Good morning,

Markets are called higher this morning. This is what's happening in the markets today:

  • Data on global jobs and China’s services industry signalled weaker economic growth. American companies added the fewest workers in seven months, unemployment in Germany unexpectedly increased and New Zealand’s jobless rate climbed to the highest level since 2010;
  • China’s high-yield corporate bonds outperformed top-rated debt by a record in April as concern eased that the world’s second-biggest economy is headed for a so-called hard landing;
  • Asian policy makers are set to announce the doubling of a $120 billion reserve pool as officials step up efforts to shield the region from global financial shocks. Finance ministry and central bank officials from Japan, China, South Korea and 10 Southeast Asian nations are gathering in Manila today to finish the plan to boost the so-called Chiang Mai Initiative Multilateralization agreement to $240 billion.
  • ECB meeting today – Draghi is expected to keep interest rates unchanged;
  • Spain will be raising E2.5bln worth of debt today made up 2015 and 2017 bonds;
  • Societe Generale SA, France’s second- largest bank, reported a smaller decline in profit than analysts estimated as a rebound in fixed-income revenue cushioned losses from the sale of corporate loans. Net income fell 20% to E732m, beating the E597.5m estimate of 12 analysts surveyed by Bloomberg. Revenue from trading fixed income, currencies and commodities rose 39% from a year earlier to E993m;
  • Chesapeake stock plunged to the lowest in three years yesterday while the cost to protect against losses on its debt surged to the highest since September 2009. Shares closed down 15% at $16.72;
  • 10-year Italian debt is yielding 5.546%, 10-year Spanish debt is yielding 5.853% and 10-year Portuguese debt is yielding 10.588%.

Yesterday I attended a JP Morgan conference on the markets. This is what their global strategist, Dan Morris, had to say about the global markets.

Overweight USA Underweight Europe

JP Morgan are still bullish on the US economy and US corporates. US equities are more expensive than European equities though there is still room for modest growth in prices of circa 8% . It is better investing in a company that although is not as cheap as it was at the beginning of the year, still has the potential to reward investors modest capital gains. If you plot the performance of the S&P to other indices, you will see that the S&P kept on increasing in value whereas European indices took a downturn. It is a fact that there are much more analysts covering US equities than there are analysts covering European stocks. Plus it is easier to track the performance of US companies because they report quarterly whereas most European companies report semi-annually.

Regarding GDP growth, investors were sceptical about the Q112 figure which came in slightly lower than expected and lower than the Q411 figure. However, the markets’ analysis was incorrect because the GDP figure was in actual fact better than expected. This is because in Q411 the figure included the build-up of inventories which were not present in Q112. GDP should always be looked at by extrapolating inventories from the figure. If you do this exercise you will realise that GDP was better than the Q411 as consumer spending increased QoQ slightly above the 2% level reported in Q4.

Also we have seen a high oil price in Q112 which was a burden on the GDP figure. The rule of thumb says that if the oil price increases by $10, GDP falls by 0.2% which means that it shouldn’t be a significant burden to the growth rate going forward. JP Morgan believe that if the situation does not improve in Iran, the world will start seeing negative supply side shocks which will have a negative effect on the world economies. It is interesting to note that a higher oil price has a much greater negative effect on US citizens that it does on Europeans. The price of petrol at the pump is loaded with tax in Europe as high as 80%. This is not the case in the US. So a higher oil price in the US will be immediately reflected in the price. Whereas in Europe it would be the case that prices remain the same and reducing the amount of tax collected by the European governments.

The $15t debt balance of the US is a problem. But at least now politicians are actually talking about it whereas in the past they always used to put the argument aside. If you are an alcoholic, you remain an alcoholic until you admit you have a problem and start doing something about it.

The probability of further quantitative easing in the US is remote at this point in time. This is good news for an economy that is recovering. Plus this is good news for the Dollar and bad news for the Euro. The Dollar should continue strengthening against the Euro. The only reason why the Dollar has weakened against the Euro was because rates are at 0.25% in the US and at 1% in Europe. Plus the US had carried out QE1 and QE2 whereas in Europe although the LTRO exercise injected E1t into the banking system, the money is still deposited at the ECB and is not being circulated in the economy.

