Daily Note – Too many mergers?

Pharma namesSummary

The World: Beware human nature & mergers!

China: Growth data looking better.

United States: The return of bond vigilantes?

Eurozone: Concerns about growth in the “core”.

Eurozone: Euro outflows develop momentum.

Good morning,

It’s another glorious day in Dublin. We are not used to this notion of six consecutive days of sunshine and heat. My book festival is just over and I feel my brain is both renewed and frazzled at the same time. However, as I maintained last week we all need stimulus to the brain and different types of stimulus, so whether it’s Salman Rushdie talking about Indian Independence or the Fatwa, Amos Oz taking us back to the Jerusalem of his childhood or ad-man Rory Sutherland’s hilarious observations about the inability of traditional economics to explain much of what is going on in the real world. All that makes us think and question, is extremely valuable.

Remember we are in the business of human nature, not economic modeling. Human nature drives investing and human nature is a function of the human condition and writing and literature are the way we tell the story of the human condition.

 On the screens, equities traded sideways in a quiet session yesterday. Markets are right at the highs so is there any catalyst for a break higher? Payrolls are still a little ways off, but if the data continues to come inline with expectations, you have to think that markets will follow the 2013 pattern of progressive upwards movements for a while yet. However, I am beginning to get worried about how valuations can still move up with earnings more or less stagnant. There are too many mergers about for my liking. Mergers are bad, not good for financial stability.

The AUD rallied yesterday on the back of the better Chinese PMI data +0.35% yesterday. We have written very little on Australia in recent weeks but we intend to take a closer look at Australian growth prospects in coming days. The Euro has been trading around the $1.36 level for the last couple of sessions with key downside support remaining at $1.35. We took our Euro short down by a third because, in the short term, the risk of a “short covering” rally is building.

It was a quiet day in Treasuries – the 10 year closed less than 0.25 bps stronger. We have taken off our 10 Year short and moved the risk back into the 5 Year sector of the curve. We maintain our bullish outlook on US growth and inflation. Indeed I expect the reemergence of bond vigilantes some time this year.

In the commodities world, Brent oil was slightly weaker as it backed off from nine-month highs because the Iraqi army seems to have recaptured territory from ISIS.

As we talked about on Friday, with the majority of oil production in IRAQ unaffected by the recent fighting, we will need to see this change for crude to continue higher.

Elsewhere, 3-month Copper extended its seven-session rally up 0.95% on news of positive manufacturing growth in China.

Figure 1: Copper Prices 3mth

Chart 1 24 June

China: Manufacturing sentiment picks up

Table 1 24 June

The HSBC PMI reading accelerated strongly in June. This confirms the pick-up in activity growth shown by official activity data in recent months. Almost all sub-indices showed signs of cyclical acceleration.

We believe the strong acceleration in HSBC PMI flash reading in May and June (see chart below) has been helped by the loosening of the domestic policy stance and stronger external demand.

Figure 2: China HSBC Manufacturing Sentiment

Chart 2 24 June

In the longer term, we expect the Beijing government will stimulate the economy (if it has too) in order to hit the “around 7.5%” growth target.

We will have a detailed note on China later this week, but just to note we have reduced our long equity position in recent days primarily because better data in the short term reduces the likelihood of further immediate stimulus.

United States: Manufacturing sentiment makes a new high

Table 2 24 June

The preliminary Markit PMI for June rose to 57.5 (vs. consensus 56.0), from 56.4 in May. These are the strongest numbers we have seen yet this cycle. (See chart below).

Figure 3: US Manufacturing Sentiment

Chart 3 24 June

All this adds to my concerns that the market is not appreciating just how strong the US economy actually is right now. With Yellen focusing on spare capacity and underemployment, there is a real risk that the bond vigilantes re-emerge from the shadows in the next few months because they will argue, as they did in 1994, that the “Fed is behind the curve”. I was reminded of 1994 watching Mexico in football last night. It’s funny how the mind works, but that’s human nature. The celebrating Mexicans jolted my memory of the Tequila Crisis because I haven’t seen Mexicans so effusively happy since the weeks before the crisis laid them low!

Eurozone: Concerns around the “core”

Table 3 24 June

The Euro area composite PMI fell from 53.5 to 52.8. The gap in performance between Germany and France remained broadly stable as both countries’ composite PMIs fell by around 1.3% on the month. (See chart below).

Figure 4: French & German Manufacturing PMI

Chart 4 24 June

This morning we saw the much-watched IFO German business confidence, which also disappointed.

Today’s data implicitly suggest improvements in the Euro area outside Germany and France.

The danger is that any slowdown in the core would spread quickly to the periphery, eliminating any prospect for, even modest, Eurozone growth this year. With the measures announced by the ECB not coming into place until the autumn, there is a danger of a further slide in the meantime.

Eurozone: Euro outflows develop momentum.

The Australian Bank Westpac looked at Friday’s Eurozone balance of payment data for April and noted the substantial reversal in investment flows. The Euro was persistently strong early in the year. The main reason for this was investment inflows into the region but these flows have sharply reversed.

Each inflow category saw large net outflows in April – direct investment, bonds and notes, money markets and equities. Eurozone resident outflows across almost all the categories contributed as much to net outflows in April as foreign investor sales.

The ECB’s latest moves will likely draw more foreign money into European equities, but Westpac says that will not be enough to offset negative outflows in other asset classes elsewhere. They also show the correlation between investments flows and EUR/USD (see chart below).

Figure 5: EUR/USD investment flows

Chart 5 24 June

We like this chart, as we have long maintained that it will be the flow of capital that will drive the Euro lower rather than the day in day headline news and noise.

Table 4 24 June

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