is more at risk than peers if Morgan Stanley’s energy outlook is too optimistic and oil falls below $25/bbl for an extended period of time. Given RF's leverage to energy and the wide range of outcomes around the impact of lower oil on RF, she downgrades the stock. Download the Complete Report
î Europe – Infineon – MS EU Semis analyst Francois Meunier and team remain Underweight as they believe that cheap credit has boosted automotive revenues for Infineon. They believe investors still view Infineon as a relative safe haven because of its exposure to electric vehicles, and this leaves the valuation at risk of significant derating from a near-peak level. They believe that the mix and price of cars in the US, and also UK/Europe, has developed positively due to easy access to credit. Lower rates and longer maturities have led to lower monthly payments. But according to their calculations, average monthly payments have remained flat and thus consumers have upgraded to more expensive cars, which have more semis content. As a result, and in line with the conclusions of our global autos team, they believe sales and profitability of auto manufacturers, and thus of semis companies, has been bolstered by cheap credit, even bigger in size than in 2007 – 13% more loans were outstanding and 65% more loans were originated in Q3 2015 vs the average 2008 quarter (according to Equifax data). As such, they think revenues are more vulnerable to a downturn in consumer credit than is currently reflected in the share price. they think the bull case for the shares requires investors to extrapolate no cyclicality for the coming 2-3 years, leading to 20% operating margin and an EV/sales multiple of 2.7x. Download the Complete Report
î India – HSBC Holdings – Anil Agarwal & Chris Manners downgrade HSBC to U-Weight (both the LN and HK listings), new PT HK$54, as they think earnings will be weaker and BoCom income is at risk. Revenue will slow as they forecast loan growth to be c2% over the next few years, they still need c200bps of capital to build, and Anil thinks sees an increasing risk of derecognition of the non-cash income of BoCom (-11% to 2017e EPS, BoCom is rated UW, and makes up 15% of HSBC. The 7.5% dividend yield has helped support the stock but even that is at risk with so much earnings uncertainty (he builds in a 40% cut in his bear case). Anil's estimates and are now ~20% below consensus for 2017/18e EPS and 8% below on revenues. On his numbers it is not cheap at 0.9x TNAV and 10.5x 2017 P/E, a ~30% premium to Asian peers. Download the Complete Report
î US – Synovus Financial Corp. – US Midcap Banks analyst, Ken Zerbe, downgrades SNV from a neutral to bearish rating driven by weak fundamentals relative to the stock’s current valuation. He does not expect significant improvement in its profitability near term, particularly as economic growth slows and the potential for higher interest rates in 2016, which would be a positive for net interest income, fades. If the US enters a recession (Morgan Stanley’s bear case), then Ken believes the company's track record for credit losses could put it at greater risk of loss relative to other banks, despite its considerable credit risk mitigation. Download the Complete Report