Weekly – Investment Advisor – 21 February 2019
|MSCI World||+9.7%||US Treasuries||+0.4%|
|S&P 500||+10.7%||US Corp||+2.6%|
|Stoxx 600||+9.3%||US Hign Yield||+5.4%|
|Emerging||+6.7%||EUR High Yield||+2.6%|
The law of the strongest
It has been decades since the US has been denounced / considered as imperialistic. Over time, the vectors of this supremacy have shifted from hard power (defence, economy, finance, politics) to soft power (culture, ideology, value, exemplarity). The novelty with Trump administration is that it a) constantly recurses to the law of the strongest and b) practically ignores soft power. US President crushed all inhibitions to transcend the law of the strongest.
Like preceding Administrations, Trump’s is weaponizing the USD against ¨non-compliant¨ foreign countries. The roots of this mechanism comes from the aftermath of Bretton-Woods. By owning the world’s reserve currency, the US benefits from an ¨exorbitant privilege¨ (V. Giscard d’Estaing, 1960). The US is the only country which prints money and runs deficits with little – if any – direct impact on its exchange rate. Indeed foreigners need to produce goods and services to ¨gain¨ USD, to settle most of their trade and raw materials transactions.
The world interbank payment system (SWIFT) is run by the US and based on the USD. The US used it to set embargos against ¨rogue countries¨. European multinationals and banks paid outrageous fines to US authorities for not respecting this. Now, Russia and Iran are under Trump radar, but Europe and Germany are not very far from it…
The USD and banking (payment) system are a weapon of choice for US governments
Premisses of a new monetary Order
China is taking gradual steps to make the Yuan fully convertible. This is a medium to long-term goal. Its share among other currency reserves in the coffins of world central banks is still minimal. The pace of this mutation ultimately depends on a political decision of the Chinese Communist Party. Chinese current account surplus has been declining last years. Therefore China recycling – i.e. buying US Treasury bonds – is mechanically declining. Beijing also entered into long-term oil supply contracts settled in Yuan. This was done with Russia and, in 2018, with Saudi Arabia! Gold and Oil markets have been organized in Shanghai. Their developments are rapid and they may soon become more than just confidential. Over time, the Yuan will definitely challenge the USD, as the unique currency of pricing for these strategic raw materials.
China is no longer aligned with the US, as being its funding country of last resort
The Chinese Yuan is profiling as the serious long-term contender of the USD
Early signs of Rebellion?
For obvious political reasons, Russia central bank not only ceased buying, but also sold all its US Treasuries. Turkey and Kazakhstan are potentially moving along the same line. Europe is attempting to circumvent the Iran embargo through a system of barter trading. Incidentally, the appetite for US government of foreign countries – globally speaking – has started to stall from 2016. See graph.
US assertiveness has become a serious concern for a growing number of countries
This is a plausible explanation for the disaffection for US fixed income securities
- Trump policy is fostering the early emergence of a contender to the USD
- A trade war and a simultaneous profligate economic policy would, inevitably, result in a US government funding crisis
Fixed income. The non-consensual trade is confirmed
First recession, then deflation. That is the worry gripping markets. Is that justified? We don’t think so.
Euro area annual headline inflation declined to 1.4% in January from 1.6% in December and 1.9% in November. Those drops have been driven by lower energy prices.
The flash core inflation came better than expected at 1.1%. Core inflation is expected to pick up towards summer on the back of strong euro area wage growth. Even more as services inflation, the less volatile component, is rebounding.
History indicates that core inflation picks up with a three-quarter lag from wage growth. Euro area Q3 wage growth was at a 10-year high of 2.5%. The underlying inflation pressures continued their gradual upward trend in 2018, but the impact of higher wages on core inflation still must materialize.
Furthermore, the recent oil prices rebound is not acknowledged by the bond market yet. European inflation expectations are back to their past years’ lows. On a year-on-year basis, oil prices in EUR terms are slightly positive.
Even if a negative contribution is still expected, as oil price reached a top in Q2/Q3 2018, the above-mentioned underlying drivers should have a larger impact.
Activity data have been weak across the board, PMIs are still painting a lacklustre picture of the Euro area economy, and finally the European Commission revised down its GDP forecasts for 2019 and 2020.
It is not that market pessimism about the economy is about to turn around sharply, but the current pricing essentially assumes a recession which, as of today, is far from guaranteed. If the markets make a redux of 2016, European inflation expectations should sharply recover.
Breakeven inflation: US and EUR
On the US side, headline consumer prices were unchanged in January for the 3rd consecutive month. Core prices rose 0.2% in January for the 5th consecutive month, marking its longest streak in 11 years. Core goods prices unexpectedly increased by 0.4%. The trend in core services prices remains firmly intact, increasing for the 5th straight month.
So, the inflation environment continues to look benign as far as the FOMC is concerned. The 2.2% core inflation rate suggests no immediate pressure on the Fed. With the past 3-months core inflation annualized rate at a 2.7%, the trend remains firm. Headline inflation will dip further due to the energy and food prices drop. Core inflation should move somewhat higher. A weaker USD is expected to support core goods prices.
- Positive view on the global inflation linked bonds
- European ones look more at risk, but by far cheaper
Equities. Commercial aviation, the fall of a giant
Airbus announced the end of the A380 program, after 12 years of flight. The industry no longer wants big aircrafts but smaller and more efficient ones. In the 1990s, unlike Boeing, Airbus bet on a global network of some big hubs, from where passengers would take smaller aircrafts for smaller airports. A bad bet. For Airbus, the scheme was point to hub to point. Finally, passengers preferred to travel point-to-point, the strategy adopted by Boeing.
