Report from Europe: Stocks Tread Water Ahead of Veterans Day Holiday

Risk appetite was back with a vengence Monday as the Dow made new year highs on back of Wells Fargo upgrading chipmaker forecasts, merger news (Comcast (CMCSA) and NBC) and even the return of LBOs (Northrop Grunman (NOC)). General Electric (GE), Caterpillar (CAT). Barrick Gold (ABX) and Intel (INTC) gained at least 2.1%, while the dollar weakened against 15 of 16 major currencies. The VIX has lost nearly 10 points in a week. The MSCI Emerging markets index has gained 6% in four days, its best run since July.

In the absence of any significant economic news (and in particular, any significant bad news), it seems that markets have just reverted back to auto pilot risk-seeking mode. To some extent, markets seem to have been comforted by the communique from G20 Finance Ministers over the weekend, which noted that “to restore the global economy and financial system to health, we agreed to maintain support for the recovery until it is assured.”

US stocks likely to be active ahead of the Veteran's Day holiday include Manchester United sponsor and equally despised insurer AIG (AIG) who may have an up day on a story courtesy of rating agency Moody’s that they may actually be able to repay Uncle Sam the $182 odd billion cost of bailing them out (so far). Cisco (CSCO) is coming to the market with a $5 billion debt offering which smells like they are on the acquisitions trail again after gobbling up Starent and Tanberg. Engineering company Fluor (FLR) (the largest Stateside) is struggling after narrowing / lowering its full year estimates after a small Q3 miss (hardly a good sign for the wider economy). Basket case bond insurer MBIA (MBI) are leading us down after posting a whopping $728 million Q3 loss. To the upside we have homebuilder Beazer (BZH) who have surprisingly returned to profit after three years, and online travel agency Priceline.com (PCLN) who again beat the seemingly easily surprised analysts estimates

