Friday Wrap Up (August, 6)

(Katarina Lau – VP of UCLIF & Lead Editor)

Welcome to the UCLIF Friday Wrap-Up, our weekly newsletter that brings you the most important market events and information during the past week! So what’s moving markets?

Equities

Since 30 Jul 2021, the Health Care Select Sector SPDR ETF (XLV) rose +1.4% while the S&P 500 (SPY) remained flat at +0.06%. The healthcare sector was the only decliner on Thursday, falling -0.8%.

On Wednesday, CVS Health (NYSE:CVS) reported Q2 adjusted EPS of $2.42, beating estimates of $2.07 and continuing its streak of earnings surprises over the last four quarters. The company also reported revenues of $72.62 billion surpassing expectations for $70.24 billion. 

Despite these strong results, the market reaction was quite the opposite – CVS shares fell -2.92% to close at US$81.55 on Wednesday. One reason is the company’s plan to raise hourly wages from $11 to $15 starting July next year. This plan comes as no surprise since the reopening economy has left many business struggling with labor shortages and resorting to wage hikes. Based on the US Jobs reports over the past 3 months, wages have risen 5.9% on an annualised basis, above the 2.4% average from the last economic cycle. Retailers like CVS require a substantial workforce for their operations, which could explain why the company only raised FY2021 guidance by 2%, even though earnings beat it by 17%.

Moreover, the rush for Covid-19 vaccinations contributed to the strong quarter and vaccinations will likely slow down henceforth. 70 percent of the US has been vaccinated and the WHO urged wealthy nations on Wednesday to hold off booster shots until 10% of the population of all countries are vaccinated. However, CVS business segments may experience a rebound for the rest of the year, with demand for elective procedures rising as the pandemic eases. CVS may also reap benefits from its past acquisition of health insurer Aetna, as insurance revenues rise 11% year-on-year.

Consumer Staples and Consumer Discretionary (Jeff Chen)

In the past week, the Consumer Staples Select Sector Fund (XLP) was down 0.8%, whilst the Consumer Discretionary Select Sector Fund (XLY) continued last week’s gains as it rose 1.0%. The consumer sector on the whole has been boosted by greater prospects of air travel, with flights picking up across the US, UK and EU, with more than 2.2 million people going through airport checkpoints in the US, a pandemic high. European airline carriers also remain bullish on the travel industry, which could spur the consumer discretionary sector on, especially for leisure and food & beverage companies, with there already being an increasing trend over the past year.

In company news, Argentine e-commerce company MercadoLibre (MELI) rose over 11% this past week, as their Q2 2021 earnings were significantly higher than a year before, with revenue at US$1.7 billion compared to US$878 million a year before, and also above analysts’ forecasts of US$1.5 billion. MercadoLibre has been riding on significant tailwinds over the last year, mainly due to Latin America’s increasing digital penetration rate and uptick in e-commerce activity fuelled by the pandemic. Despite increasing competition from Amazon (AMZN), MercadoLibre still expects to be one of the key players in Latin America, given its fintech capabilities (revenue increased by more than 88% in this segment).

Industry & Materials (Maksymilian Mucha)

Vanguard Industrials ETF (VIS) and Vanguard Materials ETF (VAW) are down 0.07% and 1.08% this week respectively. 

Qatar Airways has grounded 13 long-haul Airbus A350s alleging accelerated degradation of the fuselage underneath the paint. The company also announced it will refuse to receive any of the 23 ordered A350s until the issue is resolved. The conflict began in May when Qatar Airways first threatened to refuse the delivery of Airbus’s airplanes. This time, the Airline’s CEO publicly urged the manufacturer for action. Airbus has declined to comment, however, according to the Financial Times, a person familiar with the matter said the manufacturer has investigated the problem and no issues which would require special attention were found. Qatar Airways also has not explained how the fuselage issue can negatively influence the safety of the aircraft.

Looking at the bigger picture, Qatar Airways move may be an attempt to delay or cancel orders made before the breakout of the pandemic. Although the airline has not yet revealed its annual report for 2020-2021 FY, according to The Economist the total industry losses were $126b in 2020 and are expected to hit 438 in 2021. The situation has been especially grim for long-haul carriers, such as Qatar Airways, with Gulf countries only very recently moved from the UK’s red to amber list. Moreover, the situation in the near future is unpredictable with the surging Delta variant and incoming winter season.

Airbus (AIR) stock price is down 0.21% since the announcement, which shows that the market is not expecting a high impact of this news on Airbus’s business. Nevertheless, it might change subject to the next announcements of Airbus and Qatar Airways.

General Motors (GM) share price was down 8.98% on 4 August after the Q2 2021 results announcement. The company’s Adjusted EPS was $.1.97, below the expectation of $2.23, even though the revenue was $34.17b, beating the $30.9b expectation. General Motor’s disappointing earnings might be ascribed to three reasons. First of all, the warranty recall cost was $1.3b, including $800m related to the Chevrolet Bolt Electric Vehicle (EV), which has had to be recalled twice in the past year due to the fire risks. Secondly, the company, like any other manufacturer in the industry, is facing a severe semiconductor shortage, which causes its factory shutdowns, including 3 ones in the next week. Finally, GM earnings came in disappointment after in June it had projected better-than-expected results.

