Got Europe? Got European Equities?

We are all acutely aware of the performance YTD of sovereign bonds vs. equities. European Sovereign Bonds total return -2.7% vs. the SXXP Total Return +16.7%. Going back 2 years, the chart is just as ugly. BUT, what we suspect the market has really yet to ponder is the profound breakdown of a 15-year trade that this represents. See the long-term chart, it has broken out. Interestingly, the EU is following the US, only two years later. The US equity/bond ratio broke out two years ago and when it broke out, the trend lasted almost 12 months. Given liquidity chases an inflating asset, this ought to have profound consequences for asset allocators in Europe over the next 12 months at least, possibly much longer. Especially when you look at the likes of Germany where only 6% of assets are currently in equities or the UK where pension funds have doubled our exposure to bonds while halving our exposure to equities. Pension Fund trustees, are you listening?

More positive macro in Europe

Another week in which everyone appears frozen on both sides of the Atlantic. Trading volumes (in stocks, anyhow) are grim, with reasons NOT to trade plentiful, ranging from Greece (no progress likely here till end of June and in the meantime the trend in chatter is worsening) to the ongoing bond market meltdown. Sentiment remains bearish with the AAII Bull Index back to multi-year lows, -26.7% WoW, while the AAII Bear Index has jumped +32% WoW to year highs. Alongside this, US investors have built the highest level of short interest of the year. This notwithstanding, we have actually found some positives related to our various stock calls this week at both the macro and micro levels. The World Bank cut global growth estimates this week to 2.8%, although, looking under the hood, it seems they were actually positive on Europe, upgrading their growth estimates. The OECD Composite Leading Indicators for June were released on Monday and pointed to a continued firming of growth in the Euro area, and within the data, the standout was Italy.

Buy more Italians

We have been advocates of the Italian story for some months now and it remains one of our favourite markets in Europe, as well as being the cheapest developed market in the world on a CAPE basis. We remain buyers of Italian banks - we noted with interest the news that Banco Popolare di Milano has this week hired bankers to advise on strategic M&A options. Consolidation has been a key facet of our bullish view of Italian banks. We think Italy is going to imitate Spain three years ago. Spain used to have 50 bank branches per 100,000 people; post-reform, there are less than 10. Spanish banks now trade on 1.3x TBV. The average in Italy is 0.9x. Any real signs of consolidation should benefit those Italians most exposed to the dynamic, namely PMI, UBI (OTC:BPPUY) (OTCPK:BPPUF), BP, MedioBanca (OTCPK:MDIBY) (OTC:MDIBF) (the investment bank involved in the deals) and Intesa Sanpaolo (OTCPK:IITOF) (OTCPK:ISNPY) (a rationalising banking industry can't be a bad thing). Less obvious names include Credit Agricole (OTCPK:CRARY), Unipol Gruppo (OTC:UGFNY) and UniCredito (OTCPK:UNCFY). Those with a higher risk appetite may be drawn to BMPS (OTCPK:BMDSD), with the rights how having finished trading.

M&A and a return to animal spirits

Animal spirits look to have well and truly returned to M&A in the US. Confirmed or speculated M&A newsflow is everywhere you look at the moment. In fact, US dealmaking hit an all-time monthly record in May, surpassing previous highs at the peak of the dotcom bubble and the zenith of the debt boom that led to the 2008 financial crisis, while European completed deals remains at very low levels. European deal activity will pick up we think. It is interesting to note potential and confirmed deals are not limited to any particular sector either. The appetite and activity are truly broad based. This past weekend saw reports of 3G Capital looking at Diageo (NYSE:DEO), Shire (NASDAQ:SHPG) weighing up a £12bn bid for Actelion (OTCPK:ALIOF) (OTCPK:ALIOY), China Civil Engineering Construction Corp. looking at Balfour Beatty (OTCPK:BAFBF) (OTCPK:BAFYY), and Deutsche Telekom (OTCQX:DTEGY) (OTCQX:DTEGF) apparently looking at BT (NYSE:BT). Perhaps not all of these will happen but it does reinforce our conviction that the UK, fresh from a relieving election result, with a DY on the FTSE of 4.5% and M&A targets all over the place (Vodafone (NASDAQ:VOD), BP (NYSE:BP), GlaxoSmithKline (NYSE:GSK) all rumoured recently to boot) is probably not a crazy place to be. It's also worth reminding you of our LBO Screen.

