Takeways: US and European markets are dancing around record highs. Only one appears to be driven by economic fundamentals, but it would be misleading to suggest the US rally comes without disquiet or that Eurozone markets are all about Mario. European companies’ focus on operational improvement will provide opportunities for discerning investors. Stronger US growth could advance the first rate rise to spring 2015 – amplifying the opportunities and risks of divergence we highlighted last week. Of course, there’s a debate to be had about the balance of growth and risk in 2015, which we’ll kick off here. GDP forecasts might actually stick for the first time since 2010….but we can still hear those liquidity canaries sing. Sector dynamics continues to provide strong imperatives to do deals: from oil at $80 $75 $70 a barrel to the necessity to improve customer retention and meet capex demands as TMT convergence comes of age.
Quad-play’s undergone a technology and content makeover to become ‘convergence’. The technology and customer demand wasn’t there a decade ago, however, both have since moved on together, with the lines increasingly blurred now between communication and entertainment.
BT’s interest in O2 and/or EE – and their respective owners’ willingness to sell – highlights the increasing need to build a larger platform to distribute content and to provide a service offering that is comprehensive and differentiated across the TMT space. It also reflects the huge amounts of funding and capex required to bundle enough content and high-speed capacity to meet rising consumer expectations and compete against a constant stream of disruptive technologies and new market entrants. This need could force many companies to partner or bow out – with assets finding willing buyers or partners looking to mix and match. In particular, ‘must-have’ content will be a vital component of customer retention – although content production and ownership may not be the only model, depending on the regulatory environment. Was AOL Time-Warner a decade too soon?
The issue of regulation is a live one in this context. Competition remedies have limited telecom M&A benefits in the past; however, the growing tension between the need for infrastructure investment and the desire for competition appears to be inspiring a new approach. The European Commissions’ decision on Telefónica and E-Plus could be indicative of a more supportive environment. The picture is also complicated by the blurring lines between the TMT subsectors. The broader communication landscape has been fundamentally changed by competition and disruption from new entrants, such as OTT (Over-the-Top) providers – e.g. Netflix. And – as we’ve highlighted previously – even these groups are facing disintermediation by media companies like Time Warner, which is now offering its premium channel HBO direct to customers. We expect this to remain an active area as these battles for consumer attention play out.
Equity markets had their Wile E Coyote moment earlier this autumn, but have quickly reverted back to testing highs. The S&P 500 has notched 46 record closes so far this year, just one less than 1987 and 1998, with around 20 trading days left in 2014. Meanwhile, Eurozone equities are rallying too, hitting a less dramatic two-month high. However, the rallies would appear to have very different inspirations, with the diverging fortunes of the US and Eurozone economies in the headlines yet again. You need to go back to 2003 to find a stronger six months of US growth, as Q3 GDP hit an annualised 3.3%. Meanwhile, German GDP growth was above expectations at 0.1% Q3, with growth expected at 1.2%.
A solid base for the US rally, whilst Eurozone markets are just moving with Mario? Not quite that simple. The pre-Thanksgiving data deluge suggests that Q4 won’t be quite as strong in the US. Durable goods orders fell, consumer confidence dipped, jobless claims rose. Low interest rates are also still playing their part in US markets, as are buybacks – not the most sustainable of drivers. Nearly a third of the companies within the S&P 500 currently pay higher dividends than 10 year T-Bills, according S&P Capital IQ, compared with the usual 10%.
Still, this feels far more solid than the Eurozone rally, which seems totally enthrall to Mario’s QE hints – less so to Bundesbank dissent. But is it fair to say there is no other basis for this rise? This week brought complaints from France that the ‘Anglo-Saxon’ media haven’t been fairly reporting its recent supply-side reforms and economic progress. Figures from INSEE this week suggest that the French economy is bottoming out and confidence is improving. Across the Eurozone, there are opportunities for the discerning investor. Many companies – if not their governments – have engaged in significant operational restructuring, which leaves them well set to make the most of any growth. However, the changes made in France and across much of the region still feel incremental given that substantial debt elephant still in the room. This leaves a great deal of hope pinned on QE.
2015: growth or crunch?
Like mince-pies, 2015 predictions papers seem to appear earlier and earlier each year. We’re planning, radically, to deliver our view in January. However, we thought we might look in on the debate and provide a taster as others are wading in.
First, an observation: our analysis of UK profit warnings shows that between 1999 and 2009, January was the most prolific month for companies to warn. This makes sense given the high frequency of December year-ends and the importance of Christmas in the UK economic calendar. However, between 2010 and 2014, it’s been November that’s been most populous month. Perhaps UK companies are getting quicker at recognizing short-falls, but the tenor and timing of these warnings suggests to us that this is linked to global economic forecasts falling with the autumn leaves – as they have every year since 2010.
Some believe 2015 is the year that we break this disappointment cycle. The low price of oil, the quiet reduction in fiscal austerity and the continuation of QE through the Bank of Japan and the ECB (probably) will provide a supportive environment. They believe next year will provide the first upgrade that sticks. In the downside camp, geopolitical risk is obviously a concern. Bloomberg comments today that increasing numbers of “too small to be strategic” Russian companies are at risk of default, as increasing isolation drives borrowing costs to a four year high. Liquidity is high on our risk list. Recent market and fund gyrations are giving us a taster of market vulnerabilities in areas where banks – for reasons of regulation or risk-aversion– are less active and less able to make markets in times of volatility. CitiGroup also believes that we’re starting to feel the impact of fewer petrodollars recirculating back in debt markets.
It all could add up. High yield remains our canary. The drift up the yield curve has predicated on low defaults. If QE can’t save the Eurozone – and we’re not convinced it will – and growth disappoints, then the recovery will be tested yet again. Demand may hold out on oil and central bank support, less certain are investors’ nerves and lenders’ patience.
The two faces of low price oil
Citi’s petrodollar warning is a reminder that the low oil price – whilst a net positive for the global economy and a boon for consumers and oil importers – has some negative and unpredictable effects. There are repercussions for related industries, national budgets, currencies and beyond. Banks are struggling to syndicate sector loans. Brent crude is below $73 a barrel, putting 15 oil producing nations at below ‘breakeven point’. The Rouble, Nigerian naira and Norwegian krone are sliding. Energy stocks are falling – taking equity markets with them. The OPEC’s decision not to cut production has inspired a further dip in the price of crude, but if they had trimmed, there was a good chance that US supply would simply fill the gap – at least until some production falls below breakeven levels. It looks as if we’re going to test more of these ‘breakevens’ in the weeks ahead – $60 a barrel doesn’t look out of the question. Sometimes, the best ‘cure’ for low price oil is low price oil.