Today’s Market Moving Stories

• In the UK, the RICS survey added to the recent string of buoyant releases emanating from the UK housing market, with the October headline rising from 21% to 34%, beating the 28% consensus and representing a high since December ‘06. A considerable weight of evidence now points to the sector being in the throes of a relatively rapid recovery. That said, I remain skeptical that this firmer footing can be maintained owing largely to the poor fundamental outlook for UK homebuyers (as exemplified by continued constrained access to credit and an ongoing slackening in the labor market).
• Resonating well with the upbeat RICS report was the UK BRC retail sales monitor which rose 3.8% on a like for like basis relative to last October, representing the strongest such print for this month since ‘02. While, on the face of it this provides some hope, the consumer may be rousing him/herself from the sluggishness seen in recent months, the optimism implied by this number must to some extent be tempered by its very flattering base – October ‘07 saw a collapse on retail demand post the collapse of Lehman’s.
• An article in Tuesday’s FT suggests that booming investor demand and a shortage of supply of quality property is causing UK commercial property values to rise strongly (+2% in October according to CB Richard Ellis). Colliers CRE are now estimating that total return (i.e. not capital values) may now record a positive return this year (0.4%), against previous estimates of a 7.3% fall. Against the background of continued downward pressure on rentals in most sectors this suggests the market may start to get ahead of itself.
• Completing the raft of bearish bond data/events overnight, Fitch was reported as noting the UK to be the most likely major economy to lose its AAA rating. These comments were, however, made in a Reuters TV interview and, as such, even though they were made by the Agency’s co-head of global ratings, do not represent an official communiqué. While perhaps, then, emphasising the parlous nature of the UK’s supply outlook, these comments add little to what is already arguably in the price.
• Nonetheless, the comments have contributed to GBP under-performance Tuesday morning. Not only is the UK running the largest deficit of any G10 currency this year, but this morning’s trade figures (total trade deficit widens to £7.2 billion, much worse than the £6.1 billion deficit expected as imports rose 7.5% whilst exports rose only by 3.9%) highlight that the near 30% depreciation in Trade Weighted Index in the British pound is having little impact in lifting the visible trade balance which posted yet another large deficit.
• Eurozone data flow Tuesday morning has been disappointing. The German ZEW growth expectations declined from 56.0 to 51.1, the second consecutive drop. There can be little doubt that the ZEW growth expectations have passed their peak. Economists probably started pricing in the end of the inventory cycle in six months’ time. In addition, the majority of fiscal stimulus packages around the world may fizzle out at the summer of next year at the latest. This in turn will have a severely negative impact on the export-dependent German economy.
• And French (-1.5% month-on-month) and Italian (-5.3% month-on-month) September industrial output numbers came distinctly below expectations. The unexpected monthly declines contrast sharply with yesterday’s strong German numbers. German IP statistics nicely joined yesterday the Fall of the Wall anniversary celebrations with a higher-than-expected 2.7% month-on-month increase. Looking forward, it seems that Germany is best positioned to capitalize on the resumption of world growth and therefore some degree of intra-European divergence – such as the September numbers showed – might be expected in coming months.
• Overnight, another poor US Fed Senior Loan Officers survey, even if the Fed tries to put a good gloss on the data. Domestic banks continued to tighten loan terms and standards. At the same time, demand for credit continued to weaken, with demand varying from stronger to weaker depending on the type of loan. The net fraction of banks that tightened business loan standards was 15%. Total loans and leases, which exclude bank securities holdings, fell from $7.076 trillion in September 2008 to $6.797 trillion in September 2009 and fell further to $6.696 trillion in the latest week.
• Frederick Mishkin, one of the most reliable apologists for the Greenspan-era ignorance of bubbles, still essentially maintains the old discredited line, that Central Banks should ignore asset price bubbles. He now makes one qualification: credit bubbles are dangerous, though other bubbles are not. He says the present increase in asset prices is clearly of the second kind and does not warrant an increase in interest rates. (This is blatant nonsense. These bubbles never occur in isolation. Credit is an element of most bubbles, as speculators need, and banks are eager to provide, cheap finance to support the bubble. When you start pricking only after a credit bubble is under way, you are way too late in the game.)
• And this made me chuckle: “Investors should increase holdings of European stocks as part of a global equity portfolio as the region typically outperforms when expectations for interest rate hikes increase, said Credit Suisse Group. The brokerage switched from an “underweight” to an “overweight” stance on European shares for the first time since 2007. The economic recovery in Germany is stronger than the rest of Europe and looks “particularly attractive. Continental Europe tends to outperform when both global lead indicators rise and earnings are being revised up, a combination we expect to continue into the first half of 2010”. Germany is “aided in particular by its large manufacturing and capital goods exposure.” Nothing like being late for a party!

Copper Prices To Fall
Xi’an Maike, one of China’s largest metal importers, estimates that around 350kt of refined copper are being held in bonded warehouses and may be re-exported in the coming months. Record Chinese imports have been a key driver of copper’s impressive price recovery this year, but large amounts of unreported stocks have likely accumulated in China. Xi’an Maike estimates around 850kt vs RBS 1.1mt estimates. Exchange copper stocks have risen by 193kt (53%) since their July low, the bulk of this material going into warehouses in Asia. This reflects some movement of copper out of China but also the re-routing of shipments bound for China into warehouses in Singapore and Korea. I do not expect a massive release of Chinese copper stockpiles to cause a flood of material onto world markets in the coming months, but I do expect Chinese net imports to fall further, with modest amounts of copper re-surfacing on metal exchanges, particularly in Asia. This is likely to limit further significant price gains for copper into end 2009. Chinese flash trade data for October are due to be released on November 11. A sharp decline in copper imports would be negative for the copper price and of course mining / basic resources stocks.

