High Leverage and Falling Yields Isn’t a Bad Combination

(Bloomberg) -- The Italians love a good surprise. After stoking investor worries with its anti-EU rhetoric and tense discussions about the budget, the country’s populist government offered a proper EU-compliant deficit, sending Italian bond yields lower, which is good news for highly leveraged corporates such as utilities.

The Italian 2-year bond yield is hovering near 0% after hitting negative territory, while the 10-year yield is now comfortably below 2%; an unlikely scenario just a few months ago.

As bond proxies, utilities are first in line. Falling interest rates and soaring government bonds in Europe have already propelled those stocks higher this year. A significantly reduced country-risk could be the icing on the cake for those issuing new corporate debt.

Some of the most-leveraged Italian companies still seem to have a high cost of debt. They may be able to reduce it with refinancing, provided that the risk associated to the country continue to drop. Besides utilities, construction and toll-road operator Atlantia stands out.

More generally, Italian equities tend to move closely in sync with the bond market. And an aggressive drop in the country’s 10-year yield has widened a gap between the two, potentially signaling more room to rally for the FTSE MIB.

The relationship can be at least partly explained by leverage. The FTSE MIB has one of the highest debt-to-equity ratios in Europe, so falling yields are good news. It’s also positive for European stocks in general, given the amount of Italian debt owned by non-Italian banks.

• READ: Why Italy’s Debts Are Europe’s Big Problem

That said, the benefits may be tempered by the weighting of the banking sector in the FTSE MIB. Lenders may keep suffering as yields across Europe continue to plummet, while the ECB is more likely to ease policy and cut rates. This would maintain pressure on lenders’ margins, and financials account for about 32% of the FTSE MIB.

One more thing to keep an eye on: Italian 5-year CDS, which is an indicator of credit risk, has tightened towards 183, but is still much wider than during the first quarter of 2018 when it was trading around 100. Compared to other large European economies, the spread remains elevated.

In the meantime, Euro Stoxx 50 futures are trading up 0.1% ahead of the open.

SECTORS IN FOCUS TODAY:

• Watch cybersecurity stocks following a Bloomberg report that chipmaker Broadcom is in advanced talks to buy U.S. cybersecurity firm Symantec. Watch Sophos, Avast, NCC Group and ECSC Group. Also watch chipmakers for M&A activity after Applied Materials agreed to acquire Kokusai.
• Watch soft drinks makers in the U.K. after Boris Johnson, the frontrunner to be the country’s next prime minister, said he’ll launch a review of “sin taxes” on sugar, fat and salt. Watch AG Barr, Britvic, Fevertree and Nichols and on sugar producers like AB Foods.

COMMENT:

• “Equities are making fresh highs but sentiment and positioning are cautious,” Barclays strategist Emmanuel Cau writes in a note. “Stocks have rallied year-to-date without inflows, as investors continued to de-risk and to move into relative safe havens, i.e. bonds and cash. Cyclicals, EM equities and trade plays lagged on the way up in June, and the extreme valuation dispersion between Growth/Quality and Value stocks suggests that equities are not all priced for perfection. Fundamentals are not exciting and tail-risks abound, but the growth-policy trade-off remains supportive of equities, courtesy of the dovish central banks.”

COMPANY NEWS AND M&A:

• Deutsche Bank Explores Selling Unwanted Assets Amid Revamp (1)
• Deutsche Telekom to Cut About 1,200 Sales Jobs: Handelsblatt
• Cevian Says Its Patience With Nordea ‘Isn’t Infinite’: SVD
• Atlantia: Legal Panel Cautions Against Revoking Autostrade Concession
• BMW Widens Lead Over Mercedes at Half-Year Mark With SUV Lineup
• U.S. June Light Vehicle Sales: Company, Type, Source (Table)
• SocGen Chairman Says Was Slow to Cut Jobs at Trading Unit: FT
• Logitech Proposes New Board Members, Annual Dividend Boost
• Clarins Is Not for Sale, Clarins Holders Tell Figaro
• Mediaset Receives Request From Vivendi for Shareholder Meeting
• Transgene Says Raises EU48.7M Through Capital Increase
• Immofinanz Sees EU100 Million Property Valuation Gain in 2Q (1)

NOTES FROM THE SELL SIDE:

• The short-term outlook within European travel is likely to remain challenging and until there are signs of recovery, recommendations will be led by macro concerns, Jefferies says downgrading Thomas Cook to hold and initiating on Dart Group (hold) and TUI (underperform).
• BCP is raised to buy from underperform, while Intesa Sanpaolo is cut to underperform from hold at Jefferies, which sees scope for provisions to undershoot but says removing rate rises leaves its 2021 profit estimates on southern European banks ~11% below consensus.
• Henkel’s investor day on Tuesday “reminded of all the potential we see in this business,” even if recent delivery doesn’t totally reflect this, Jefferies says in note, reiterating a hold rating on the stock.