Vodafone and Liberty

Continuing the M&A theme, we remain excited by a possible deal between Liberty and Vodafone. Investors seemed to react positively a couple of weeks ago when the prospect of talks between Liberty and Vodafone turned to reality, something we had called a number of weeks ago. These two companies have before them an opportunity to create both a leading pan-Euro converged telco powerhouse and significant long term value for shareholders of each. It would be a game-changing deal and requires commensurately big, bold decision-making on Vodafone's part. Yes, there would be several hurdles to clear for a full-on Vodafone/Liberty deal: major disposals, balance sheet considerations, concessions and, not least, efficient use of operating tax losses. These should not be insurmountable and certainly not enough to stand in the way of an opportunity which major shareholders on both sides seem to support and which may not arise again. If battling through a complex deal doesn't appeal to Vodafone's management and board, it's possible that Liberty's new stance on owning mobile assets turns them into a buyer. On that basis, we think they could make a deal work at c.300p per Vodafone share or more (c.28% upside).

European Telcos: further positive developments

This week our favourite Portuguese stock NOS announced they had carried out a bond issue, placing €50m 2015-19 bonds at 1.26% and two further €50m tranches of commercial paper at rates we understand are similar. This is a huge improvement on their current cost of debt where one of their bonds carried a coupon of 6.85%. While the shift in the marginal cost of financing is very large, from c.7% to c.1%, it is only one of the many drivers of the equity story. Assuming management is unable to find anything more attractive to buy than NOS shares, the relatively unlevered balance sheet should see strong shareholder payout growth over the next three years. We remain buyers.

Numericable (OTCPK:NUMCF) is another one of our picks in the sector - following a c.17% pullback from the highs, it is now trading at just 5.9x FY18 EV/EBITDA on our forecasts. That's almost as cheap as the large cap telco incumbents. Under the stewardship of the exceptional team at Altice (OTCPK:ATCEY), we expect management will continue to drive EBITDA margins higher - much higher than consensus suggests. Our forecasts assume 47% in FY18 and consensus is still at just 38% (i.e. 300 bps expansion over the next 2-3 years, after 700 bps in half a year) and hence a higher 2018 EV/EBITDA valuation of 6.7x. With or without a deal on the horizon, we think now is an attractive entry point to build positions in NUM. Our view is: if a deal can't be done in France, Numericable will look beyond France to create value. Neither of these two outcomes are in the price. We remain buyers.

Peak car theme: Uber doubles rides per day to one million in a month!

Is the Automotive sector accelerating towards a precipice of demand? The impact of car-sharing and autonomous driving remains one of the most important dynamics to get right in the sector we think. Does the pick-up in ride-sharing lead to a BOOST in car demand BEFORE it negatively impacts it? Perhaps. What is clearly seen is the acceleration in the popularity of the likes of Uber in key markets. The FT on Friday reported how the number of rides/day in China has doubled in a month to one million. That being the case, it is easy to underestimate the impact and speed ride-sharing can have. Speak to any major auto CEO globally and they are all investing heavily in China. Perhaps at the top. What is clearly the case is recent demand growth in China YoY has been very disappointing, April and May were two of the worst months for years. The share prices of Dong Feng and Brilliance have been heavily hit. Will growth in Chinese consumer finance growth come to the rescue? Watch this space.

Elekta: underwhelmed by the CMD, still too expensive

As we suspected, the CMD was an opportunity to talk about cost savings and paint the business in a good light. We are not impressed. The major red flag for us was the long term guidance of more than 10% sales growth was maintained, but the drivers for this better-than-the-industry growth have completely changed. No longer is it because of EM exposure, since this is a reason for the UNDERPERFORMANCE of the group last year. Now it's the MRI‑Linac product (a product with dubious commercial potential) and higher software exposure (something that exists today but clearly hasn't helped). This is wishful thinking indeed. As per the margin improvements, the group is targeting to return to the margins of last year only in three years time and with unquantified (at this stage) restructuring costs. Clearly, something is very wrong, it's not just delays in orders. Elekta (OTCPK:EKTAF) (OTCPK:EKTAY) remains overvalued in fundamental terms and we think management have yet to face up to the deficiencies of their business. We remain sellers.