Nevertheless, General Motor still reported the record operating profit of $4,117m, up from the Q2 2020 operating loss of $535m, and the revenue increase of 104% YoY. Since Wednesday, the company’s share price is up 3.26%. Looking forward, General Motors raised its EPS full year guidance from $4.50-$5.25 to $5.40-$6.40. The feasibility of this target will largely depend on the global chip situation and as mentioned in the previous Wrap-Up, according to Intel’s CEO it is not going to improve in the latter half of this year. Therefore, the General Motor’s earnings are likely to be worth following this year.

Utilities (Jonathan Leng)

This week, the S&P 500 Utilities Index closed at 343.05 points, 2.3% higher than its position a week ago following positive earnings announcement by a few utility companies. For instance, Sempra Energy’s (SRE) second-quarter 2021 adjusted earnings per share (EPS) were $1.63, surpassing analysts’ estimate of $1.61 by 1.2%. The strong growth is primarily due to an increase in the number of customers and the strategic marketing of its responsible energy solutions.  American Electric Power (AEP) reported second-quarter 2021 adjusted earnings per share of $1.18, which exceeded the average estimate by $0.04NextEra Energy (NEE) reported second-quarter 2021 adjusted earnings of 71 cents per share, up about 9% from the year-ago period. This beats the Zacks Consensus Estimate of 67 cents by 5.6%. The main factor powering that growth was the investment to expand its portfolio of renewable energy assets. The company continues to expand its backlog, adding 1.84 gigawatts of new renewables and energy storage projects during the quarter, making NextEra an attractive long-term investment. 

Energy regulator, Ofgem announced today that prices for 11 million households whose bills are dictated by the main price cap introduced in 2019 will have to be increased by £139 whereas another 4 million households will have their bills raised by £153. This can cause significant disruptions to financially stretched individuals and vulnerable households, especially when inflation seems to be on the rise too. The hike in wholesale gas prices seemed to be intractably linked to the shortage in Russian’s supply of natural gas as well as the unpredictable weather being more cold than usual. Many energy companies would have to find ways to mitigate these risks and it is likely there will be more market consolidation amidst distressed sales, vertical integration to hedge supply chain risks and loss-making strategies to retain customers.

Fixed Income

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Rates (Suraj Suresh)

The global pile of negative bond yields has ballooned to a staggering $16 trillion, which is a six-month high. Negative bond yields mean issuers of debt are paid to borrow. The current bond rally is the primary cause of this, dragging bowering costs to below zero.

Source: https://www.wsj.com/market-data/quotes/bond/BX/TMBMKDE-10Y

Bond yields worldwide are continuing to fall with 10 Year German Bundt, which serves as a benchmark in the euro zone, falling to -0.48%. The bond rally is down due to an increase in demand by investors for the safe-haven security as the spread of the Delta variant is causing a depressed view on growth. 

In the US, the benchmark 10-Year Treasury note went up to 1.26% as everyone anxiously waits for the non-farm payrolls report by The Labour Department. There remains uncertainty on the number of jobs that have been added back to the economy, from 350,000 in the low end to 1.2 million on the high end. With Jeremy Powell hinting at the possibility of ‘tapering’ in the last FOMC meeting, strong economic data could signal tighter monetary policy and the slowdown of the Fed’s aggressive $120 billion bond-buying program.

Credit (Xuan Boh)

In the EMEA, corporate upgrades are at their highest in over a decade in Q2 2021 (Fig. 1). However, these are not all due to economic certainty derived from vaccine rollouts. Only 6 rating upgrades of 24 in the quarter were due to reversals of downgrades caused by COVID-19, others were due to improving credit profiles pre-pandemic or conservative financial policies that are in line with higher ratings. Russian companies accounted for a third of upgrades, outpacing any other EMEA country. A common thread running through these companies was greater debt reduction due to conservative approaches to leverage. 

In China, this week saw even greater declines in the credit scores of several government-linked organisations – reflecting fast-growing cracks in the credit market. Huarong Asset Management Co.’s  ‘BBB’ Long-Term Issuer Default Ratings (IDR) have been maintained on Rating Watch Negative (RWN) by Fitch because of limited transparency on the delayed publication of its annual report and uncertainties over its restructuring strategy. Evergrande Group’s Long-Term Foreign-Currency Issuer Default Ratings (IDR) have been downgraded to ‘CCC+’ from ‘B’ by Fitch because its liquidity is heavily reliant on short-term debt and trust loans (Fig.3). 

Currently, Evergrande’s liabilities involve more than 128 banks and 121 non-banking institutions. Defaults would cause ripple effects across financial institutions that have direct exposure via loans and indirect holdings through financial instruments. The ring of a regulatory purge echoes throughout government policies throughout the week – through the education sector and more – and in credit markets too: 5 government bodies – including the People’s Bank of China, vowed to strengthen the supervision of credit rating businesses.