TECHNICAL OUTLOOK for Stoxx 600 index:

• Resistance at 392.7 (July 2018 high); 397.9 (May 2018 high)
• Support at 381 (50-DMA); 374.5 (61.8% Fibo)
• RSI: 66.4

TECHNICAL OUTLOOK for Euro Stoxx 50 index:

• Resistance at 3,514 (May high); 3,596 (May 2018 high)
• Support at 3,410 (50-DMA); 3,403 (61.8% Fibo)
• RSI: 68.6

MAIN RESEARCH AND RATING CHANGES:
UPGRADES:

• Aker Solutions raised to equal-weight at Morgan Stanley
• Avanza upgraded to hold at SEB Equities; Price Target 75 Kronor
• BCP upgraded to buy at Jefferies; PT 32 Cents
• Castellum upgraded to buy at Kempen & Co; PT 195 Kronor
• EDF upgraded to buy at HSBC; PT 13.50 Euros
• Fabege upgraded to buy at Kempen & Co; PT 155 Kronor
• Henkel upgraded to buy at Goldman; PT 100 Euros
• Sophos upgraded to overweight at JPMorgan; PT 4.80 Pounds
• Standard Chartered upgraded to buy at SocGen; PT 8.40 Pounds
• Vonovia upgraded to buy at Kempen & Co; PT 47 Euros
• Wood upgraded to overweight at Morgan Stanley; PT 7 Pounds

DOWNGRADES:

• Assa Abloy Downgraded to Equal-weight at Barclays; PT 220 Kronor
• Catena downgraded to neutral at Kempen & Co; PT 295 Kronor
• Intesa downgraded to underperform at Jefferies
• PGS ASA cut to equal-weight at Morgan Stanley; PT 18 Kroner
• Petrofac cut to equal-weight at Morgan Stanley; PT 5.30 Pounds
• SpareBank 1 SR downgraded to hold at Carnegie; PT 108 Kroner
• Thomas Cook downgraded to hold at Jefferies; PT 13 Pence
• Valeo downgraded to underperform at MainFirst; PT 24 Euros
• Vallourec cut to underweight at Morgan Stanley; PT 3 Euros
• Wartsila downgraded to underweight at JPMorgan; PT 12.50 Euros

INITIATIONS:

• Dart Group rated new hold at Jefferies; PT 9 Pounds
• Klaveness Combination Carriers rated new buy at ABG
• TUI rated new underperform at Jefferies

MARKETS:

• MSCI Asia Pacific up 0.4%, Nikkei 225 down 0.7%
• S&P 500 up 0.3%, Dow up 0.3%, Nasdaq up 0.2%
• Euro up 0.03% at $1.1288
• Dollar Index up 0.02% at 96.75
• Yen up 0.19% at 107.68
• Brent up 0.3% at $62.6/bbl, WTI up 0.3% to $56.4/bbl
• LME 3m Copper down 0.1% at $5883.5/MT
• Gold spot up 0.4% at $1424.5/oz
• US 10Yr yield down 3bps at 1.95%

ECONOMIC DATA (All times CET):

• 9:15am: (SP) June Markit Spain Services PMI, est. 52.8, prior 52.8
• 9:15am: (SP) June Markit Spain Composite PMI, est. 51.7, prior 52.1
• 9:45am: (IT) June Markit Italy Services PMI, est. 50, prior 50
• 9:45am: (IT) June Markit Italy Composite PMI, est. 49.5, prior 49.9
• 9:50am: (FR) June Markit France Services PMI, est. 53.1, prior 53.1
• 9:50am: (FR) June Markit France Composite PMI, est. 52.9, prior 52.9
• 9:55am: (GE) June Markit Germany Services PMI, est. 55.6, prior 55.6
• 9:55am: (GE) June Markit/BME Germany Composite PMI, est. 52.6, prior 52.6
• 10am: (EC) June Markit Eurozone Services PMI, est. 53.4, prior 53.4
• 10am: (EC) June Markit Eurozone Composite PMI, est. 52.1, prior 52.1
• 10:30am: (UK) June Markit/CIPS UK Services PMI, est. 51, prior 51
• 10:30am: (UK) June Markit/CIPS UK Composite PMI, est. 51, prior 50.9
• 10:30am: (UK) June Official Reserves Changes, prior $2.31b

* For a daily wrap on developments in European equity capital markets, click here

©2019 Bloomberg L.P.