Aviate Shorts

While most of the WWDC 2015 event was dominated by Apple's (NASDAQ:AAPL) Streaming music service, there were some updates about Apple Pay and the Apple Watch that are relevant for Swatch (OTCPK:SWGAY) (OTCPK:SWGAF). While we are still very early in the life cycle of the Watch, Apple is many years ahead of the incumbent watch brands. Swatch's riposte so far is within Swatch brand watches only and features will be limited to payment via the watch and some sports-related functionality. We don't think the Swatch Group is preparing for the next five years or adapting to the threat the Apple brand represents in China. Pearson (NYSE:PSO) continued to breakdown this week. The Department of Education announced this week the establishment of a task force to ensure accountability and oversight of career colleges and for-profit institutions. These steps will likely lead to pressure on college balance sheets and, in turn, Pearson services. Structural headwinds for Pearson persist. We remain sellers.

Aviate stocks in the news

Positive developments for ARM (NASDAQ:ARMH) this week. According to a PBOC report last week, the total volume of mobile payment transactions in 1Q rose by 109% YoY with the value up by 921% (to RMB 39.78tn). This still represents just under 5% of total non cash transactions so the potential growth in this area is vast. The change in the way Chinese consumers transact represents a significant tailwind for ARM's growth. Dong Energy in China named Vestas their preferred supplier this week. Vestas is a long-term member of our GET-Clean basket and was added recently as a technical buy. A new study published in the Lancet last weekend showed a 45% rise in the prevalence of diabetes worldwide since 1990. While the report makes for depressing reading, it gives us further confidence in our Novo Nordisk (NYSE:NVO) call and we remain buyers.

1. Attention EU pension trustees - your 15-year trade has come to an end!

We are all acutely aware of the performance YTD of sovereign bonds vs. equities. Bonds total return -2.7%, SXXP total return +16.7%.

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Going back 2 years, the chart is just as ugly.

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BUT, what we suspect the market has really yet to ponder is the profound breakdown of a 15-year trade this represents. Total return, EU equities vs. sovereign bonds, the long term.

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Interestingly, the EU is following the US, only 2 years later - US equity/bond ratio broke out two years ago - and when it break out, the trend lasted almost 12 months. And note, it is NOW breaking out of the resistance level last seen pre-crisis.

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Given liquidity chases an inflating asset, this ought to have profound consequences for asset allocators in Europe over the next 12 months at least, possibly much longer.

2. Europe: more positive macro

The latest OECD Composite Leading Indicators have just been released this week. As a reminder these are designed to anticipate turning points in economic activity relative to trend. Of most interest to us is what they are saying about Europe. This week's CLIs are pointing to firming growth in the Euro area, particularly in France and Italy (see charts below).

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Oecd.org/std/leading-indicators

Italy remains one of our favourite markets in Europe as well as being the cheapest developed market in the world on a CAPE basis. We remain buyers of Italian banks generally (our favorites remain Intesa, MedioBanca, Popolare di Milano (OTCPK:BPMLY), UBI, followed by UniCredit and then second derivatives, Credit Agricole and Unipol Gruppo), the fund managers (Azimut (OTCPK:AZIHY) (OTCPK:AZIHF), Anima and Banca Generali), the Billionaires club of Mediaset (OTCPK:MDIUY) (OTC:MDIEF), EI Towers, Telecom Italia (NYSE:TI), MedioBanca (again)), credit cycle beneficiaries like Cerved and small cap retailer OVS.

europe.aviatelive.com/tag/italian-stocks

3. Italian Banks: consolidation coming

We view with interest the news that Banco Popolare di Milano has hired bankers to advise on strategic options in M&A. Consolidation has been a key facet in our bullishness towards the Italian banks. The precedent for consolidation can be clearly seen in Spain which underwent a period of consolidation three years ago. Whereas they once had 50 or so banks, they now have <10. About 30% of branches have been closed vs zero closures in Italy (who have the highest number of branches per 100,000 people, 54, of any country in Europe). That's about to change, so too the P/B of the Italian banks. Spanish Banks now trade on 1.3x TBV. The average in Italy is 0.9x. Any signs of consolidation occurring should benefit those Italians most exposed to the dynamic, namely PMI, UBI, BP, the investment bank involved in the deals MedioBanca, and Intesa Sanpaolo (a more rationalised banking industry can't be a bad thing). Less obvious names include Credit Agricole, UnipolSai (OTC:FDIAY) and UniCredit. Those with a higher risk appetite may be drawn to BMPS.

