Credit Suisse: Draghi e Bce: Market expectations too high for Draghi to match

At yesterday’s meeting of the European Central Bank (ECB), President Mario Draghi announced a suite of measures to further stimulate the Eurozone economy and effectively prolong the bank’s quantitative easing (QE) program. The market reaction suggests that expectations of what the ECB might have done were too high. More importantly from an asset allocation point of view, the reappearance of volatility underlines the fact that markets are moving towards an environment where central banks can no longer be as supportive as they have been in the past five years.

Mr. Draghi announced a deposit rate cut of 10 basis points, an extension of QE to March 2017 and potentially beyond that if needs be, the reinvestment of the proceeds of the ECB’s investments back into the QE program, continued refinancing programs from the ECB and an extension of QE eligible assets to encompass some regional European debt. Markets had been focused on more generous measures, notably a bigger deposit rate cut and a formal increase in the size of the monthly purchase by the ECB.

Focus now turns to the Fed meeting on 16 December

In addition, comments by Mr. Draghi as to the likelihood that inflation would rise through the next eighteen months and that the Governing Council was not unanimous on the package of additional measures contributed to a less emphatic reading of the ECB’s strategy by markets. Major government bond yields rose sharply, equities fell by approximately 2% and the euro rose by up to 2% relative to the US dollar. To some extent, the sharp market moves highlight the risks of crowded positioning and we may continue to see a balancing of long rates and short euro positions in coming days. The manner in which the Federal Reserve presents its likely rate increase on 16 December will also have a significant bearing on the EUR. In addition in forex, the strengthening of the euro may ease the pressure on the Swiss National Bank to respond to the ECB’s moves.

From an investment strategy point of view, the rise in yields plays to our underweight position in fixed income. We also highlight that in the latest Investment Committee meeting, we cut our rating on high yield to neutral from outperform. Overall in equities we are neutral, with an overweight in European equities. Though the first reaction to the ECB’s announcements is not positive, we feel that the ECB’s moves are supportive of the euro economy. Further, any more sharp moves upwards by the euro in coming weeks may provide an opportunity to add to European equities.

ECB fails to meet elevated expectations

The set of new easing measures by the European Central Bank (ECB) was at the lower end of elevated markets expectations, but does not change our expectation of a continued moderate economic recovery.

The ECB announced various easing measures yesterday, but most were just at the lower end of expectations: the size of the deposit rate cut (–0.3%), the extension of the asset purchase program (March 2017) and the unchanged pace of monthly asset purchases (EUR 60 bn). Apart from these parameters, the ECB announced the inclusion of regional and local sovereign debt instruments (with Germany the main beneficiary) and a reinvestment policy of maturing principal (which becomes relevant only in the spring of 2017).

Going forward, we expect the ECB to remain on hold and focus on the implementation of the asset purchase program, unless Eurozone economic data were to unexpectedly deteriorate. In the spring of 2016, it will review the parameters of current program, providing the next “regular“ opportunity for new easing measures. The ECB’s decision also has implications for other central banks, particularly in small open economies with strong ties with the Eurozone. One of the most prominent is the Swiss National Bank (SNB), which we continue to expect to follow with a 25 basis points rate cut at its regular meeting on 10 December in order to soften appreciation pressure on the EUR/CHF exchange rate. For more details on the ECB decision, please refer to our Research Alert from 3 December 2015, “ECB fails to meet elevated expectations.”

OTHER DATA HIGHLIGHTS

–  GLOBAL, SERVICES PMIs: The services Purchasing Managers’ Index (PMI) for the Eurozone indicates further expansion in the services sector, with November’s PMI at 54.3 only slightly below expectations (54.6) and higher than last month’s PMI (54.1). The expansion was evenly distributed across countries, albeit France and Italy mitigated a further acceleration. Also, the period of sustained output growth in the USA seems to continue (56.4 vs. 54.8), though the non-manufacturing ISM index fell from 59.1 to 55.9. While the latest readings indicate a softer expansion of the service sector in India and China, the PMIs for Brazil and Russia both recovered, even though Brazil’s still remained substantially below the expansion threshold.

