StreetAccount summary - EU weekly recap

StreetAccount summary - EU weekly recap: STOXX Europe 600 +4.26% 
Friday, April 15, 2016 04:05:17 PM (GMT)

  • Overview:
    • European markets ended at firmer levels for the first time in four weeks. There was no one standout catalyst, though more signs of stabilization in China received attention, Eurozone inflation steadied and there was conjecture on short covering activity . 
    • The improvement in global risk appetite was a challenge for the German bond market, which underperformed after the run of recent strength, widely thought to be market participants front running increased ECB bond buying. 
    • The BoE policy update saw Brexit risk feature prominently in policy discussions and it left its key policy settings on hold and maintained guidance that a rate hike was more likely than not over its forecast horizon. 
    • There was more headline volatility related to Greek reform discussions, with the IMF and the EU still at loggerheads over fiscal targets, which is holding up the first review of the third bailout and delaying further aid disbursement. 
    • In terms of sector highlights, the most widely followed development in Europe was Italy's new bad bank fund aimed at shoring up its bank balance sheets and managing non-performing loans (NPLs).
    • Meanwhile, with the EU referendum campaign kicking off in earnest in the UK, there was some attention on UK house builders, which underperformed as London property showed signs of a slowdown.
    • Attention in Europe is also expected to remain on Q1 earnings, though there are mixed expectations for the period ahead given the permutations from ECB policy.
  • German Bund yields rise after hitting trend lows:
    • German Bund yields hit the lowest level in a year on Monday at 0.07% and then reversed to hit highs of 0.18% on Thursday before settling at 0.13%, leaving it 4bps higher on the week. The widely cited themes were a combination of improved risk appetite, a reduction in crowded position and prospects for a pick-up in inflation. Of note, the final Eurozone inflation reading for March was unexpectedly revised up to 0.0% from the 0.1% fall initially reported. Energy still remained a big drag on the headline index, though with oil prices showing some signs of stabilization, the core reading, holding firm at 1.0%, received some attention. Against this backdrop, comments from ECB's Nowotny resonated, stating that it was important not to over dramatize low inflation with prices expected to rebound in the summer. The sell-side also pointed at that a stabilization in inflation should reduce the pressure on the ECB somewhat, leaving the focus on the full implementation of the March measures rather than heightening expectations for another deposit rate cut. ECB Vice President Constancio said that overall he thought that negative deposit rates had been a positive for the euro area, but admitted that were limits. He noted that the policy would become counterproductive if it led to cash withdrawals and forced banks to pass on costs via negative deposit rates or increased lending rates.
  • BoE press the Brexit issue:
    • The BoE left its key policy settings on hold by a unanimous 9-0 vote as expected. There was no surprise in the policy statement, with the narrative acknowledging the slowdown in activity, but it reiterated that a rate rise was still more likely than not over the forecast horizon. Given the extent of the slowdown in UK activity, there was conjecture prior to the update that two members of the MPC could call for a cut. However, contrary to speculation, the minutes did not show an explicit discussion on easing. Brexit risk did feature heavily, with the Bank highlighting the need for caution because the EU issue made it difficult to interpret data. It said that the Brexit vote was likely to hit demand in the short-run, raise supply side uncertainty and there were signs that business decisions are being delayed . The BoE's cautious approach is in line with sell-side expectations, that it was more likely to look through slower data given the asymmetric risks attached to the outcome. There were some positives, with the BoE seeing little change in broad activity since it released official macro forecasts in February. It also noted that the recent rise in risk appetite should support economic activity and it expected the sterling fall and firmer oil prices to boost inflation. 
  • Italy’s new bad bank fund:
