1. We know the definition, but what is the essence of QE?
2. Our year-end tactical view remains: rotate into beta and banks.
3. China: a credit junkie no more?
4. Kone (OTCPK:KNYJY): good numbers.
5. Financial engineers are so last Thursday.
6. "You will never lose your job owning IBM"… errrr
7. ThyssenKrupp (TYEKY): more to play for.
8. Barratt Developments (OTCPK:BTDPY): growing momentum.
9. "Slowed, but not collapsed."
10. Charts: Ricardo is reiterating eight sell calls today.
11. Remain a seller of oil services.
12. Ebola and easyJet (OTCQX:ESYJY).
13. Trader watch: Swatch (OTCPK:SWGNF), positioning, Norsk Hydro (OTCQX:NHYDY), Reckitt Benckiser (OTCPK:RBGLY) and GKN (GKNLY).
1. We know the definition, but what is the essence of QE?
One of the inherent characteristics of QE is the "socialisation of private sector credit risks."
While the EU debates the moral dilemma associated with buying outright the sovereign debt of nation states, the ECB is side stepping the issue and heading straight to the private sector where there is so much more they can buy (NB: Moral dilemma = Germans are deeply opposed to buying primary issuance which is straight debt monetization aka what Germany did in 1923 under Havenstein with disastrous consequences). The ECB already has committed to buying covered bonds and ABSs but as Reuters suggest, this may extend to corporate bonds on the secondary market, "with a decision likely in December with a view to begin buying early next year."
Until we know for sure, banks may rally in anticipation which leads us back to our year end thesis.
2. Our year end tactical view remains: rotate into beta and banks.
Notwithstanding our long-term bias to favor those quality growth compounders (many of which went on-sale last week) and the fact we are not necessarily making a call on the market generally, our year-end call for a beta rotation into banks (and miners) remains. As we discussed in our note last week, there are a number of positive event-risks upcoming for banks, starting with more clarity on bond purchases from the ECB, the AQR results (Sunday) and the ECB lending survey late next week. Should this point to improvement in net-lending figures, the links to TLTROs (remember these?) will be made, with the qualifier that the March tender will include a multiplier of 3x.
All, or any, have the potential to be big market movers, and so we would position for such now. As discussed, these are purely tactical considerations, but given the year we have just had a consideration of such is certainly warranted.
3. China: a credit junkie no more?
China has just posted GDP figures which were pretty dull, in line with their own forecasts and those of the market. What is important however, is this number has occurred despite a collapse in shadow-finance. In fact total incremental social financing fell -40% YoY over the quarter, the majority of which came from a collapse in growth rates in off balance sheet lending (-80% YoY) with some lines, notably Trust Loans actually shrinking (i.e. not simply a slower rate, but absolute fall). In other words China could be growing on a far more sustainable basis. Moreover, the curtailment of shadow banking and the transition to more transparent/centralized forms of lending remove a large part of the systemic risk factor surrounding China and put the entire "credit junkie" thesis in jeopardy.
On 8x P/E, nearly half that of the S&P, with growth accelerating and with the incremental negatives becoming harder to identify… Got China?
4. Kone: good numbers
Kone reported strong orders growth over the past quarter (+17.4% at comparable exchange rates). Sales grew as expected by 8.0% (consensus 8.6%). The EBIT margin of 14.8% remains well ahead of peer Schindler (OTCPK:SHLAF), which reported an EBIT margin of 10.1% this morning on an underlying basis for the YTD. EBIT guidance for the full year has been narrowed from a range of €1,000-1,050m to a range of €1,015-1,045m (consensus €1,044m), assuming no major changes in FX in the months ahead. Orders growth is a clear positive, and the note that the Chinese new equipment market continued to grow well leaves little for the bears to latch on to today. New orders growth and commensurate prepayments have helped take working capital down from already excellent levels, and boosted FCF as a result. As long as orders growth remains, we believe Kone is one of the best positioned industrial firms and it remains a buy.
NB: Kone screened the best (along with Next and Novo Nordisk (OTCPK:NONOF)) in terms of being a high-quality compounder with a history of growing returns over time. It has bounced nicely since we added to it, but we see more to play for as the market is likely to apply premium for assets such as this, given the current scarcities of growth, cash-yield and consistency.
5. Financial engineers are so last Thursday
One of the more interesting things to come out of the IBM (IBM) fiasco yesterday was Stanley Druckenmiller's recycled comments from July that IBM's financial engineering practices, which include tripling its debt to repurchase stock, are exactly what has been wrong with the current economic recovery. Druckenmiller said that despite a stock price that had, to that point, risen more than 50% since the 2008 stock market bottom, IBM's sales were identical to what they were six years ago. These comments were in the spirit of highlighting the problems he believes have been created by Fed policy, in particular thwarting capex and encouraging companies to engage in financial engineering rather than invest in their business. Our hope at the beginning of the year was higher rates would help this trend reverse; financial engineering would make way for investment, something FMs told us they were pushing for. Deflation/growth concerns soon scuppered that idea, but it remains relevant for any longer term consideration of stock investment, for at some point those companies that have grown EPS at the expense of returns will have a day of reckoning. Think Tesco (OTCPK:TSCDY). The other interesting takeaway was comments from the IBM CEO that "results also point to the unprecedented pace of change in our industry."