The cancellation of the Emirates order gave the end clap. Problems of profitability, with engines, problems of access in airports. Airlines are reluctant to purchase quad-engines carrying more than 500 passengers, preferring efficiency by using full seating capacity.
It is a relief. And better visibility for investors. The impact will be limited and all employees of A380 program will be relocated to other programs, with orders being large and representing 8 years of production. During the life of the A380, the Airbus group generated profits despite A380 charges. The development and launch costs of the A380 were € 18 billion for 250 aircrafts delivered. The A380 program has been well managed because it was profitable since 2015.
Boeing preferred to develop the 787 Dreamliner, a dual-engine aircraft with the same range that the A380, but more flexible in terms of roads. Finally, the airline company have abandoned the A380 in favor of the A350 and A330.
The prospects remain bright for the 2 aircraft manufacturers which are in a duopoly situation. They strengthened their positions: in 2017, Airbus purchased Bombardier’s short-medium-haul aircraft program, mainly to gain market share in the United States, and in 2018 Boeing purchased Embraer’s commercial aircraft (regional aircraft). The goal of the 2 aircraft manufacturers is to limit as much as possible the emergence of a future competition, in particular Chinese one. They will rely on the digital and the new Airbus weapon is called Skywise, a gigantic big data integrating airlines, commercial flights and computer systems that will predict and reduce the downtime of aircrafts through predictive maintenance.
The visibility of the commercial aviation sector is good and resilient to external shocks. Passenger traffic doubles every 15 years, i.e. +4.4% per year.
The development of emerging countries and its middle class will result in a need for 40’000 new aircrafts within 20 years, or 2’000 additional aircrafts per year. Today, there are around 22’000 commercial aircrafts in the world and the fleet is estimated at 48’000 aircrafts in 2037. The 2019-2037 market will represent approximately $6’000 billion of sales. By 2037, sales breakdown in units: 75% single-aisles (mainly A319-320 and B737), 20% twin-aisles/wide body and 5% regional aircraft; and in dollars: 55% single-aisle, 40% twin-aisles/wide body and 5% regional aircraft/freighters.
In commercial aviation, Airbus and Boeing are pretty close with 800 aircraft deliveries each in 2018. They are equitably sharing the global market for commercial aviation. In terms of group sales, Boeing with $100 billion is larger than Airbus ($62 billion), because the military activity is more important at Boeing.
We are therefore positive on the sector in the medium-long term.
- Valuations : Airbus € 135 and Boeing $ 470
Equities. The transformation of Nestlé
The #1 in global food and beverage company, Nestlé, is transforming itself to become a global leader in healthy and organic nutrition and durable products (product manufacturing mode).
In mid-2019, Nestlé will publish the production line of certain products and the processing of certain raw materials such as fish, coconut, vegetables, spices, coffee, cocoa, eggs, cereals, sugar and milk. Nestlé is researching biodegradable water bottles. The 2025 goal is 100% recyclable packaging. Nestlé wants to reduce its carbon footprint. Nestlé has made several acquisitions in healthy nutrition and health: Terrafertil, Sweet Earth, Freshly and Atrium Innovations.
It has grown stronger in coffee with the agreement to market Starbucks products around the world. Nestle also acquired Blue Bottle Coffee and Chameleon Cold Brew, the #1 in cold coffee in the United States.
Nestlé sold its US confectionery business, sold Gerber Life ($ 1.5 billion) and will soon sell Nestlé Skin Health and Herta in charcuterie (CHF 680 million sales).
The 2018 results were good with organic growth of 3%, with a 2020 target of +4%. Sales climbed by 2.1% to CHF 94 billion and operating profit was up 3.9% to 13,752 billion, with the margin improving from 14.8% to 15.1%. Free cash flow increased from CHF 9.4 billion to 10.8 billion. 2019 should be part of the same trend. At 19x 2019 profits, the Nestlé PER is higher than the traditional food/beverages sector, but lower than that of companies in the healthy/bio/sustainable nutrition segment (around 21x).
- Valuation of Nestlé at CHF 97 per share
Equities. Rally of European banks?
They have been abandoned. Weaker sector performance over 1 year: -24% versus -2% for the Stoxx 600. 2nd worst performance in 2019: +6% compared to +9% for the Stoxx 600.
The Brexit, the rise of nationalist parties in Italy, Austria, Poland and Hungary, the poor health of the Italian and German banking sector, and the weak economy are all factors that push investors away from European banks. And most recently, the European Commission’s refusal of a merger of the Siemens and Alstom in rail activities, while a process of transnational consolidation in the euro zone could bring back interest on European banks; Nationalist forces would oppose this process.
Last Friday, the banking sector rebounded sharply after a senior ECB official comments, Benoît Coeuré, on a possible new round of long-term loans for banks, signaling that the economic slowdown in the euro area is more important than expected. Italy is in recession and Germany narrowly avoided it.
After decreeing that US car imports pose a threat to US national security, Donald Trump will soon attack the European, and therefore German car industry. A threat to the economic growth of the euro area.
If the ECB supports the European economy, the banking sector should behave better. The eurozone banking sector is cheap with a price-to-book value of 0.64 compared to 1.24 in the United States and 1.04 in China. The PE 2019 ratio sector average in the euro zone is 7.6x compared to 10x in the United States. We maintain our prudent fundamental position on European banks, but we can play a short term rebound.
- A short-term rally of the banking sector is possible
- To play Eurozone banks: Lyxor Euro Stoxx Banks (BNKE FP / LU1829219390) or BNP Paribas (valuation € 47)
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