EDRG: US jobless data saw further improvements in February

The public sector is still shedding staff but the pace has slowed significantly from 10-20,000 in 2011 to less than 10,000 this year. Income growth is still weak but the number of hours worked rose 0.6% last month (+2.8% over a year) and overtime returned to pre-crisis levels.
Unemployment was unchanged at 8.3% but underemployment (non-voluntary part time workers) fell further to 14.9% compared to a peak of 17.2%. After upbeat figures in autos, February’s retail sales rose 1.1%. January was revised up to 0.6% from 0.4%.
Industrial production in the eurozone rose in January, edging 0.2% higher after falling 1.1% in the previous month. The improvement was mainly due to the energy sector which had been hit by very mild weather in December but four out of five sectors came in higher.

EUROPE
Markets rose sharply over the week, taking the advance since the last significant low on November 25 to close to 23%. The rally reflects lower investor concern over macroeconomic factors and the eurozone crisis and both cyclicals and financials continue to perform well. True, the Greek situation has cleared up a little. Following the debt swap agreement, eurozone finance ministers released a first tranche of EUR 35.5bn in aid. The remaining EUR 130bn should be released this week when the “formal conditions have been met”. After Isda’s ruling that Athens’ use of collective action clauses to force private creditors to accept haircuts had effectively triggered a credit event, the Greek CDS auction will take place on Monday. It will be based on the new 30-year bonds issued in the restructuring process. The latest quotes suggest holders might receive 77% of the nominal. The total amount to be settled is apparently under USD 2.5bn. The process is not expected to encounter any difficulties.

Following the bond swap, S&P has rated the new bonds CCC. This should in turn cause Greece’s sovereign rating to be
revised up to CCC. After Moody’s move last week, another agency, Fitch, has put the UK’s AAA on negative watch. There is a 50% chance that the rating could be downgraded in the next 2 years. Fitch says the UK has very little room to manoeuvre in the event of future economic shocks.

Zodiac (civil aviation) has released solid half-yearly sales with more than 16% organic growth. The company says it intends to publish more optimistic guidance on growth for the current financial year.

Qatar’s sovereign wealth fund continues to reinforce stakes in French companies with a preference for luxury, sport and
media. It now owns 2% of Total and 1% of LVMH. The Goldman Sachs infrastructure fund is said to be on the verge of
bidding for Veolia Environnement’s UK water businesses (London and South-East England). The deal is estimated at around EUR 1.5bn and would be part of a EUR 5bn asset disposal plan up to 2013. Several European newspapers have just announced that Alstom is thinking about acquiring the German wind turbine producer REpower from India’s Suzlon
Energy. Alstom’s CEO, Patrick Kron, who has always been openly interested in the sector, is trying to reassure investors by ruling out any wild adventure that would entail raising money in unfavourable conditions. In banks, INTESA’s Q4 operating profits beat expectations by 16% thanks to favourable interest rate margins, insurance profits, trading income and good cost controls. The company’s guidance for 2012 is cautious and the dividend payout is expected to fall.

As expected, results at Germany’s E.ON( electricity) were hit by the exit from nuclear power and difficulties in the wholesale gas business. The dividend was nevertheless unchanged at EUR 1 for 2011 and forecast at EUR 1.1 in 2012 and 1.1 minimum in 2013 which is a very positive sign for the share.

US
In another upbeat week, the S&P and Dow Jones both advanced by 2.5% on encouraging macroeconomic pointers. Manufacturing in the New York area accelerated, the Philly Fed has now been rising for 4 months and jobless data continued to improve. 233,000 jobs were created in February, more than the 225,000 expected and the unemployment rate is still at a 3-year low. The NASDAQ also closed above 3,000 for the first time since 2000 due to heavy buying of Apple and catching up from large caps.

Markets were also reassured when the FED said 15 out of 19 banks had passed the latest stress tests. JP Morgan unveiled a 20% rise in its quarterly dividend and a fresh share buyback programme; Wells Fargo’s dividend will increase by 83% and the bank will buy back more shares to boost profitability. And the FED was more optimistic about the economy which it now expects to grow modestly.

In company news, Apple briefly moved above USD 600 to capitalise USD 560bn on momentum generated by the new iPad launch. Molycorp gained 7.5% after the US joined forces with Europe and Japan to appeal to the WTO over hina’s
restrictions on rare earth exports. Financials and cyclicals performed very well this week: banks gained 8%, capital goods rose 4% and semiconductors finished the week 3.5% higher. Utilities and consumer staples underperformed.

JAPAN
In the absence of bad news, the Topix jumped 4.2% and the Nikkei average finally broke through a JPY10,000 resistance line at close after touching it a few times intraday earlier in the week. Both posted more than 7 month highs. The weaker yen to the dollar and strong economic data out of the US as well as Japan’s stronger-than-expected January machinery orders helped the rally across the board. The yen weakened against the dollar by 3.2% to a level not seen in nearly a year after the Bank of Japan decided to expand loans by JPY 2tn for private sector growth but pegged the ongoing asset purchase programme at JPY65tn. The yen also softened against the euro by 2.6%.