Source: S&P Capital IQ

4. M&A: a return of Animal Spirits

It seems everywhere you look at the moment there is M&A (confirmed or speculated). In fact US dealmaking hit an all-time monthly record in May, surpassing the previous highs seen during the peak of the dotcom bubble and the zenith of the debt boom that led to the 2008 financial crisis. The overall value of deals in US-bound mergers and acquisitions activity amounted to $243bn in May compared to $226bn during the same month in 2007 and $213bn in January 2000, the previous biggest and second biggest months respectively, according to Dealogic data. We suppose this is little wonder given the amount of cash currently being held by corporates ($1.73trn alone by US corporate) and the lack of viable alternatives barring buybacks/specials dividends. Couple this with the simple fact that the world continues to be awash with cheap money and that there is a genuine hunger among global investors, specifically debt investors, to gain more than the often below inflation returns they currently get from government bonds and AA rated corporates, and the world looks set for a rebound in deals. Animal spirits look to have well and truly returned to M&A. What is interesting is that potential and confirmed deals are not limited to any particular sector either, the appetite is truly broad based. Just over the weekend we had reports of 3G looking at Diageo, Shire weighing up a £12bn bid for Actelion, China Civil Engineering Construction Corp. looking at Balfour Beatty, and Deutsche Telekom apparently looking at BT. Maybe these don't all happen but it does reinforce our conviction that the UK, fresh from a relieving election result, with a DY on the FTSE of 4.5% and M&A targets all over the place (VOD, BP, GSK, all rumoured recently to boot) is probably not a crazy place to be. It's also worth reminding you of our LBO Screen.

5. Vodafone: stay long on Liberty deal optionality

Investors seemed to react positively a couple of weeks ago when the prospect of talks between Liberty and Vodafone started to become a reality, as we had been saying would happen. When the first formal confirmation of talks from Vodafone last week were accompanied by suggestions of a potential asset swap, that initial excitement was quickly dampened.

These two companies have before them an opportunity to create a leading pan-Euro converged telco powerhouse and, through that process, long term value for both sets of shareholders. It would be a game-changing deal and, commensurately, needs some big, bold decisions on Vodafone's part. At this end of the process, that might seem daunting and one can see how the initial foray into discussions might begin with exploring simpler solutions. In reality, an asset swap (of, say, the UK and Germany) would be cumbersome, almost counter-productive, and miss out on a opportunity to create far greater value. The market seemed to reach that conclusion quickly last Friday, and we think Vodafone management should recognise that.

Yes, there would be several hurdles to clear for a full-on Vodafone/Liberty deal: major disposals, balance sheet considerations, concessions and, not least, efficient use of operating tax losses. But they should not be insurmountable and certainly not enough to stand in the way of an opportunity which major shareholders on both sides seem to support and which may not emerge again. If fighting through a complex deal doesn't appeal to Vodafone's management and board, it's possible that Liberty's new stance on owning mobile assets turns them into buyer - on that basis we think they could make a deal work at c.300p per Vodafone share or more (c.24% upside).

6. NOS: new bond issue announced this week underlines refinancing tailwind

NOS is due to pay back €200m of expensive retail bonds with a coupon of 6.85% on 19 June (the ZON Multimedia 2012-15 bonds). The all-in cost of this debt is actually around 8%. This week NOS has announced it has placed €50m of NOS 2015-19 bonds at 1.26% and two further tranches of commercial paper of €50m each, at rates we understand are similar to the NOS 2015-19 bonds. That is a huge change. Note, one of three bonds listed on Bloomberg (€100m of floating rate notes due Nov 2019) appears to be trading at 79c on the Euro (8% yield to maturity) - we believe this price is anomalous, but if you can it might be worth considering buying these bonds.

While the shift in the marginal cost of financing is very large, from c.7% to c.1%, it is only one of the many drivers of the equity story. Market repair appears to be taking hold in convergent fixed/mobile offerings, margins should improve as cost cutting flows through and exceptional costs drop out, while interest costs and capex (in absolute terms) are set to fall YoY for several years. The radical reshaping that begins at Portugal Telecom now that Altice has officially assumed ownership provides an additional opportunity to win customer share in the short term.

