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CANTOR FITZGERALD IRELAND LIMITED
Quarterly Outlook Q4-14
In Q4 we examine the consequences of the opposing central bank policy measures in
developed economies, the likely impact of monetary policy on equity indices, and
some of our preferred companies that provide exposure to the recovery in Ireland.
R
OCTOBER 2014
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C A N T O R F I T Z G E R A L D I R E L A N D LT D O C T O B E R 2 0 1 4
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Quarterly
Outlook Q4-14
Foreword
Seven years after the beginning of the financial crisis, Q4/14 should mark a significant
juncture in the global economic recovery. In the coming weeks we expect the US
Federal Reserve to complete the final reduction of its asset purchase programme. This
will conclude the third in a series of similar endeavours since the collapse, designed to
improve liquidity and get the US economy back on track. Similarly, we expect the Bank
of England to start down the path of normalising interest rates with a 25bps hike,
reflective of the progress the economy has made, and its level of growth. These events
however are in stark contrast to the likely course of action within Europe. Here the stage
is being set for further wide scale monetary easing, as policy makers attempt to stave
off disinflation or another recession. We have deemed this divergence of Central Bank
policies as both necessary, and likely, since the latter stages of 2013.
Against this backdrop, equity markets too stand at an inflection point. Years of relaxed
Central Bank policies have done much to inflate asset prices globally; the increased level
of funds in the system hunted for yield wherever it could be found, thereby driving
prices higher. We believe this has resulted in equity market valuations that are
unsupported by the subdued earnings growth environment. In our view, the equity
market rally of recent years is not on a sure footing; rather it is mainly the beneficiary of
accommodative Central Bank policy which is now coming to an end.
As such, the importance of specific stock selection has become ever more acute during
the course of 2014. This quarter investors should not rely on a rising tide lifting all boats.
We have positioned our core portfolio to take advantage of sectors which we believe
should benefit during a period of increased volatility. We retain a preference for noncyclical industries like Pharmaceuticals, Food and Telecoms. These positions should be
complimented by our preferred companies in other sectors, which offer lower market
correlation, strong balance sheets, attractive dividend yields or appealing valuations.
David Donnelly
Investment Analyst
October 2014
OCTOBER 2014
C A N T O R F I T Z G E R A L D I R E L A N D LT D
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Quarterly
Outlook Q4-14
Q4 Thoughts
Eurozone – Recovery remains subdued, and policy initiatives
have had limited effect to date. We see a wider QE programme
as likely in Q1 2015
UK – We expect the BOE to begin rate rises this quarter, as
growth in the UK economy remains robust
US – We expect tapering to be completed this quarter, with rate
rises beginning in Q1 of next year. However, despite
improvement in industrial data, significant slack remains in the
US labour market, while the average US consumer is yet to
substantially benefit from years of stimulus
Emerging Markets – Though we have concerns regarding
lending practices and the extent of debt in China, authorities
have again displayed willingness to maintain the 7.5% growth
target in the world’s second largest economy
Bond Outlook – We believe policy loosening by the ECB should
continue to depress yields in the Eurozone, with investors
switching to longer-dated maturities. Conversely, we expect an
upward trend in US Treasury yields, reflective of the expected
tightening by the Fed in Q1/15.
Irish Sovereign – The Irish 10 year should continue to narrow
versus the soft core in the coming quarter in our view, and trade
more closely in-line with France/Belgium
Currencies – As expected, the divergent policies of Central
Banks has weighed heavily on the euro. We look for the euro to
consolidate versus the dollar around current levels in the short
term, to facilitate further moves lower. From a Technical
perspective, below $1.27 we see no significant support until
$1.215
Valuations – Valuations in equity markets remain elevated in
our view, inflated by years of loose monetary policy. We believe
markets are not accurately pricing in the benign earnings
environment, or the level of geo-political risk
Commodities – We remain bearish on Brent Oil, noting
diminished demand in Europe due to slower growth, but look
for it to find support at $90.98. Equally, we are also bearish on
gold due to the benign global inflationary environment, but
look for the precious metal to find near term support at $1203
Core Portfolio – No further changes are made to the core
portfolio following our removal of Siemens and reduction of
positions in Intel and Apple during the last quarter. We retain a
preference for names which offer defensive qualities, such as
strong balance sheets, high dividend yields, or exposure to less
cyclical sectors
Q3 Investment Theme – Irish Recovery: As the marco
backdrop in Ireland continues to improve, we highlight some of
our preferred names which we believe offer exposure to this
theme – Bank of Ireland, Ryanair, FBD and Irish Continental
Group
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C A N T O R F I T Z G E R A L D I R E L A N D LT D O C T O B E R 2 0 1 4
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Quarterly
Outlook Q4-14
Key Themes Revisited
In our Investment Strategy for 2014 we outlined ten key themes for the year, which we used as a basis for our asset allocation
decisions.
