Equities flat ahead of big week for central banks

Equities
Indices
Morning Note

Shares open flat as markets look ahead to the FOMC meeting later in the week, whilst Lufthansa shares tumble on a profits warning.

European equities look pretty flat on the open after a decent run last week for global equity markets. The S&P 500 closed a shade lower on Friday. Asian shares a bit wobbly overnight. Gains may be hard to sustain with the Fed in focus and no clear signs of progress on trade.  Investors may take a bit of risk off the table in the next couple of days.

US commerce secretary Wilbur Ross has poured cold water on any hopes that we might get a trade deal from the G20 meeting and said the US is ready to increase tariffs on China if necessary. 

FOMC meeting

All eyes are of course on the Fed meeting this week. It’s hard to recall a time we headed into an FOMC meeting with so much at stake and with so much uncertainty about what might be agreed. This means the potential volatility around the event is likely to be substantially higher than at most recent FOMC meetings. Traders may start to show some nervousness ahead of the Fed meeting if they think it won’t be accommodative as hoped. 

We’ve also got the BoE and BoJ expected to stand pat. We could though see some hawks on the MPC vote for a rate hike to signal their intent, as it appears waiting for Brexit clarity could take a while longer than policymakers had anticipated. Three members of the rate-setting Monetary Policy Committee have in the last week or so said that rates will likely need to rise at a faster clip over the next two years than the market is currently pricing. This week could be when they signal their intent.

EURUSD is looking softer ahead of the Fed meeting with the apparent failure of the double-bottom breakout from the descending wedge. Last trading on 1.12, a breach on the downside of this handle opens up a return to the 1.110 level immediately. Sterling remains softer too ahead of the Bank of England meeting with the dollar broadly firmer. GBPUSD has last holding support at 1.2580 where we long-term rising trend support coming in.  

Oil 

A fair old whipsaw last week as geopolitical tensions in the Middle East temporarily lifted prices. But on the whole the bleak demand outlook is weighing on prices and we have seen Brent retreat to the comfort of $62-$62.50. WTI is a shade below the $53 level.  Yet to see a sustained downside break again but it may be coming, albeit rising geopolitical tensions may offer support.

Speculative long positions have been heavily reduced – CFTC data showing a trimming in net long positions of around 50k contracts from 400k reported in the COT on Jun 7th to 351k reported on Friday. That’s down from a high of around 547k at the end of April. The reduction in net long positions reflects worries about a supply glut as demand weakens and US production ramps. 

Effectively the market has decided that OPEC will choose to extend its production curbs when it meets later this month/early July. To do anything else would be to risk a collapse in prices. Saudi oil minister Al-Falih is optimistic about extending cuts. His confidence is now being discounted by the market however.

Equities

Deutsche Bank – If no one wants to marry you because you’ve got too much baggage, the answer is to get rid of the baggage. Deutsche plans to set up a bad bank (that’ll make two then) to offload some of the least profitable elements of business. This is Sewing’s big play – we await to see whether it’s enough to really convince shareholders that we’ve hit the bottom. Profitability targets still look rather distant.

Airlines – Lufthansa’s profits warning has taken the wind out of the airlines today. The margin on its preferred metric is seen between 5.5% and 6.5%, down from the previous guidance for adjusted EBIT margin of 6.5 to 8%.

At the end of April we noted that Lufthansa’s Q1 loss wasa red flag for the airline sector. Over-capacity in the European short haul market, intense competition and the resulting pressure on fares can be blamed for the decline in profitability, whilst rising fuel costs are an added headache. The sector always does a good job at competing away margins in the good times. No signs that anyone is prepared to reduce capacity therefore we would anticipate the wave of consolidation in European short haul is not over.

Babcock/Serco – Babcock confirms speculation it’s been approached by Serco. Not an immediately obvious move but the two are a pretty good fit and we had anticipated some consolidation in the sector given the problems for outsourcers. Serco has been doing well against a tough backdrop for outsourcers, meeting new higher performance targets, whilst Babcock has been suffering.  Babcock has been downgrading its forecasts for a while and has been on a persistently downward spiral. Last month Babcock reported profits down 47% last year and warned of a tough outlook for the coming one. 

Morning Note: Trade war escalates, Uber IPO caution, IAG profits sag

Equities
Forex
Indices
Morning Note

Tariffs on $200bn worth of Chinese exports were raised to 25% last night. Trump was true to his word, and there is no can kicking. This marks a sharp escalation in the trade spat, but it’s not gone nuclear yet.

Talks between the Chinese and the Americans are continuing today, although we don’t hold out much hope of anything meaningful being achieved this week.  

It all tends to suggest Mr Trump is playing one of his aces in order to force the Chinese into concessions. His bet is that the US economy can weather any hit from tariffs better than China. He is probably right but this will not help ease uncertainty about the global economy. Beijing is weighing whether to retaliate. 

Yesterday the S&P 500 bounced off its lows, closing down just 0.3% at 2870.72, having plumbed lows around 2835. The Dow was offside by 139 points on the close, but was over 400 points lower at one point. Algos seemed to bidding it up after the ‘beautiful letter’ nonsense.

Oil has rallied, indicating markets have had enough of the selloff. Brent was last pushing up at 70.75, above the key 70.60 resistance point. The flag pattern does look like it could be a bullish continuation pattern that is just about complete – watch for a leg higher. But failure to cement the tentative gains we see this morning would be bearish – look for the area around 69.50 for support.

Asian stocks bounced overnight and European futures point higher today. Chinese stocks were last about 3% higher – just remember how much these stocks had sold off earlier in the week.  There is still hope that a deal will be done.

Uber prices at low end 

Uber priced at the bottom end of the range at $45. It’s a rough time to be coming to the market after the selloff this week but this IPO exists to a degree in its own bubble. Are you betting on the long payoff? If not, you may well be disappointed – profits are not coming any time soon.  

But shares could yet pop higher today, partly because of this conservative approach that Uber clearly learned from Lyft’s bumpy ride post-IPO. I said yesterday (Uber set for big pop despite Lyft worries, 09/05/19) that I would not be surprised if the people selling Lyft stock are simply doing so in preparation for the Uber listing, so be careful reading too much into the Lyft troubles. FOMO is a strong emotion. 

Nevertheless, my main concern is the slowing revenue growth. Whatever the cash burn, you’d want to see accelerating top line growth in a disruptor coming to market.  

IAG profits sag

Profits at IAG were hit by rising fuel costs and a big FX headwind, whilst we see a broader thread across airlines with margins being competed away. Excess capacity remains a problem, as we heard from Lufthansa. In fact, we can pretty much regurgitate what we noted about Lufthansa – lots of competition means no one has the pricing power, whilst labour costs are a factor, but the biggest headwind right now is fuel costs, which were up 15.8%. Non-fuel costs were 0.8% higher. 

Although passenger revenue growth was at a healthy clip, up in excess of 5%, first quarter operating profit slumped to €135 million before exceptional items, which was down 60% from a year before on pro forma basis. Profits after exceptional items – which were zero in Q1 – were down 86%. FX headwinds knocked €61m from the bottom line. 2019 operating profit is seen in line with 2018 – which means no growth in the year ahead. 

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