Assuming management is unable to find anything more attractive to buy than NOS shares, the relatively unlevered balance sheet should see strong shareholder payout growth over the next three years. We remain buyers.

7. Numericable: in a consolidating sector, we see most upside potential

Following a c.17% pullback from the highs, NUM is now trading at just 5.9x FY18 EV/EBITDA on our forecasts - that's almost as cheap as the large cap telco incumbents. We expect management, under stewardship of the exceptional team at Altice, will continue to drive EBITDA margins higher - much higher than consensus suggests. Recall that they have delivered c.700bps of margin expansion in just a couple of quarters to reach nearly 35% in Q1 2015. That was broadly the initial target management had guided for the medium term (2-3 years out) which consensus had taken at face value until the Q1 update showed what this management team is capable of. Internally, Patrick Drahi expects margins to surpass 50%. Our forecasts assume 47% in FY18 and consensus is still at just 38% (i.e. 300bps expansion over the next 2-3 years, after 700bps in half a year) and hence a higher 2018 EV/EBITDA valuation of 6.7x.

On our numbers, valuing the stock on 8x FY18 EBITDA offers around 47% upside from current levels. The potential value creation from acquiring Bouygues Tel could double that, and the drivers and rationale for a deal at some point remain intact, though timing is unclear. France is one of the last two major markets yet to consolidate from four to three players (UK will do post Hutchison-3/O2 and Italy looks to soon follow via 3/Wind), and the regulator remains open to it. BTel is the obvious target and Num-SFR is the only credible buyer. Through a combination of eliminating BTel's capex spend and driving EBITDA margins up towards Num-SFR's level (from just c.20% currently), the scope for value creation is huge. We estimate that an all cash deal at EUR9bn would lift upside in NUM to nearly 100%. In reality, for a deal to be appease Martin Bouygues it is likely some equity issuance and dilution would be involved.

With or without a deal on the horizon, we think now is an attractive entry point to build positions in NUM. Our view is if a deal can't be done in France, then Numericable will look beyond France to create value. Neither this nor consolidation in France is in the price. We remain buyers.

8. DT: we are sceptical re press speculation the CEO is not interested in TMUS/DISH

According to an article in the NY Post, Timotheus Hoettges (CEO of Deutsche Tel) is supposedly not "very interested in merging with Dish". First thing to note is that at the end of the very same article is a comment that a DT spokesperson says that the quotes and paraphrases in the article are false! So take the headlines with a pinch of salt. That said, should there be any substance behind the article, we'd note the following:

  • T-Mobile (NASDAQ:TMUS) now clearly seems to be in play;
  • Even if the Hoettges does have a preference for a merger with Sprint (NYSE:S) first (and then a deal with Dish (NASDAQ:DISH), as the article suggests) we think that would still be tough to get past the regulator, which is the very reason initial moves towards a merger last year didn't go anywhere; and
  • In the absence of a deal with Sprint, a deal with Dish seems to be the only credible option for TMUS and Dish should be keen in order to not to see the value of its spectrum evaporate.

Note also that DT is the controlling shareholder of TMUS, but doesn't control the board and so far from being the sole decision-maker.

We think DT remains interesting based on TMUS optionality, amongst other factors - stay long.

9. Oil rally: likely to be unsustainable. Supply chain still warning

US crude oil production in May reached its highest monthly level in 43 years, EIA said yesterday, at a time when OPEC output remains elevated with Saudi pumping record amounts and Iran about to ramp up production after years of sanctions get lifted. Russia, too, is pumping near record amounts and above $65 more shale becomes viable again… recall last week, former head of OPEC research talking prices back to $40 later this year.

While API data this week showed another decent draw, some of the recent inventory decline is owing to seasonal demand (driving season) as well as brought forward demand as refineries have pushed back scheduled 2015 maintenance into next year to take advantage of incredible margins currently available on cracking spreads. Sooner or later production has to fall, or demand has to jump, in order to see sustainable oil rally.