    • Italian banks finished on a stronger footing after Italy’s lawmakers and policymakers agreed with bank executives at the start of the week over the creation of a bad bank fund, managed by private asset manager Quaestio, which will act as a buyer of last resort for banks that struggle to raise equity capital or cannot sell off portions of their bad debts. Monte dei Paschi (BMPS.IM) +27.6%, Intesa Sanpaolo (ISP.IM) +6.7%, and UniCredit (UCG.IM) +11.9%. While the official size of the fund was not disclosed, press cited officials touting a range between €3B-€6B, backed by various institutions including state-lender CDP putting in ~€300M. Initial sell-side takeaways were broadly mixed as analysts said the rescue fund should reduce near-term risks to bank stock prices, but the size of the fund may be limited in the context of Italy’s ~€360B of NPLs, which have undermined lending as the country struggles to recover from a recession. The bulk of the funding is expected to come from major Italian banks, insurers and asset managers with UCG.IM and ISP.IM both announcing contributions to the fund, which has been well-received by market participants. While the government’s plan to create a bad bank with public funds had previously met resistance from European officials, forcing it to water down initial plans, the fund is likely to be approved by lawmakers in Rome and Brussels in the coming days to speed up collateral recovery of bad debts.
  • Greek drama intensifies:
    • The spat over reforms-for-funding between Greece and its lenders intensified this week as talks stalled, forcing Greek Prime Minister Tsipras to defend his record in implementing measures, while criticizing the IMF over its insistence that Greek authorities need to do more to overhaul the economy. It followed remarks by IMF chief Lagarde who questioned Greece’s ability to meet its budget targets, noting that the 3.5% target in the short term is highly unrealistic and the primary surplus of 3.5% cannot be maintained over the long-term. Greece disagreed with the Fund, as did some EU lawmakers, who praised Greece’s reform efforts but remained unwilling to budge on the position of offering substantive debt relief. The IMF however, reiterated its long-standing view that Greece needs significant debt restructuring, fueling concerns that the country’s creditors are also at deep odds with each other. Some officials said that the Greek talks may even need US involvement for a breakthrough, as Washington is becoming increasingly concerned about a returning Greek crisis, particularly during a year filled with other major political risks such as the Brexit vote, a rise in euroskepticism across western Europe and US presidential elections. 
  • UK house builders weighed by Brexit and London slowdown:
    • UK house builders underperformed, with uncertainty over the economic outlook and signs of a slowdown in London house prices weighed on the home construction sector. Bellway (BWY.LN) (9.2%), Persimmon (PSN.LN) (8.1%), Berkeley Group (BKG.LN) (7.0%) and Barratt Developments (BDEV.LN) (5.5%) were among the biggest movers. The Brexit issue remains a headwind, with further signs of a slowdown. UK construction output fell 0.3% in February, weaker than expected, and followed a 0.2% fall in January. The RICS house price balance also fell to 42% in March from 50% in February. The narrative was also pessimistic in the short-term, with RICS expecting a slowdown in London and the south-east in the coming months, fitting in with recent anecdotal reports that investment in the London market has slowed. However, RICS still expects any weakness to be short-lived due to underlying supply and demand imbalances and projects a cumulative increase by ~20% by 2020. The sell-side are still flagging the risk of foreign investors locking in profits in London real estate given Brexit uncertainty, with very little to separate those in favor of EU membership and those calling for an exit. The FT's poll of polls tracker is currently showing stay on 43% and leave on 42%. 
  • Q1 earnings season eyed:
    • With US earnings season kicking off this week, the European market turned its focus on its own quarterly reporting period, expected to be in full-swing next week. For Q1 on the whole, STOXX 600 earnings are expected to decline by 13.1% from Q1’15, according to Reuters. Bloomberg discussed a major earnings theme about corporate executives shying away from reinvesting in their own businesses and instead bulking up balance sheets or tempting shareholders with acquisitions and stock buybacks. It cited JPMorgan analysts who said the ECB’s efforts to revive investment could backfire and drive companies to take advantage of the cheap funding to repurchase shares, adding that analysts have slashed their capex projections for STOXX 600 companies by 11% since December. Goldman Sachs analysts meanwhile argued that in a macro environment characterized by low rates, low inflation and low GDP growth, EPS growth rates have fallen to near zero - a level only previously reached during the GFC. The firm characterized the European equity market as one with high valuations, a weak profit outlook and scarcity of revenue growth.
  • Sector Performance:
    • Notable outperformers: Basic Resources +12.72%, Banks +8.09%, Insurance +5.54%, Oil & Gas +5.10%, Auto & Parts +4.60%.
    • Notable underperformers: Real Estate (0.24%), Technology +0.71%, Retail +1.10%, Media +1.20%, Food & Beverage +1.67%.

Subjects: Market Summaries - EU, Weekly Recap - EU