Fig. 1
Fig.2 S&P, European Non-financial Ratings Upgrades and Downgrades Since February 2020

Real Estate

Real Estate Investment Trusts (REIT’s) (Soubhik Sengupta)

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On 29th July 2021, Twitter announced that it was shutting its offices in New York and San Francisco in response to the surging spread of delta variant. Boston Properties Inc (BXP), a REIT that owns 177 office properties in the US, saw its share price decrease by 4.72% by 3rd August.

Before we go deeper into this week’s wrap-up, an understanding of diffusion indices is crucial. A diffusion index value of 100 represents a well-balanced market; a value lower than 100 indicates weak market conditions; and values significantly higher than 100 indicates strong market conditions. According to the SIOR Commercial Real Estate Index, the diffusion index value for US office real estate increased by 14.37 points to 80.56 in Q1 2021. Meanwhile, the wider commercial real estate (inclusive of retail space, industrial warehouses and factories, and restaurants), saw its diffusion index value increase by 18.12 points to 122.24. This means that despite an improving outlook, the office real estate market still remains much weaker than other kinds of commercial space.

Working from home may become a permanent feature going forward. A survey by Blind found that 64% of employees would turn down a $30,000 pay increase in order to keep working from home indefinitely. With office REIT leasing spreads at its lowest since the early 2010s, office vacancies are likely to persist and we can expect office REITs like Boston Properties Inc to continue to see its share price decrease.

Commodities

Oil & Precious Metals (Anouska Jha)

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The Hydrogen Energy and Commodities Market is not a Straight Line.

As of Friday 6 August 2021:

The Dow Jones Commodities Index is up 0.5% at US$892.78

The S&P GSCI is up 0.9% at US$526.69

WTI Crude prices are up 0.6% at US$69.46, with Brent Crude prices down 0.8% at US$71.71

This week can be described as one of contradictions, not only for investors, but for policy watchers and analysts of the market. The global development of the hydrogen economy highlights the importance of infrastructure readiness for the renewable transition; the UAE announced its $1 billion green ammonia facility in Abu Dhabi, Italian company Eni revealed aims to store CO2 produced from conventional hydrogen production in Egypt, and the UK will announce its new hydrogen strategy next week. The latter is especially interesting as it involves information on how policies will attempt to boost hydrogen demand, such as through minimum quotas in specific-use areas, offering specific insights on growth trade opportunities. 

However, alongside this one must observe the increase in US coal exports and oil and gas Permian rig counts, which climbed to 603 in the mid-week. This is due to a higher number of Permian basin drilling, where improved efficiencies have pushed its production to near pre-COVID levels. On the one hand, possible companies to watch for investors are Chevron (CVX), whose Permian basin volumes have increased in Q2 2021, and the company plans to add 2 additional rigs before 2022. Chevron also reported sales and other operating revenues of $36bn for the quarter ended 30 June 2021, which is more than double compared to $16bn a year ago, suggesting that the company has clearly benefitted from growing demand and a surge in oil and gas prices. A quantitative outlook suggests a long trade for investors. However, with more investor scrutiny surrounding the renewable transition, one may wish to be cautious of being too bullish on these current growth stocks. Moreover, more time is necessary to discern how government and industry will interact in a time of uncertainty regarding OPEC+ production and the Delta variant, to produce innovative hydrogen-based decarbonized infrastructure, and how shipping lanes and storage will adapt to such developments.

Foreign Exchange

G10 & EMFX (Noah Martle)

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The Swiss National Bank’s portfolio surpasses SFr1tn

The Swiss National Bank (SNB) has been assertively purchasing significant volumes of foreign equities since 2015 to increase the supply of Swiss Francs to the FX markets and drive down the Swiss Franc’s value. Despite this, the SFr has appreciated 6.99% against the $ from 1.030 to 1.102 over the past five years

The reason for the appreciation of the Franc is twofold. Firstly, during economic uncertainty, Switzerland is seen as a financial haven. Therefore, Covid-19 has led to an increase in investors holding their funds in Swiss bank accounts. Moreover, the Federal Reserve, ECB and BOE have all targeted an ultra-loose monetary policy, increasing upward pressure on the Swiss Franc. As a result, due to the SNB’s unorthodox monetary policy and rising US equity prices, the SNB’s investment portfolio has surpassed SFr1tn for the first time. 

Refinitiv, 2021

Weekly News

The Rand/Dollar exchange rate remains high at 14.635 as South Africa’s President Cyril Ramphosa announces various changes to his cabinet.

The Federal Reserve’s Vice Chairman Richard Clarida said that ‘he expects the conditions for raising interest rates to be met by the end of 2022’. This resulted in an appreciation of the Dollar/Pound exchange rate.

Finally, the Bank of England has indicated that ‘some tightening of monetary policy is likely to be necessary’ to curb inflation over the next two years. This hawkish comment is because end of year inflation expectations have risen to 4%.

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