Although valuations are cheaper in Europe it is still not time to switch out of US equities and into European equities. It doesn’t make sense to buy into something which doesn’t have an outlook or an outlook that is not looking good. It is close to impossible to pick a bottom, this is true, however knowing that there are still headwinds in Euroland, it would be prudent to stay overweight the US and underweight Europe.

The equity market and the sovereign bond market are telling two different stories and it cannot be that both are correct. It is JP Morgan’s view that the equity story is correct and sovereign yields of Germany, the US and the UK have to start coming up. When you have a bull market, you normally have yields that are rising. In Q112 we saw markets that rallied 20% however, yields remained low close to the 2% level. The situation in Europe is improving even though at a very slow pace.

When asked if JP Morgan sees opportunities in Europe, the answer remains Germany. There is still a lot more upside to be earned from the Germany market despite the strong performance we have seen in Q112 when the market was up 20%. Germany benefits from a weakening Euro and as the Chinese continue to increase their consumption spending, they demand more goods from Germany, boosting the strength of the German economy. The German DAX is trading below its long term average despite the strength we have seen in the markets. They are underweight financials and see opportunities in corporates which have been beaten down in price due to all the uncertainties is Europe.

Italy and Spain

Italy is not considered a threat despite its debt/GDP ratio of 120%. The country’s interest/GDP is very much sustainable (close to the 4%) and it has a balanced budget surplus. JP Morgan are confident that Italy will meet its obligations and not default on any of them.

Spain on the other hand is a totally different beast. There is a lot of uncertainties in Spain which are not a problem with Italy. For example, Spain has a debt/GDP ratio of 70% which is much lower than that of Italy. 60% of the loans the banking sector makes go to individuals for personal use. There isn’t must risk here with a default rate as low as 3%. This is because the Spanish know a priori that if they do not pay the loan repayment, the law in Spain is very strict and they will end up losing everything. So they will not take on more risk then they afford.

The problem comes from the remaining 40% which go to commercial loans. These have a default rate of c20% and 20% of all commercial loans in Spain sum up to E100bln. Spanish banks have reserve totalling E50bln, this is why the government came out saying that the Spanish banks need to increase their reserves by a further E50bln.

The E50bln can be raised in two ways. One as a loan from the Euroland or another as a loan from the Spanish government. The latter is more probable because the ECB isn’t known for solving individual country problems. Plus adding a further E50bln to Spanish debt would result in a debt/GDP ratio of c80% which compared to other European countries would not be seen as an outlier.

Other things that are worrying in Spain is the high unemployment rate of 25% and the recessionary environment the country has to deal with while at the same time solve its problems to be able to stay in the Eurozone.


Basically JP Morgan’s view is in line with that of Morgan Stanley, Nomura and Deutsche Bank which are saying that despite the slowdown in growth from last year, the Chinese economy is still performing well. The Chinese are increasing their spending rate and the number of loans given to individuals is increasing. This is exactly what Europe needs to solve its problems but isn’t happening in Europe because corporates are not borrowing. Keep investing in China.


JP Morgan are bullish on US equities and think that within the next 12 months we will see modest gains of c8%. They are still underweight Europe and don’t think it is time to start entering into European equities until the outlook improves. They are bullish on emerging markets especially China but do not see opportunity in Japan as the trend has not reversed despite the short term strength in the Yen we have seen the last couple of weeks.

Stock to watch: Brenntag (Price E92.92, Price Target E117)

Brenntag is the leader in full-line chemical distribution, offering over 10,000 industrial and specialty chemicals to 160,000+ customers in around 70 countries. The company operates in a highly fragmented industry and as the largest player, has a size and scale advantage over its competitors, which are mainly mom and pop operators. We also expect Brenntag to continue to benefit from the long term trend to outsourcing in 3rd party chemical distribution. In addition to these attractive organic drivers, Brenntag has the ability to play a part in industry consolidation and with upside potential we rate the stock a BUY.

For further information on Brenntag or other stocks we follow, contact our offices on 25688688.

Good day and happy trading!

Kristian Camenzuli