It is interesting to note two warnings in the services space this week. The first coming from Weir Group (OTCPK:WEIGY) (OTCPK:WEIGF), which highlighted a sequential decline in O&G. At Q1, O&G orders were -29% (OE -44%, AM -15%), 5-month figure is -34% YoY, so Apr and May were much worse. Fort Worth (main Texas facility) is suspending operations temporarily (in Q1 talked about job cuts) saying current decline is slower than the last month, seeing growth H2 weighted. The second warning comes from small cap LED darling Dialight (OTCPK:DIALF). The company is mostly blaming the drop off in O&G orders which came out of nowhere, in Q1 they were fine. O&G is 25% sales, wasn't the entire reason for the drop but they are not saying what else drove it on the call, other than a knock-on effect from mining. Around half of their business is flow (i.e. not order driven) and mostly through distributors, so in actual fact visibility close to zero.

We continue to believe it is too early to be re-entering the oil services space.

10. Elekta: we remain underwhelmed post the CMD

As we suspected, the CMD was an opportunity to talk about cost savings and paint the business in a good light. Since our conclusion is 'no change' and we remain sellers (because it's expensive still and suspect worse to come), we will keep our conclusions specific to the CMD and not a rerun of what we think is wrong.

  • ST growth - really key, saying H1 negative, H2 returning to growth is the aim, but nothing on underlying for FY16, no guidance. MT growth 3-4% reasonable assumption, we shall see
  • LT growth >10% - this is purely speculative, with mkt 6-8%. They said at CMD last year EXACTLY the same thing, BUT the rationale was because they are a growth company and have high EM exposure. But since they blame EM for the poor growth just reported in FY15, the drivers have magically been swapped to their MRI-Linac and software (which is highly dubious). RED FLAG
  • MRI-Linac - nothing new here, commercial rationale doubtful at $8-10m price point. When the CEO was asked will it ACTUALLY be real time imaging at launch, he said he didn't know! Oh dear. Very large risk to margins with this product (they get the MRI from partner Philips, no margin on that bit) and nothing to non-research hospitals till probably 2019/20
  • Costs: some broad disclosure, better material purchasing, lower COGS, less on IT, better inventory mgmt. BUT, no idea of costs to implement, so no net number at this stage. In broad terms, assuming revs grow +3-4%, will get back the 600bps loss of EBITA margin they had last year in 3 years time. Not substantial, running numbers but don't think that's enough to meet consensus
  • Working capital: they had a good year in collections last year, implied that is not sustainable
  • R&D: going to cut level of gross spend, better efficiencies sought. The state of the Balance Sheet isn't helping (dividend cut helps though). Our take, they have overspent in trying to catch Varian and now have to rethink (Varian spends much more on R&D)

11. Novo Nordisk, stay long

New study published in The Lancet shows a 45% rise in the prevalence of diabetes worldwide since 1990. The amount of health loss from diabetes rose by 136% over the period. University of Washington highlights "rising tide" of Type 2 diabetes leading the challenge of nonfatal illnesses as the next major threat of disease burden and diabetes has risen from #10 cause of disability to #7 over the last 20 years.

At the ADA over the weekend Novo reported positive Phase 3b data from its DUAL V study showing its drug Xultophy led to a statistically significant reduction in HbA1C and its LIRA-Ramadan study showed positive results of blood glucose control, significant weight loss and lesser episodes of hypoglycemia. The Xultophy data and momentum is of particular note as HbA1C control is the holy grail of diabetics. While not likely launched until the end of next year it has the potential to become a significant new blockbuster for Novo.

Stay long Novo Nordisk.

12. Swatch: Apple Pay coming to the UK in July, Watch upgrades coming

While most of the WWDC 2015 event was dominated by Apple's Streaming music service, there were some updates about Apple Pay and the Apple Watch that are relevant for Swatch.

Apple Pay will be launched in the UK in July. The company has agreed on details with eight major banks, including Natwest, HSBC (NYSE:HSBC), and Lloyds (NYSE:LYG). Retailers including Boots, Marks & Spencer, Lidl and Waitrose have also signed up. In total 250,000 merchants will accept Apple Pay. It will also be available to use with Transport for London, meaning commuters can use it on London buses and the Underground (note Apple so far has not managed to break into transport in the US). The partnerships with the eight banks gives Apple a good chance of making Apple Pay more successful than in the US so far.

