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Weekly – Investment Adviser

PERFORMANCES 2019

Equities Obligations
MSCI World +20.8% CHF Corp +2.9%
S&P 500 +24.2% US Govt +7.4%
Stoxx 600 +20.0% US Corp +14.1%
Nikkeï +16.4% US HY +12.1%
SPI +28.2% EUR Gvt +8.8%
China +28.9% EUR Corp +8.1%
Emerging +7.3% EUR HY +8.5%
Devises Matières 1ères
USD index +1.4% Gold +15.3%
EURUSD -3.3% Silver +9.3%
EURCHF -2.7% Brent +17.9%
USDCHF +0.7% CRB index +6.1%
USDJPY -0.7%
EM FX -3.2%

 

Raging corn belt

In 2005, the US Energy Policy Act enacted a Renewable Fuel Standard (RFS), which required billions of gallons of biofuel to be blended into the fuel supply. Since then, the total acreage planted in corn and soybeans (used to make biodiesel) has risen by ~20 million acres. Consequently, the rural Midwest experienced a spectacular improvement of corn / soybeans demand. Actually, about 40% of corn production went to ethanol.

Source USDA - 06.12.19

But, recently, things changed dramatically for different reasons. Last year, forces aligned to significantly reform the RFS. In short, the White House decided to gradually reduce its support to this industry, following the collapse of oil prices. Therefore, Trump Administration granted exceptions to refineries, regarding the proportion of ethanol they should include into their end-product.

In addition to that, the rural Midwest has been battered by floods and tariffs this year.
In this delicate context, corn belt farmers – and politicians – delivered a message to Trump at the end of last summer. Fix the policies hurting corn and prompting ethanol plants to close, or lose parts of your political base…

Surprise surprise, early October, the Environmental Protection Agency and the Department of Agriculture proposed new rules on ethanol to help corn and soybean farmers. They would namely ensure that a gasoline blend made of 15 percent ethanol will not only be available at the existing pumps but also at new pumps. The proposal also includes measures favoring the export of ethanol to foreign markets. Rust and corn belts, which supported Trump are under growing economic pain. Clientelism of Trump administration is attempting to contain discontent.
Corn – and industrial – belt states largely supported Trump three years ago
Difficult economic conditions may change the political tack in these swing states in 2020

 

Exciting primaries

Primaries at the Democrat party are developing with the usual suspense and twists. The confrontation between the ¨socialist¨ / left wing and more centrist one experienced a spectacular latest adventure with the arrival of M. Bloomberg. Now, the more centrist pole (a ticket of Biden plus Bloomberg) has taken over from Warren, who was largely ahead last summer.

Incidentally, the rise of Elizabeth Warren – a non-market friendly candidate – coincided with a much more volatile period for financial markets. Her latest spectacular decline has also been in sync with Wall Street rebound!

EN - US president election - 06.12.19

A victory by Trump, Warren, or a Biden/Bloomberg ticket would spell different outcomes for the economy and for financial markets

  • Eventually, US 2020 elections are going to have a significant impact on markets
  • But don’t draw premature conclusions, as electoral uncertainty remains much too elevated at this juncture

 

Fixed income. Stress in the high yield

According to the latest FOMC minutes, several members indicated that the corporate debt market imbalances have grown. It raised the concern that deteriorating credit quality could lead to sharp corporate bond spreads widening. This is not new. According to the Federal Reserve Economic Data, the non-financial corporate debt has increased by 64% over the past decade to reach $10 trn, however profits have vastly increased. But they have peaked in 2014, even if they have rebounded last year thanks to the corporate tax cuts.

Credit markets have delivered impressive returns this year across most sectors. In the high yield segment, a large share of bonds is now trading near or at their full valuation. It seems likely that prices will be capped. According to BoA, almost 90% of callable BB-rated bonds now are trading to call date and the negative convexity is at its worst level since the 2013 Fed taper tantrum.

The US Investment grade net leverage is now approaching highs not visited since early 2000. The high yield segment has already outpaced its previous peak for years now. After 2 years of significant decline, the high yield leverage has abruptly resumed its upward trajectory. High yield companies have taken advantage of the extended low yield environment and chase for yield mindset to issue massive amount of debts.

The US corporate debt, as a percentage of profits, is steadily increasing too. According to Moody’s, it has recently reached 840% of the core pretax profits of US nonfinancial companies. Further climb could lead to a high-yield default rate rise.

Source moodys - 06.12.19

Over the past weeks, credit spreads have remained stable. A notable exception are the CCC-rated bonds. The CCC spread has widened by over 80bps in the past month and its yield has exceeded the 11.5% hurdle. This is a sign of stress, while equity markets were reaching new highs. Since the beginning of the year, the picture is even worse.

All other grades of credit are showing tighter spreads, while CCC spreads are slightly wider. As a result, the average CCC-rated bonds coupon is now well below its average yield, which raises refinancing risk in the coming months.