Equities
✔
Market consolidation (Q1 ✓, Q2 ✓): European and UK equity markets have failed to make new highs this year, and
although US markets have pushed higher in the latter stages of Q3, the gains have been marginal and have not been
held for prolonged periods.
✔
Elevated valuations increase the importance of sector selection (Q1 ✓, Q2 ✓): This is clearly evidenced by our
overweight positioning in the Tech sector, and its significant outperformance year to date. Sector selection remains
a key aspect of investment strategy for the fourth quarter.
=
Selectively overweight European equities (Q1 =, Q2 ✓): Geopolitical risk and economic sanctions on Russia have
weighed on European equity indices. Despite the weakness, most of our European core portfolio names have
performed exceptionally well in difficult market conditions.
✔
Corporate investment a key growth driver (Q1 =, Q2 ✓): Announcements of new Buyback programmes have
dwindled in recent months; however M&A activity remains prevalent. Rather than returning cash to shareholders,
companies are increasingly pursuing earnings enhancing opportunities.
Bonds
=
Rising bond yields (Q1 ✗, Q2 ✗): Although starting from a low base, there has been a gradual increase in bond
yields in both the US and UK in anticipation of the beginning of interest rate tightening by Central Banks, yields
remain lower in Europe as a result of further policy loosening by the ECB.
✔
Buy Irish issuance (Q1 ✓, Q2 ✓): The initiation of further stimulus by the ECB is set to depress bond yields further.
This would be exacerbated if a large scale Quantitative Easing programme were to be rolled out, thereby driving
bond prices higher.
Macro
=
The return of volatility (Q1 ✓, Q2 ✓): Short periods of intense volatility have been followed by more prolonged
periods of complacency. In our view, investors are not accurately pricing in the geo-political and economic risks that
are currently present. This, coupled with the completion of the Fed’s QE programme, should lead to an increase in
market volatility over the coming quarter .
✖
German Consumer (Q1 =, Q2 ✓): Having spiked higher in June, German Retail Sales fell sharply in July as concerns
over tensions with Russia, one of Germany’s largest trading partners, weighed on sentiment.
✔
Subdued earnings growth (Q1 ✓, Q2 ✓): Earnings forecasts have reduced steadily over the course of the year, and
now stand in line with the growth expectations that we set out in our 2014 Investment Strategy Outlook.
✔
The US dollar to outperform the euro (Q1 ✗, Q2 ✓): The divergent policies of the ECB and Fed, coupled with the
two-speed economic recovery being seen in the US and Eurozone has led to a significant decline in the euro versus
the dollar. Concerns over the economic effects Russian sanctions would have on countries in the Eurozone has also
weighed on the single currency.
OCTOBER 2014
C A N T O R F I T Z G E R A L D I R E L A N D LT D
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Quarterly
Outlook Q4-14
Economic
Outlook
Disinflationary concerns remain central within Europe, which we believe
will ultimately prompt a wider QE programme in Q1/15. Meanwhile, we
expect the Fed to conclude its asset purchases this quarter, and see the
beginning of a rate tightening cycle by the BOE as likely.
Eurozone
The Eurozone continued to lag behind
the UK and US economies during Q3.
Weaker growth and inflation, coupled
with heightened geo-political tensions,
resulted in reduced confidence across
the region. During the quarter, ECB
President Mario Draghi announced a
number of additional measures to try to
stimulate growth, including cutting the
refinancing rate to 0.05% from 0.15%,
reducing the deposit rate to -0.2% from
-0.1% and announcing an Asset Back
Security (ABS) purchasing programme.
Q3 also saw the first Targeted Long Term
Refinancing Operation auction, with
uptake of €82.6bn well below the
expected range of €150-300bn.