Of course if Apple Pay does get traction in the UK, that would bode well for Europe and for using the pay features on the Apple Watch. On the Watch, there is a new operating system coming (watchOS2), just two months after launch. Most importantly, developers will have access to it meaning they will be able to develop apps that reside on the Watch (not the iPhone). As we have learnt with the iPhone, success is about the combination of apps and the under interface. We are still very early in the life cycle of the Watch, but Apple is still years ahead of the incumbent watch brands. Swatch's riposte, so far, will be limited to Swatch brand watches only and features will be limited to payment via the watch and some sports features. But without giving third parties access to scaled ecosystem on a robust operating platform, the smart features will struggle to get any traction we think. The Swatch Group is not preparing for the next five years or adapting to the threat the Apple brand represents in China, The Swatch Group's biggest market, where Apple is the number 1 luxury brand. China's mobile payment transactions rose 109% in Q1 YoY but value was up 921% YoY. We remain sellers of Swatch.

13. ARM: mobile commerce in China doubling YoY

According to a PBOC report last week, referenced by our Asian research team, the total volume of mobile payment transactions in 1Q rose by 109% YoY with the value up by 921% (to RMB 39.78tn). This still only represents just under 5% of total non cash transactions so the potential growth in this area remains vast.

Alibaba's (NYSE:BABA) Alipay Wallet has more than 270m monthly active users (vs PayPal at just 165m) and can be used for both on and offline payment. Tencent's (OTCPK:TCEHY) Tenpay and the Chinese government's Unionpay are the next two largest competitors and given the under-penetration of mobile payment and the fast growth of eCommerce in general in China, we think currently there is plenty of room for all players to benefit from significant growth.

This change in the way Chinese consumers are transacting represents a significant tailwind for ARM's growth. Stay long.

14. Pearson: breaking down, for good reason

Lack of policy change coming out of the Education Innovation Africa forum in Kenya this week. Pearson has been a key advocate of education improvements in developing nations but the pace of change is slow.

In the US, the Department of Education on Monday night, surprisingly, announced plans to create a debt relief program for students. The Obama administration has announced it will forgive federal student loans owed by Americans who can prove their schools broke a state law, such as false advertising, fraudulent recruiting or other deception, to lure them to apply and borrow funds. The move is not likely limited to Corinthian Colleges which is now bankrupt suggesting other education institutions will be held accountable for misleading practices.

The Department of Education has also established a task force to ensure accountability and oversight of career colleges and for-profit institutions. These steps will likely lead to pressure on college balance sheets and, in turn, Pearson services.

Last week Pearson paid out $7.7m in common core settlement in New York and agreed to not feature or sell any Pearson commercial products funded by the Pearson foundation.

Structural headwinds for Pearson persist. We remain sellers.

15. Trader Watch: Sentiment, Man Group, Technicals, BMW

i) Sentiment

A measure tracking expectations for correlation among SX5E shares has climbed to 0.82, up from 0.43 in April. This month, 375 Stoxx 600 shares have fallen each day on average, compared with about 285 since mid-2006… The index selloff, now 7.5% from record highs in April, has been driven by heightened Grexit concerns and a bond rout backdrop. But high correlation brings opportunities to pickup names/themes - top picks on our EU buy list include: Vodafone, Deutsche Telekom, Telekom Italia, Numericable, Mediaset, Vivendi (OTCPK:VIVEF) (OTCPK:VIVHY), NOS, Fiat (NYSE:FCAU), Roche (OTCQX:RHHBY), GSK, Rio Tinto (NYSE:RIO) and ARM.

ii) Technicals

A number of reiterations from Riccardo this week. He reiterates his buys on Royal Mail Group (OTCPK:ROYMY) (OTCPK:ROYMF), Thales (OTCPK:THLEF), Hargreaves Lansdown (OTCPK:HRGLY), Banco Popolare, Rentokil (OTCPK:RTOKY) and Fraport (OTCPK:FPRUF). On the short side he reiterates sells on EDF and Delta Lloyd (OTCPK:DLLLY) (OTCPK:DLLLF).

iii) BMW, Brilliance chart in context, but: The long-term chart of Brilliance (OTCPK:BCAUF) (OTCPK:BCAUY) is looking very scary and needs monitoring given BMW's (BAMXY) domestic partner is going to be the longer term driver of value in China as parallel imports drain BMW of a profit stream from China.

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That said, we have to acknowledge the BMW stock price is -18% from the highs and the 200 DMA just 2% away. At some point, positive data from growth in the US is likely to trump concerns in China. That may be some time off, but for those with shorter term horizons, reaching the 200 DMA might be a good point to reduce the short position.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.