Weekly – Investment Adviser
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Originally, the White Knight was a fictional character of Lewis Carroll (in his book Through the Looking-Glass). The White Knight saves Alice from the Red Knight. In the financial language, it refers to a person or an organization that saves a firm from difficulties – or a hostile takeover -. In contemporary language, a white knight is often considered as a savior, a benefactor.
The Fed, a White Knight for the repo market
The interbank refinancing market experienced a serious hiccup at the end of last September. Very short-term interest rate spiked abruptly, raising fears of a liquidity / confidence crisis in the banking system. In the past, a few kinds of similar adventures proved leading indicators of serious banking / financial crisis. The Fed decided to intervene to put a lid on the looming problem. It actually did it massively, even when compared to former emergency injections of liquidities in the context of QE activities.
Please move along, there is nothing out there! J. Powell was adamant: there is no crisis, this is just a technical issue, due to new regulation, end of the quarter, etc. Moreover, one should definitely not consider this as QE, because the underlying assets purchases by the US central bank are exclusively bills and other short-term papers.
Last September, the – Fed – White Knight actually saved the money market from a confidence crisis. This massive injection (be it QE or not) supported risky assets, essentially by doping expectations. But let’s face it, such an extreme pace is not sustainable…
More prosaically, the failure of the nuclear talks with Washington in Sweden would have convinced the North Korean leader to return to a strategy of bidding. Is Kim playing Beijing’s card by adding pressure on Trump ahead of the December 15th deadline?
The White Knight metaphor is in vogue these days
- Each and every ¨White Knight¨ doesn’t necessarily call for good news…
- Monitor the end of the year to ensure that the money market remains under durable control
- Investors shouldn’t be (too) complacent about further liquidity injections, which would decelerate significantly
Fixed income. After the Fed, now the ECB
Last month, the Fed dismissed the idea of taking interest rates into negative territory. Their effectiveness, as the Euro-area and Japan growth and inflation failed to positively respond, is challenged.
Since the negative rates adoption in 2014, the European GDP q-o-q has never exceeded 0.8% and the core inflation 1.5%. Euro zone finance ministers are vocally pushing back against this regime.
Christine Lagarde already mentioned she is not a huge fan of negative rates. Bundesbank President Weidmann and Dutch central bank Governor Knot were already skeptics of loose policy. Bank of Spain governor said he could not rule out that sub-zero policy could harm monetary-policy transmission. And more striking, the Bank of Italy Governor, a long-time backer of monetary stimulus, has started criticizing the sub-zero policy, saying he prefers asset purchases. So, negative rates are less sustainable and will need to be reversed.
The central bank has, in fact, already considered their criticisms by adjusting its negative rate mechanism. The last Draghi decision, the launch of a bank tiering system, was a tacit admission that negative interest rates are not working properly.
Under the recently introduced ECB tiering system, banks can have 6 times their minimum reserve requirements remunerated at 0%, rather than -0.5%. Banks that have total deposits lower than that threshold can attract deposits from other banks.
This has pushed deposits out of Germany into more cashstrapped areas. The latest ECB data show that the Bundesbank’s Target2 balance dropped by €78bn while that of Italy rose by €48bn and France by €19bn. The implication is that tiering is prompting German banks to park their deposits at under-allocated banks in Italy and France.
The main consequence is a larger demand for government bonds from those countries. Italian banks tend to favour Italian government bonds and French banks French government bonds.
- Still expecting higher German yields
- Favor peripheral debt
Equities. Big twist in the luxury sector
By buying Tiffany & Co for $ 16.6 billion, LVMH is fighting Cartier (Richemont).
Kering is interested in the Italian Moncler (high-end Winter sporting apparel), which has a market capitalization of € 11 billion (IPO in 2013). With 43% of sales, Asia is the largest market of Moncler, with fifty stores in China. Moncler has diversified into shoes and bags. Since 2010, sales increased from € 300 million to € 1.4 billion in 2018. Moncler would allow Kering to add an Italian pearl in its portfolio and reduce its dependence on Gucci, as well as to have a new growth driver, while that of Gucci is slowing down. Since 2003, Moncler’s annual sales growth has been 24%.
Aston Martin could be the subject of an attempted purchase by billionaire Lawrence Stroll, who has invested in Pierre Cardin, Ralph Lauren and Tommy Hilfiger through Global Brands Acquisitions Corp. The Aston Martin stock price rose 18% last Friday on the rumour. Difficult to value Aston Martin who multiplied profit warnings in the last quarters. The company is in debt, has lower profitability levels and does not have Ferrari’s pricing power. In the event of a takeover, we estimate Aston Martin at £ 9 per share (£ 6.3 today), but an investment in Aston Martin is speculative.
- We value LVMH at € 450 per share, Kering at € 630 and Ferrari at € 200
Oil. OPEC+ further reduces production
OPEC+ has decided to reduce production by 500,000 barrels per day to support crude prices. Saudi Arabia needs to support the going public of Aramco whereas the Minister of Energy estimates it at $ 2’000 billion in a few months.
Analysts estimate that prices will be under pressure in 2020 due to slowing demand and higher production from non- OPEC producers (US, Norway). Since 2017, OPEC+ production has been reduced by 2.1 million b / d by the agreement, the balance being the slowdown in demand and a unilateral decrease in Saudi production.
The energy sector posted, by far, the worst performance in 2019 with +3.5% compared to +22% for the MSCI World and +15.2% for Utilities, the second worst sectorial performance.
In 2008-09 and 2014-15, the energy sector underperformed due to falling oil prices.
In 2020, a recovery in prices will be driven by expectations of an increase in demand, rather in the second half of 2020, and the confirmation of the slowdown in US shale output. For the time being, there is a debate about whether shale oil production is slowing (see graph below) in the United States because of low prices or less efficient basins. In the context of the Green New Deal, the shale gas / oil debate will intensify in the race for the US presidential election.
By 2025, analysts believe that the United States will not be able to repeat the growth rates of shale observed in 2010; which will inevitably lead to a tightening of supply. And the number of bankruptcies of shale oil producers in the United States has been very high since 2018. Wall Street has no appetite for debt issued by a sector that, taken as a whole, has barely won money, which explains the decline in investment. In Permian basin in Texas, productivity gains seem to be slowing and shale oil wells are delivering an increasing share of hydrocarbons closer to gas than oil.
Within the International Energy Agency, concerns are growing over the lack of new oil resources and the lack of infrastructure.
- We remain overweight in the energy sector over the medium to long term
- We favor large integrated oil companies, mainly Total and Chevron, as well as oil services like Halliburton
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