Markets hate change, but whereas IBM trades on 9x yr2, SAP is still on 14x. Remain a seller. (here)
6. "You will never lose your job owning IBM"… errrr
7. ThyssenKrupp: more to play for
ThyssenKrupp is still down a few percent from where we first highlighted its incredibly oversold RSI and after re-interpreting German IP numbers to paint a far less negative picture than most were extrapolating (October 8th). Since then we have had good numbers from Schindler & Kone, both E&E comps, improvements in IP-related data (see German car sales), HRC steel prices are actually up since August whereas iron-ore prices and oil (key costs) have collapsed. Electrolux (OTCPK:ELUXY) also reminded us of the benefits of those restructuring names that are delivering on their programs. We believe ThyssenKrupp could be another of these (it is in our RB). For this reason and the fact it has been subject of indiscriminate selling we remain a buyer and would be adding to the shares into their numbers in a few weeks time, the 20th of Nov).
8. Barratt Developments: growing momentum
As discussed, this remains the perfect context for cash-strong dividend payers who will be buoyed by lower rates. It is breaking out today. More here: here.
9. "Slowed, but not collapsed"
There has been a slowdown in industrial activity but it is nowhere near the levels implied by the market's recent "crash." As we discussed on Oct 8, the market extrapolated August trends which can be explained mostly by seasonals and in any case have rebounded since. Indeed Auto registrations for Germany were up more than 5% in September and European car sales rose +6%. Texas Instruments talked up autos last night and Michelin have seen tire sales rise 3% in Sept. China has grown without excessive loan growth. Lufthansa (OTCQX:DLAKY) is seeing normal cargo trends. Atlas' numbers yesterday were fine. Schindler this morning was good - and Kone's numbers are very good. Yes, we are ignoring the bad stuff, but it appears that's the only way to provide some balance.
We would buy more Maersk (OTCPK:AMKBY) and ThyssenKrupp.
10. Charts: Ricardo is reiterating 8 Sell calls today
He is reiterating his Sells on Subsea 7 (OTCPK:SUBCY) (see comment on Oil Service below), Gemalto (GTOMY), Marks & Spencer (OTCQX:MAKSY), Continental, Richemont, Adidas (OTCQX:ADDYY), Adecco (OTCPK:AHEXY) and Volvo (VOLVY). He remains underweight the EU Oil & Gas Sector which is making new multi-month lows in RS vs. SXXP, and he would sell any rallies. The DJ Stoxx McClellan indicators are deeply oversold and he is looking for a short term bottom however there is no signal yet.
11. Remain a seller of Oil Service
While we are starting to see some value emerge in the large-cap E&P names (BG Group for example) we continue to fade the service names, with the exception of shale-gas plays (see horizontal rig counts at highs vs. Weir Group). If the oil service companies go after growth, they often do so at the wrong price. Remember the contractors who grew through the crisis, and then warned once contracts got going, on margins.
Sell strength, more pain to come.
12. Ebola and easyJet
The WHO has declared Nigeria to be free of the Ebola virus after six weeks with no new cases being detected. "After an intense struggle to stop the spread of infection, Nigeria hasn't seen an Ebola case in six weeks".
It can be done…
Stay long easyJet.
It has been hit by these concerns, which is odd given they have ZERO exposure to African routes.
13. Trader watch: Swatch, positioning, Norsk Hydro, Reckitt Benckiser & GKN
i) Swatch
Swiss Watch Exports rose 2.8% Y/Y in September - the best figure since Feb, and against a high "base" of +8.5% a year ago. Within the data, sales of Gold Watches rose 5.6% Y/Y by volume and rose 6.5% by Value. Richemont most exposed but could be reason enough for some of you to cover some Swatch.
ii) Positioning and relief from…
VIX, big fall.
$ keeps unwinding…
Refer to our positioning email from the Weekender.
iii) Norsk Hydro, buy
China is mandating that at least 30% of new government vehicles be powered by alternative energy by 2016. That drive to build electric cars is likely to set up a greater-than-forecast surge in demand for aluminum, according to Novelis. Use of aluminum in auto bodies by China, Japan and South Korea is around 50k tons and expected to grow at about 30% a year for at least the next decade. Positive read for Norsk Hydro, Anglo American (AAUKY) and Rio Tinto (RIO).
iv) Reckitt Benckiser
Like for like sales (ex Pharma) rose 3% in constant FX in Q3, and by 4% in the first 9Ms. By Category, Health decelerated to +7%, after +11% at the 9M stage, while Home accelerated to +3%, after +1% at the 9M stage. "now expect to demerge RB Pharma before the year-end." Guiding to FY revenue at the lower end of the + 4-5% range. Remains a long-term buy.
v) GKN
'The commercial Aerospace market was robust - military was flat. Overall Aerospace sales saw organic growth of 3.0%, and the Trading Margin rose from 11.0% a year ago to 13.3%. The main disappointment is that Agri Equipment demand "fell sharply" - should we really be that surprised, given what has been happening to Commodity prices? On Autos, the Outlook is "to remain positive, with a lower rate of growth in Q4." Driveline saw organic sales growth of 7% in Q3 (in local FX). Trading on 11.3x cons '14 PE and 10.5x '15, and having just bounced off its lowest level since June '13, this looks like a good entry point. Positive read across - again - for Safran.
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