Global Weekly: Decent earnings fail to excite investors

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The quarterly reporting season has come into swing with several important (US) companies publishing figures and guidance. Although it is still early days, decent corporate results so far seem not sufficient to spur investor enthusiasm, due to fears that the bar has been set too high for the upcoming quarters.

On balance however, company guidance has been moderately positive so far. Two technology bellwethers, Intel and Apple, announced revenue growth exceeding expectations, confirming the strong momentum of US technology stocks. In Europe, one of the leading IT stocks, SAP, reported quarterly results as well. Despite raising its 2020 guidance, the company didn’t exceed future consensus estimates.

Meanwhile, mounting fears about the corona virus weighed on global equity markets which had recently been recording all-time highs. As health risks increased, travel restrictions and other measures taken by the Chinese authorities did not convince investors that the outbreak will be contained soon. The impact on Chinese stock prices has not been visible yet as markets were closed due to the Chinese New Year.

Real estate and utilities are the sectors that have showed most resilience in the face of the corona virus scare. Both benefited from falling yields and only moderate exposure to emerging markets. Luxury goods and car manufacturers have been hit hardest, due to the importance of the Chinese consumer for their business.

Bonds: Corona virus concerns dominate markets

Investors have been concerned about the spreading of the corona virus and its potential impact on the global economy for two weeks now. As a result, implied volatility (a measure of what markets think about future volatility) was pushed above 18. This is the highest level since early October 2019, when fears were fuelled by the US-China trade war and the potential of a hard Brexit.

Early this week, disappointing macro data added to the concerns. The German IFO business climate index fell to 95.9 in January, missing the consensus estimate of 97.0 and below last month’s reading of 96.3. Meanwhile, the 10-year German Bund played its safe-haven role. It hit its lowest level year-to-date at -40 basis points (bps) dropping by over 24 bps in just two weeks.

On the other side of the Atlantic, the situation was predictably similar with the 10-year Treasury yield dropping to 157bps (as a reminder: it started the year at 188 bps). On the credit front, investors logically favoured European and US investment-grade credits and sold or avoided riskier assets. As a consequence, spreads of emerging market debt (+35 bps), US high yield (+50 bps) and European high yield (+30 bps) all widened.

Within the high yield universe, US high yield in the CCC tier-group underperformed and widened the most, as the substantial decline of the oil price affected upstream oil-related industries which are widely represented in the CCC tier-group. The fall in the oil price is related to the restrictive measures taken to fight the corona virus and its potentially negative impact on global trade.

The Federal Reserve voted on Wednesday to keep the target for the federal funds rate at 1.5% to 1.75%, unchanged from December. This was widely expected by analysts and had limited impact on markets. Fed Chair Jerome Powell expressed concerns about the corona virus outbreak. “It’s a serious issue. There is likely to be some disruption of activity in China and probably globally,” he said.

Lockdowns and quarantines in manufacturing hubs in China mean it is unlikely that the corona virus scare will pass without material economic disruption.

Notwithstanding the above, we stick to our base-case scenario for modest improvement. We believe central bank intervention will support the economy and extend the economic cycle by keeping interest rates low and providing monetary stimulus. We are, overweight European credits as this asset class is benefiting from the EUR 20 billion asset purchasing programme of the European Central Bank. In our high-return strategy, we keep a positive bias to emerging market debt (EMD) vs high yield. The latest macro data from emerging markets along with Powell’s rather dovish speech, combined with more attractive pricing, all speak for EMD, which could even get further support from a weakening US dollar over the coming months. High yield remains, in our opinion, very expensive and volatile with limited upside in EUR or USD-hedged in the medium-term.