Top advancers included steel producer JFE, up 14%, on its plans to raise H-beam prices and its success in securing a double-digit cut in coking coal prices with suppliers. Property stocks like Mitsui and Mitsubishi rose 10% or more on expectations that accommodative monetary policies would help alleviate their heavy interest payments. Insurers were also strong: T&D HD, Dai-ichi Life, NKSJ and Tokio Marine added 10% or more. Stock brokers Nomura and Daiwa advanced some 10% as trading volumes rose even more.

Among losers was Sharp, down 3%, although it soared later as investors applauded the arrival of a new CEO. Asahi Kasei declined 1% after the chemical conglomerate announced it would acquire US defibrillator maker Zoll Medical for
JPY2.2bn, a deal which could entail very high goodwill amortisation charges. Power companies dominated the loser list following strong gains overall in the previous week.

ASIA
Asian markets moved higher over the week albeit more modestly but Shanghai followed by Hong Kong turned lower on Thursday after Prime Minister Wen’s closing speech to the National People’s Congress. His long address cooled expectations on the Chinese market and seemed to take domestic investors by surprise. In our view, this is not alarming but the speech made several important points.

1) Wen spent 10 minutes commenting on the mistakes he and his team have made over past years. This referred to the massive liquidity injection and boost to lending between end 2008 and end 2009 in response to the global crisis. This created numerous problems in the property sector and in provincial government debt levels.

2) The speech provided further confirmation that unlike the US and Europe, China will remain very cautious over monetary policy even if inflation falls. Wen added that property prices were still too high, contradicting large property groups like China Vanke which think prices have already retreated to reasonable levels.

3) Lastly, Wen made a very important statement in declaring that the renminbi’s appreciation against the USD had gone far enough. After gaining 4.4% vs. the US last year, the RMB has been stabilising so far this year. China is keen to end US pressure for the RMB to rise further.

The other headline event this week was the sacking of Bo Xilai as first secretary of the communist party in Chongqing, one of China’s four autonomous cities (equivalent to a province). Bo was a rising figure in the Chinese political arena. He was supposed to be joining the political bureau as part of the new team which is due to take office before the end of 2012. His dismissal followed a farcical episode involving his right hand man and head of police in the town, Wang Lijun, who sought refuge in the US consulate, asked for asylum and even claimed he needed protecting against Bo Xilai himself! Both men had hitherto been regarded as the champions in the fight against corruption and the mafia. Mr Wang is accusing Bo Xilai of corruption and the government seems to share this view. Reshuffling of key responsibilities in the central government is clearly not over.

Elsewhere, an interesting IPO in the Philippines is looming. GT Capital, a conglomerate belonging to billionaire George
S.K. TY, controls Metro Bank, the country’s second largest, holds the exclusive Toyota franchise for the Philippines (33% market share and average annual growth of 14%), owns a high growth electricity generation company, has an insurance partnership with Axa and a property subsidiary. The country’s population of 95 million is growing by close to 2% a year and real GDP growth should be in excess of 4.3% in 2012 vs. 3.7% last year, all of which should benefit the conglomerate’s various business divisions. The company’s top management is well-regarded and the market cap should be USD 2bn, a significant amount for the Manila market. We expect the IPO to attract a lot of interest.

OTHER EMERGING MARKETS
It was a busy week in India. As expected, inflation edged higher to 6.95% in February. As a result, and after lowering required reserve ratios by 75bp last week, the Reserve Bank of India chose to leave its repo rate unchanged at 8.5%. This could put back any resumption in infrastructure investments. The budget was approved on Friday morning. The main points are: a hike in oil taxes from Rs 2,500/t to 4,500 for producers, a 14% increase in tobacco tax (less than expected and an increase in taxes on small cars from 10% to 12% and from 22% to 25% for large cars. The Federal government’s deficit rose to 5.9% from 4.6% in 2011. The good news is that the government wants to cap subsidies at 2% of GDP.

BP and Nikko have revised down reserves in the KG/D6 fields managed by Reliance Industries from 6 TCF to 1 TCF! In coming weeks, we will have to keep a close eye on monetary policy following the budget vote. The Reserve Bank of India wanted to wait for the budget to be approved before determining any rate cuts as a fiscal deficit will increase money supply and undermine the fight against inflation.

The Brazilian market was practically flat this week, despite headwinds from China which revised down its GDP growth target to 7.5%. Better-than-expected US economic figures continued to drive markets higher. Meanwhile, the government announced that the 6% IOF on foreign loans will now be extended to all foreign loans and bond placements of a minimum maturity of 5 years, up from the previous 3 years. As a result, the BRL depreciated by 2.2% during the week. The central bank also released the minutes of the last monetary policy meeting which suggested there was a strong probability the Selic would not fall below 9% and that accelerated easing in March was mostly front-loading. Chile’s central bank kept its rates unchanged at 5%.