The ongoing conflict in Ukraine
represents one of the primary geopolitical risks facing the market. Tensions
were heightened during last quarter, as
pro-Russian forces and Ukrainian
Government troops battled in the east
of the country. A tentative ceasefire has
been agreed; however, uncertainties
remain in Ukraine’s Industrial heartland,
with pro-Russian rebels calling for a
number of independent states to be
formed. Any re-escalation or additional
sanctions by the west or Russia will
continue to inhibit Eurozone recovery,
given Russia’s significant trade links with
Europe, particularly Germany.
In light of this, the marginal impact
current monetary policy measures have
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had to date, we see the case for a larger
Quantitative Easing style action as
strong, and believe this will likely come
in Q1/15. The accompanying chart of
the Citigroup Eurozone Economic
Surprise Index shows that, of late, data
points in the Euro area have successively
come in below expectations. When
viewed in conjunction with economic
headwinds as a result sanctions, the
unavailability of credit, benign earnings
growth and declining inflation readings,
QE may be required to stave off another
recession in the Eurozone.
Overall, we expect the European
recovery to continue to lag behind the
UK and US during Q4. The Asset Back
Security purchasing programme, which
we expect to begin after the ECB’s bank
stress tests in October, may provide
some support for equity markets.
However, given the markets belief that
significant stimulus is required; we still
believe that some QE type policy will be
undertaken, most likely during Q115.
UK
The
possibility
of
Scottish
Independence represented a significant
overhang for the continued recovery of
the UK economy in the closing stages of
Q3. This was reflected in asset and
currency price moves through
September. With the uncertainty now
removed, the Bank of England is free to
move forward with a monetary policy
tightening cycle, which we expect to
begin this quarter.
Economic data remained strong during
the quarter, with improvement in
industrial, retail, manufacturing and
Figure 1: Citgroup Economic Surprise Index - Eurozone
%#$
&#$
'#$
(#$
!(#$
!'#$
!&#$
!%#$
!"#$
Source: Bloomberg
C A N T O R F I T Z G E R A L D I R E L A N D LT D O C T O B E R 2 0 1 4
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Quarterly
Outlook Q4-14
inflation readings. The BoE believes that
spare capacity in the labour market is
now as low as 1%, and has accordingly
raised its growth forecasts for 2014
slightly to 3.5%, from 3.4%. Wage
inflation is the last significant hurdle for
the UK, growing at just 0.6% YTD,
despite the pickup in the wider
economy.
Given the pace of recovery within the
UK, and the growing chorus of voices
within the Monetary Policy Committee
calling for policy tightening, we expect
to see the first 25bps rate rise in the UK
this quarter. The most recent minutes
show that two of the nine MPC
members are pushing for rate hikes, and
this number is sure to grow if economic
data remains on track.
Figure 2: Federal Reserve Consumer Credit Outstanding Amount
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3250
3150
3050
2950
2850
2750
2650
2550
2450
Source: Bloomberg
Figure 3: US Employment Situation
US
18
4.5
In our view, the years of QE, while
exceptionally beneficial to asset prices,
has done little to improve the situation
of consumers in the US. In short, Wall
Street has benefitted more than Main
Street. As we have highlighted many
times, Labour Force Participation, the
percentage of people who are available
for work and actively seeking
employment, remains at twenty year
lows. While the elevated level of
Underemployment and the low
Average Hourly Earnings figures suggest
that the skilled, higher paying jobs
which were lost during the crisis, have
been replaced with lower paying,
unskilled jobs. We believe Government
17
4
16
3.5
15
14
3
13
2.5
12
11
2
10
1.5
9
1
Underemployment ( %)
Average Hourly Earnings ( $)
The US continued its steady recovery
during the third quarter. Largely positive
economic data intensified focus on the
Fed meetings, as the market looked for
indications on the timing of interest rate
rises. In her post meeting statement, Fed
Chair Yellen emphasised that any future
tightening cycle would be dependent
on the strength of economic data
points. Though industrial data has been
strong, significant slack remains within
the labour market.