Company News

• The European Commission has objected to Oracle’s (ORCL) acquisition of computer maker Sun Microsystems (JAVA), throwing the $7 billion deal into question.
• Kraft (KFT) ducked inside yesterday’s Takeover Panel deadline and formalised its indicative offer for Cadbury (CBY) at 300p cash plus 0.2589 new Kraft shares for each Cadbury share. This offer is obviously subject to movements in Kraft’s share price as well as the USD/GBP exchange rate, but late yesterday was worth in the region of 709p. This is well light in both total price and the cash component of an offer that would prove attractive to Cadbury’s shareholder, albeit this is only likely to prove Kraft’s opening salvo to prevent them being timed out by the Takeover Panel. Cadbury’s Board immediately rejected the “derisory offer.” I suspect that it may be some time before this is resolved. The combination of the expectation of Cadbury’s shareholders on price and their desire for cash (as opposed to Kraft shares), as well as Kraft’s need to remain investment grade, mean that, in my view, there is a better than even chance Cadbury remains independent (say 55-60%).
• In their Q3 interim management statement, CRH (CRH) reported that EBITDA was down 25% on sales that were down 19%. This represented a marked improvement on the 41% decline reported in H1, as results benefitted from cost saving measures, reduced energy related costs and less challenging comps. Cash flow remained strong, with net debt falling from €5.1 billion at the half year stage to €4.2 billion. Trading conditions remain difficult however, compounded by poor weather in the US in October. The stock was off about 4% Tuesday morning.
• Vodafone’s (VOD) H1 numbers showed sales up 9.3% to £21.8 billion (down 3% on an organic basis) and EBITDA up 2.9% to £7.5 billion, bang in line with consensus. Cash flow generation was strong, with free cash flow before licence and spectrum payments up 29.1% to £4 billion. The company has confirmed its guidance for the full year of adjusted operating profit in the £11-11.8 billion. The stock was off 4% by early afternoon.
• Banking stocks had a mixed morning with HSBC (HBC) rallying 4.5% after saying it’s Q3 profit was “significantly” higher than a year ago on lower loss provisions. But in contrast Barclays (BCS) (hard to digest / understand numbers) dropped 4% on a 54% flop in net income and a very poor knock by their capital markets division (i.e. the very area where Goldmans (GS) and JP Morgan (JPM) made oodles of money).
• German auto maker VW (VLKAY.PK) fell 3% (preferred shares down 13%) on news that Qatar’s plans to sell half its stake (about 25 million shares) in the company. The biggest winner in the Stoxx 600 today is ceramic linings maker Cookson group (up 11%) after saying that profits would be at the upper end of analysts estimates, while catering company Sodexo (SDX) slid 6% after their CEO said the financial crisis had slowed new business growth.
• DCC has reported a strong set of H1 numbers with divisional operating profit of €56.6 million versus Davy’s forecast of €51.8 million. EPS came in at 50.1c versus Davy’s forecast of 47.3c with the main driver of the earnings beat was once again the Energy division. And DCC has announced that it has reached conditional agreement for the acquisition of Shell Direct Austria GmbH from Shell Austria.
• Grafton’s IMS for the first ten months of the year reveals that revenues look to be slightly better than what analysts were expecting for 2009 overall. The other salient point is that the rate of decline in underlying sales continues to moderate, especially in the UK. The statement also makes some encouraging noises about its prospects in the UK for 2010.
• Despite the obvious impact of a severe recession in Ireland, Irish Continental Group continues to trade relatively well. Its IMS Tuesday morning said, “EBITDA for the first nine months was €41.7 million,” which means it is on track to report a FY EBITDA of close to €50 million. Bloxham’s comment that ICG remains a highly attractive equity for value investors. Its sustainable yield of over 7.5% is strapped to a cash machine that is eliminating debt at rapid speed while its leading market shares on the Irish Sea give it defensive attributes amid the recession. Steady as she goes indeed.

And Finally… Should The Government Stop Dumping Money Into A Giant Hole?

Disclosures: None

Comments

[jg1945:]

nice report

Nov 11 11:53 AM