The most surprising element is that at the same time, the cross-over spread, i.e. the spread between the BB and BBB rated bonds has compressed to reach its tightest level ever seen. This is well illustrating the search for yield and the market complacency for higher quality high yield rated bonds.

CCC-BBB - 06.12.19

  • Move up in the credit quality, favor investment grade bonds
  • BBB is still the place to be as companies will do what they can to protect their ratings
  • High yield bonds currently offer very little value

 

Currencies. Swiss growth not as good as it seems

Swiss GDP grew by 0.4% in Q3 2019, after 0.3% in Q2, primarily supported by the export of chemicals, pharmaceuticals and energy.

According to the SECO, without the boost from these sectors, the growth would have been close to zero. Overall, the cyclical slowdown is confirmed. Private consumption slowed. Investments in capital goods and construction recovered slightly.

Switzerland KOF - 06.12.19

The Swiss economy is still facing some headwinds, although some signs of stabilization are emerging. Leading indicators are still shaky but stopped falling in October. The composite PMI stood at 49 in October, up sharply from 43.4 in September. The KOF leading indicator also rose slightly to 94.6 in October from 93.1 in September. The question now is whether the rise in these indicators is temporary or whether it heralds an acceleration of the Swiss economy.

  • Too early to expect a CHF weakness

 

Equities. The impact of the slowdown in car sales on global growth

In its latest reports, Fitch Ratings says the slowdown in the global auto market has had a material impact on overall economic growth and the manufacturing slowdown. In 2019, the decline in car sales will be greater than in 2018, with a significant decrease (-11%) in China, the largest car market worldwide. Sales in Europe and the United States are expected to decrease by about 2%. Fitch Ratings and Moody’s Investors Service believe there is no reason for the auto market to rebound in 2020.

Global Car Sales - Annual Charge - 06.12.19

A shock on the demand for cars obviously has a negative impact on manufacturers and equipment manufacturers, but also on steel, aluminum, glass, rubber, copper, automation and robotics, semiconductors, specialty chemicals, … The automotive sector accounts for 44% of global demand for industrial robots and automation systems. To name just a few examples, companies such as ABB, Sika, EMS-Chemie, Autodesk and Dassault Systèmes, the two world leaders in software for industrial robots, are affected by a decline in car sales.

The multiplier effect of the automotive sector at 2.4x is the highest in the economy, meaning that a change of 1 unit in final demand has a 2.4x greater impact on the entire industrial chain. In 2018, a 4 basis point decline in global car sales reduced global GDP by 0.2%.

After announcing the cancellation of 9,500 jobs at Audi, Daimler has announced at least 10,000 job cuts by 2022 to finance the expensive electrical transition. Major manufacturers and equipment manufacturers announced 30’000 job cuts in recent months. By 2025, some 114,000 jobs will disappear in Germany. The automotive sector in Germany accounts for nearly 5% of GDP, 880,000 direct jobs and 19.5% of manufacturing output. According to the IMF, the global automotive sector accounts for 5.7% of global economic output and 8% of world trade.

Thomson Reuters, ODDO BHF Securities - 06.12.19

Some analysts believe the peak of sales, Peak car, is behind us due to the transition to hybrid / electric engines and the reduction of CO2 emissions. The German manufacturer Continental has just made value adjustments, considering that global sales of cars will not rebound in the next 5 years because of this period of expensive technological transition and the war of the big European cities against diesel engines, but also because of a world that is becoming protectionist, favoring local production and increasing import tariffs.

EN - US passenger car sales per units

We know the saying that when real estate goes well, everything is fine. But today we are aware of the im-portance of the automobile sector and it is urgent that governments act with ecological political projects, which would pass in a first time, by subsidies and tax incentives to the purchase of hybrid cars and electric. It is necessary to support a vital sector for the economy.

Consumers should be all the more sensitive to subsidies as the average age of cars continues to rise. It went from 10.5 years in 2013 to 11.2 years in 2018 in Europe and 11.8 years in the United States.

The rise in the average age is not only explained by the economic slowdown or the lack of tax incentives, but also by a better quality of cars.

EN - Average age of vehicles in the US

  • Strong political reaction is needed in China, the US and Europe to support the automotive sector
  • As long as there is no such desire, we stay under-weighting on the automotive sector
  • We prefer FCA ands PSA due to the merger

 

Disclaimer
This document is solely for your information and under no circumstances is it to be used or considered as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. All information and opinions contained herein has been compiled from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to their accuracy or completeness. The analysis contained herein is based on numerous assumptions and different assumptions could result in materially different results. Past performance of an investment is no guarantee for its future performance. This document is provided solely for the information of professional investors who are expected to make their own investment decisions without undue reliance on its contents. This document may not be reproduced, distributed or published without prior authority of PLEION SA.