8
Average Hourly Earnings
Underemployment
Source: Bloomberg
transfer payments, and an abundance of
capital as a result of QE, have allowed
the public to maintain a level of
consumption not indicative of their
earnings power. As a result, this has
boosted Industrial data points and
company earnings. The accompany
chart shows the significant rise in
Personal debt (excluding mortgages) in
the US since 2011. Combining this with
OCTOBER 2014
the rise in earnings and revenues of
retailers aimed at lower income
consumers, and those of short term loan
companies, would suggest that the
average American consumer is living
from pay-cheque to pay-cheque. Since
interest rates have remained so low, this
debt has been sustainable. However, as
the Fed begins to raise interest rates, this
situation becomes less tenable.
C A N T O R F I T Z G E R A L D I R E L A N D LT D
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Quarterly
Outlook Q4-14
Moreover, many of the US companies
that have failed to meet earnings
expectations in Q2, have done so
primarily on the Revenue side,
suggesting the early signs of a demand
issue in the economy.
Despite this, inflation in the US stands
near the Fed’s target of 2%, while GDP
growth is currently a robust 2.1%. The
Fed is acutely aware that monetary
policy cannot stay accommodative
forever. We expect the final taper of
asset purchases to occur at the Fed’s
October meeting, and see the first rate
rise coming in Q1/15. This is in contrast
to consensus expectations of the first
rate rises occurring in Q2/15. We see
such a postponed date as unlikely given
that the Fed expects normalised rates of
1.5% by Q4/15 and for rates to be 2.753% by 2016. Should it delay action until
Q215, it would imply that the Fed would
need to raise rates in all but one of the
remaining meetings in 2015 to meet
forecasts, leaving little time to reassess
market conditions. We believe such a
rapid pace of tightening, if it were to
happen, would have a substantial
negative impact on markets, and as
such believe this course of action to be
unlikely.
Emerging markets
Market expectations for expansion of
the Chinese economy are currently
7.4%, slightly below the 7.5%
Government target. However, an
increase in Industrial Production of just
6.9% suggested a slowdown may be
taking hold in the world’s growth
engine. In order to maintain the pace of
expansion, China’s Central Bank, the
People’s Bank of China (PBOC),
announced that it would inject $81
billion (500 billion Yuan) into the
country’s top 5 banks over the course of
3 months. However, as we highlighted
in our Q3 Outlook, concerns remain over
the level of private debt in the Chinese
economy, and this liquidity injection
could further encourage poor lending
practices.
The level of lending in China has
increased significantly in recent years, in
part through the “Shadow Banking”
system – a collection of alternative
financiers including trusts, leasing
companies and money market funds.
Fears are mounting that the number of
non-performing assets on bank’s
balance sheets will rise considerably if
Figure 4: Inflation Rates
Though there are risks regarding the
credit situation in China, it is also
important to note that the country’s
economy is on track to surpass the US
and become the largest in the world.
The government is committed to
maintaining its target of 7.5% growth,
and inflation expectations remain at a
manageable 2.4% for 2014. As a result
policy makers have a degree of flexibility
with regard to stimulus measures. We
have long maintained that China’s
transition to a more open, free economy
could be a turbulent one, but would be
beneficial on balance in the long run.
Table 1: GDP Forecasts
Country
2013(A)
2014 (E)
2015 (E)
2.2%
2.5%
3.0%
-0.4%
0.8%
1.4%
US
2.2%
2.1%
3.0%
UK
1.7%
3.1%
2.6%
China
7.7%
7.4%
7.2%
Brazil
2.5%
0.3%
1.5%
India
4.7%
5.5%
5.4%
Ireland
0.2%
2.8%
2.5%
Global
Eurozone
Source: Bloomberg
3.25%
3.00%
2.75%
2.50%
2.25%
2.00%
1.75%
1.50%
1.25%
1.00%
0.75%
0.50%
0.25%
0.00%
!"#$%&'()#
#
UK
EU
US
Source: Bloomberg
8
the economy slows. Signs of stress are
starting to show. In half-year filings to
the Hong Kong and Shanghai stock
exchanges, many of China’s biggest
banks reported a jump in bad loans for
the period.
C A N T O R F I T Z G E R A L D I R E L A N D LT D O C T O B E R 2 0 1 4
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Quarterly
Outlook Q4-14
Portfolio Performance
and Positioning
Our asset allocation weightings have been adjusted slightly for this quarter, increasing our cash weighting
to 10% and paring our equity exposure to 55%. We make no further changes to the core portfolio, having
reduced positions in Intel and Apple, and removed Siemens during Q3.