–  EUROZONE, RETAIL SALES: Eurozone retail sales increased by 2.5% YoY, although weaker than last month’s reading of 2.9% YoY and below estimates. The reading continues to point to solid consumer demand in the Eurozone. Demand growth was spread broadly across countries, though Slovenia, Austria, Ireland and the UK are mainly responsible for the moderate decline in October (–0.1% MoM).

–  AUSTRALIA, RETAIL SALES: Retail sales in Australia increased 0.5% MoM in October, following two consecutive months with 0.4% MoM growth. The quarterly growth rate thus remained upbeat at 1.0% QoQ, and the strong recovery of consumer confidence over the past months points to continued strength of private consumption going forward.

–  JAPAN, WAGES: Japanese total labor cash earnings increased 0.7% YoY in October (vs. consensus of 0.5% YoY), but the previous month’s growth rate was revised down to 0.4% YoY from 0.6% YoY. Despite the stronger-than expected October print, wage growth in Japan has overall been disappointing this year, given high corporate profitability and a tight labor market. Even more worryingly, the upward trend in base wages growth has softened over recent months, from 0.4% YoY in July to 0.1% YoY in October. With substantial wage growth being the missing link in the Bank of Japan’s narrative of a “virtuous cycle” that will ultimately lead to higher inflation, the next round of Shunto spring wage negotiations will be very much in focus by Japanese policymakers and markets.

–  BRAZIL, CENTRAL BANK MINUTES: The minutes from last week’s monetary policy meeting signaled that the future policy rate path will be highly dependent on incoming data and the development of fiscal policy over coming months. Continued fiscal slippage and uncertainty stemming from the impeachment proceedings against President Rousseff keep the risk to inflation tilted to the upside. If the political stalemate continued, additional regulated price and/or tax hikes (which do not need Congress’ approval) would be in the cards. Next week’s inflation print will likely show a further rise to double-digit levels for November (around 10% YoY). More relevant for the next monetary policy meeting in January will be the December inflation print though – a continued increase in inflation would trigger a rate hike, in our view (not our base case though). In addition, the impact of a fi! rst policy rate hike by the US Fed would be taken into consideration as well since a sharp depreciation of the BRL could add to upside risks to inflation.

–  TURKEY, INFLATION: Inflationary pressures kept rising in Turkey, with both headline and core inflation surprising to the upside. Particularly worrying is the continued upward trend in core inflation, which reached the highest level in over a year (9.2% YoY) and thus deviates significantly from the inflation target (3.0–7.0% YoY). Given unfavorable inflation dynamics and the prospect of weakening capital inflows amid monetary tightening in the USA, pressure on the Central Bank of Turkey (CBRT) to tighten its monetary stance is rising.

INVESTOR WATCH LIST

US November non-farm payrolls (‘000): Consensus: 200; Prior: 271

Given the strong rebound in October, some normalization closer to the average pace of monthly payrolls gains in 2015 appears likely.

S&P downgrades eight US banks

–  S&P downgrades eight US banks due to lower likelihood of extraordinary state support.

–  Moody’s changes Russia’s outlook to Stable.

–  Medtronic’s Q2 2016 results in line with market expectations.

–  Changes to our US Top Picks List.

–  Changes to our Themes in Portfolios idea “US Technology: Mobility, infrastructure, security.”

–  Bobst holds financial conference

Removal of rating uplift due to lower expectation of extraordinary state support

On 2 December 2015, S&P downgraded the non-operating holding companies (NOHC) of all eight large US global systemically important banks (G-SIBs) by one or two notches due to lower likelihood of extraordinary state support to the banking sector. According to the rating agency, the step was taken after its revised assessment of the US resolution regime, under which the NOHC creditors would be ultimately responsible for providing support to the operating entities. Also, the view takes into account the recently released rules on TLAC that will be finalized by 2016 and will require banks to maintain minimum levels of capital and long-term debt that can be tapped-in to absorb big losses without burdening taxpayers. No negative action has been taken on the operating subsidiaries of these US GSIBs.