CONVERTIBLES
Investors were once again focused on new convertible issues. The market was busy across all geographical zones. In Europe, sportswear company Adidas raised EUR 500m. The company’s good credit rating ensured strong investor demand. In the US, two small cap pharma stocks, Salix Pharmaceuticals and Medivation, raised USD 600m and 275m respectively. Both have drugs in phase III trials. In Japan, OSG Corp raised JPY 15bn. To make up for its long, 10-year maturity, it comes with puts after 3, 5 and 8 years. The Asia ex Japan zone was the most dynamic with issues from China Overseas Grand Oceans (property development), 361 Degrees, a Chinese sports company and Khazanah, a state investment fund in Malaysia. Note that the Khazanah convertible is exchangeable into Parkson Retail.

In company news, Ingenico has been chosen by Siemens for a contactless pre-payment solution contract. Abengoa has agreed a forward start loan with a pool of 13 banks. Shire has pulled a US regulatory filing for Replagal which will mean a delay of 2-3 years before marketing can start. However, the impact on sales is limited and the share price did not suffer overmuch.

In Asia, investors applauded results from China Overseas Land & Investments. Investors are once again focusing on Chinese property companies, some of which are issuing high yield bonds or planning to do so. Agile, for example, raised USD 700m. In the US, SBA Communications completed the financing of its acquisition of Mobilitie LLC by issuing new shares. Lastly, financials moved higher on news that most US banks had passed the latest stress tests.

COMMODITIES
Gold was particularly volatile over the week and even dipped below USD 1,635/oz intraday. This was down to traders deciding that the crisis was over and liquidating long futures positions. But holders of gold ETFS continued to buy and we have heard no rumours of central bank selling. We also note that US government debt is still out of control while private debt is rising again. (This partly explains why US economic data has improved.) We continue to believe gold as an insurance will stay in favour for some time whatever Wall Street might think.

Given the Chinese New Year, China’s commodity imports in February were astonishingly high: 485,000 tonnes of copper (+17% on January) and 64.98m tonnes of iron ore (+10%).

Oil is still stuck above USD 120 amid fears over shipments that transit by the Detroit of Hormuz. The US/Europe sanctions are starting to bite: Iran’s oil production fell to a 10-year low in February but still amounted to 3.38 million b/d. On Thursday, oil prices sank on rumours that the US and UK were about to sell strategic reserves on the market. The price recovered slightly when the story was denied. But, with soaring oil prices threatening to derail the global economy, strategic reserves are in fact the only weapon OECD countries have at their disposal. During the summer of 2011, 60 million barrels were sold on the market but the results were not very effective as this represented barely 30 days of global consumption which is not enough to reverse a trend. At the same time, the timing of such sales would be extremely risky as the supply side could quickly deteriorate due to events like hurricanes in the Gulf of Mexico, a return of the Arab spring in North Africa and terrorist attacks in Iraq.

ASSET ALLOCATION
Equity markets added to gains as US indices moved above 2011 peaks. On Thursday, the S&P 500 closed above 1,400. European indices are still below last year’s highs and trading is still relatively light. Between March 8 and 15, the major
indices performed as follows in local currency:
– Standard&Poor’s 500 +2.7%

– Euro Stoxx 50 +3.2%
– TOPIX +3.3%
– MSCI Emerging markets +2.5% (in EUR)
Bond markets, particularly in the US, were hit by equity market advances. The yield on the 10-year US Treasury rose 27bp over the period to 2.28%, its highest level since October. The Bund was less impacted and yields moved up to around 2% (+20bp). Yields on Spanish and Italian debt stabilised at levels seen in the last few weeks. But Spanish debt suffered from the government’s decision not to respect its official deficit target of 4.4% of GDP and aim for 5.8% instead (vs. 8% in 2011). Yields ended the period above 5%.

The week’s headline event was the yen’s fall. It finished 1.8% lower, breaking through 83 against the USD (compared to the October peak of 75.7). The Renminbi also fell to 6.32, wiping out part of its recent rise. The EUR weakened against the USD and fell back to around 130 compared to 1.35 at the end of February.

Our weekly allocation committee decided to raise US equities by one notch from neutral to positive. Over the next few weeks, we will also be raising exposure to Latin America in our emerging market allocations as the zone’s fundamentals are improving. In fixed income, we benefited in full from the brutal surge in US and German Yields and have since reduced these shorts through options.

Edmond de Rothschild Europe Flexible: the fund benefited from the previous week’s changes and gained 2% between
March 7 and 14. Exposure varied between 40% and 48% over the week.