It has long been our contention that
equity market valuations are elevated at
current levels. In our view, markets are
not accurately pricing in the benign
earnings growth environment and the
higher levels of geo-political risks that
are present. Instead, the equity rally is
being driven by the wealth of liquidity
being provided by global central banks.
Earnings growth expectations have
declined sharply over the course of the
year, and now stand broadly in line with
the forecasts we made in January. The
market is now looking for just 7.3%
earnings growth for S&P companies in
2014. On a quarterly basis, expectations
are for 6.2% earnings for Q3, down from
8.9% in June. Similarly, European
companies are forecast to post just a
5.4% increase in earnings for the year,
down from 13% at the start of 2014.
This combination of rising equity prices
and falling earnings estimates further
exacerbates the elevated nature of
valuations. The yield premium at which
US equities trade over risk-free US
Treasuries has more than halved since
2011, and now stands in-line with its
long term average, as illustrated on the
accompanying chart. Without a pull
back in equity prices, we expect this
spread to diminish further in coming
months. This is particularly the case in
the US and UK, where likely Central Bank
monetary policy tightening should
result in rising bond yields.
Table 2: Asset allocation for 2014
Equities
Bonds
Commodities
Alternatives
Cash
Previous - Q314
60%
20%
5%
10%
5%
Current - Q414
55%
20%
5%
10%
10%
Source: Cantor Fitzgerald Ireland
As such, we remain defensively
positioned within the core portfolio, and
believe equity markets are vulnerable to
a pullback. As the accompanying table
shows, we reduced our equity exposure
during the quarter from 60% to 55%,
increasing our cash weighting to 10%,
reflective of our beliefs outlined above.
We believe opportunities still exists
within pockets of the equity markets,
thereby making specific stock selection
ever more critical. Portfolio exposure
should reflect the underlying market
situation, but also take advantage of
attractive valuations where they exist.
For example, we have been heavily
weighted toward the Tech sector in
2014, increasing our portfolio weighting
Figure 5: Spread between S&P Earnings Yield and US 10 Year Bond
7.00%
6.00%
5.00%
4.00%
3.00%
%&'()*+,-))./+,.(+)01,+.2)
)
2.00%
Source: Bloomberg, Cantor Fitzgerald Ireland Research
OCTOBER 2014
C A N T O R F I T Z G E R A L D I R E L A N D LT D
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Quarterly
Outlook Q4-14
to 19% at the start of the last quarter,
thereby making the sector our largest
exposure alongside Financials. Tech
substantially outperformed other
sectors during the summer months, and
many of our selected names
outperformed their parent indices by
over 5%.
Figure 6: Return on Cantor Fitzgerald Ireland US Tech Picks vs S&P Index
20%
18%
15%
13%
10%
8%
Portfolio Changes
5%
Intel:
3%
We reduced our exposure to Intel at the
end of Q3, realising some of the
substantial gains we have recorded in
the stock. The shares have seen a ~38%
gain this year, on top of the ~26% gain
in 2013, resulting in a ~64% rise since
inclusion in our portfolio. The weighting
in Intel was reduced from 3.5% of the
equity allocation, to 1.5%. Despite this
reduction, we still strongly believe in
Intel’s story. We expect the company to
benefit further from ongoing PC refresh
programmes in order to stay compatible
with the latest versions of software, and
the rapid growth of mobile devices.
However, we believed it prudent to take
some of the profits given the significant
outperformance of both the stock and
the wider Tech sector year to date.
Apple:
Similarly we took some profit in Apple,
given the extent of our gains (+22% year
to date), concerns about a retracement
in the wider market, and the lack of a
short term catalyst. We reduced the
exposure in the core portfolio from 4%
to 2%. However, again we remain
positive on the stock long term,
retaining our BUY rating with a target
price of $123 based on 14x our FY15
earnings estimates plus the $22.05 net
cash per share
10
0%
-3%
-5%
Cantor Fitzgerald Ireland US Tech Picks Portfolio
Source: Bloomberg, Cantor Fitzgerald Ireland Research
Siemens:
We removed Siemens from the portfolio
during Q3, reflective of the effects
increased sanctions on Russia would
have on economic recovery within
Europe, and the resulting impact on
Industrial companies’ earnings. We
believe Siemens is vulnerable in the
short term to market weakness, as
management joined with a group of
European companies highlighting the
negative effects sanctions would have
on business. Longer term we continue
to like the underlying investment case
at Siemens, particularly the company’s
successful restructuring. As such we
would look to re-enter the stock at lower
levels.