Moody’s upgrades Russia’s rating outlook due to stabilization of external finances

Moody’s has changed the outlook on its Ba1 rating on Russia to stable from negative. According to Moody’s, the change reflects the stabilization of Russia’s external finances and the diminished likelihood of the economy facing an intense shock in the next 12–18 months such as from additional international sanctions. Moody’s, however, noted Russia’s structurally weak growth potential and over-reliance on the oil and gas industry as constraints on the rating. Russia is also rated BB+/Negative by S&P and BBB-/Negative by Fitch.

Medtronic maintains 2016 guidance

Medtronic (MDT US, BUY) reported Q2 2016 (FY ending April 2016) sales of USD 7 bn (+6% on comparable basis; up 62% YoY), in line with consensus, primarily driven by robust performance in the USA (+6% on comparable basis). Emerging markets growth at 13% was sequentially better, which we believe would be viewed positively by investors. Better cost rationalization resulted in an adjusted EPS of USD 1.03 (vs. consensus of USD 1). With good H1 2016, Medtronic remains optimistic about achieving its full-year guidance. The Covidien integration seems to be on track, and we expect the performance to improve as synergies are realized in future. We reiterate our BUY recommendation on the stock. Sound cash flows enable debt reduction (from acquisition) though likely slow given strong shareholder focus. We affirm our Stable fundamental credit view and our BUY recommendations on the USD 2.5% 2020, 3.15% 2022, 2.75% 2023, 3.625% 2024, 3.5% 2025 ! bonds.

Removing Nike, IFF, Tyco, Medtronic, Schlumberger and VMware

Given the stock’s superior performance in 2015 and limited upside to our target price, we remove Nike from our US Top Picks list. We further take profit on IFF after the stock’s solid recent performance. We also remove Tyco and Medtronic as we anticipate limited catalysts for these stocks in the coming months. Additionally, we take out Schlumberger and VMware as both stocks have been added to our Restricted List.

Adding Intel, Visa, AT&T and Pioneer Resources*

To maintain our exposure to the IT sector, we add Intel to our US Top Picks list as we see the company as favorably positioned in light of its focus on Data Center Group, Internet of Things and Memory. We further add Visa to the list as we expect the stock to continue benefiting from growth in the global payment industry. To reflect our positive strategy stance on the telecom sector, we add AT&T which should profit from growing OTT services, more rational competition and cost savings. Finally, we add Pioneer Resources to the list, an energy stock which is attractively valued in light of its production and resource growth potential, in our view.

We drop Verint Systems

We dropped Verint Systems (VRNT US, Neutral*) from our Themes in Portfolios idea “US Technology: Mobility, infrastructure, security” since the stock has become less attractive, in our view. On Wednesday, 2 December 2015, the company published its Q3 2016 (FY ending January 2016) results below its own guidance and street expectations. But more importantly, FY 2017 revenue growth of 5% YoY is meaningfully lower than VRNT’s “double-digit” long-term growth target, due to persistent macro headwinds and expectations for weaker pipeline conversions over the near-to-medium term. It now appears that the headwinds are more structural or at least longer-term in nature.

Bobst (High BB, Stable) updates 2015 guidance and gives 2016 outlook

Bobst improved its FY 2015 sales guidance slightly to CHF 1.3 bn, with a positive effect from organic growth and consolidation, but offset by FX. While H1 was more about volume and price pressure, Bobst is said to be testing price elasticity in H2. Year-end backlog grows +14% YoY, being strong for Sheet-fed and weak for Web-fed. The EBIT margin (>5%) and net profit margin (>3%) were affirmed. For FY 2016, expected sales are between CHF 1.31–1.35 bn, while the EBIT margin remains >5%. FY 2015 capex will be stable, while FY 2016 capex could be close to twice as high (postponement of Chinese plant, investments into SG&A, production optimization). The group forecasts global packaging consumption growth of 2015–2020 with a CAGR (2015 – 2020) of 3.9% for flexible materials, 3.6% for folding carton, and 4.3% for corrugated board. Long-term guidance was confirmed (sales CHF 1.4–1.5 bn; EBIT margin 8%), along the focus! on platforming and modular concepts, increasing presence in Asia and MEA, and digital packaging supply. We affirm our High BB Stable rating as well as our BUY on BOBST 2.125% 2019 and HOLD on BOBST 1.5% 2020.