C A N T O R F I T Z G E R A L D I R E L A N D LT D O C T O B E R 2 0 1 4
S&P
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Quarterly
Outlook Q4-14
Table 3: Core Portfolio at 1 October 2014
Stock
Price
31/08/2014
Total Return Local Cncy (%)
Year to date
Total Return Euro (%)
Year to date *(SIP)
Fwd P/E
FY1 (x)
Carrefour
24.5
-13.22
-13.22
15.9
2.84%
3.5
BMW
85.0
2.77
2.77
9.5
3.34%
3.5
GKN
319.2
-12.40
-6.35
11.6
2.66%
4.0
Aryzta
82.4
21.55
23.47
14.6
1.04%
3.5
Glanbia
11.4
2.44
2.44
19.1
0.93%
3.5
William Hill
369.8
-5.71
0.79
12.9
3.32%
3.5
Ryanair
7.5
20.16
20.16
15.6
2.86%
3.5
AIG
54.0
6.56
16.34
11.7
0.93%
4.0
Prudential
1,376.0
5.67
12.96
14.6
2.62%
4.0
JP Morgan
60.2
5.06
14.71
10.8
2.59%
3.5
Allianz
Div Yield
FY1
Target
Weight (%)
128.4
2.76
2.76
9.3
4.68%
4.0
GSK
1,413.0
-8.48
-2.17
15.1
5.75%
4.0
Pfizer
29.6
-0.90
8.21
13.2
3.52%
3.0
GE
25.6
-6.26
2.35
15.3
3.45%
4.0
Lloyds
76.9
-2.55
4.17
10.0
1.56%
3.5
2,437.0
10.63
18.26
10.4
4.83%
4.0
Exxon Mobil
94.1
-5.12
3.59
12.5
2.88%
4.0
Apple
100.8
27.80
39.21
15.9
1.81%
2.0
Google
588.4
4.91
14.54
22.2
0.00%
4.0
Intel
34.8
37.29
48.55
15.3
2.61%
1.5
SAP
57.1
-6.68
-6.68
16.5
1.81%
4.0
Vodafone
204.4
-17.38
-11.68
30.5
5.53%
3.5
Smurfit Kappa Group *
17.4
-1.90
-1.90
11.3
2.62%
3.5
Royal Dutch Shell
Travis Perkins *
1,664.0
-6.39
0.88
14.0
2.34%
3.5
Verizon *
50.0
10.20
21.43
14.1
4.27%
3.5
eBay *
56.6
13.08
22.14
19.1
0.00%
3.5
14.7
2.72%
Weighted Average (Local Crncy)
4.5%
Portfolio Total Return (€)
10.72%
Benchmark Return (€)
Source: Bloomberg
*SIP = Since Inclusion in Portfolio
11.25%
Figure 7: Core Portfolio: Sector split
Figure 8: Core portfolio: Geographic Split
19%
Cash
8%
15%
US
35%
11.5%
8%
8%
7%
7%
6%
3.5%
3.5%
3.5%
3.5%
3.5%
UK
30%
GER
12%
EU
17%
Source: Cantor Fitzgerald Ireland Research
Source: Cantor Fitzgerald Ireland Research
OCTOBER 2014
C A N T O R F I T Z G E R A L D I R E L A N D LT D
11
R
Quarterly
Outlook Q4-14
Asset and Sector Performance
Table 4: Equities
31/12/2013
Price Level
30/06/2014
30/09/2014
Q3
YTD
4,539
6,749
9,552
4,177
1,848
2,116
4,700
6,744
9,833
4,408
1,960
2,048
4,875
6,623
9,474
4,493
1,972
2,364
3.72%
-1.80%
-3.65%
1.93%
0.62%
15.40%
Name
ISEQ
FTSE100
DAX
NASDAQ
S&P 500
Shanghai
Level Change
Fwd P/E
Div Yield
7.39%
-1.87%
-0.82%
7.59%
6.70%
11.72%
17.5x
13.8x
13.4x
21.9x
16.5x
9.4x
1.47%
4.74%
2.83%
1.28%
1.96%
2.85%
Table 5: Currencies
Name
Price Level
EUR/USD
EUR/GBP
EUR/CAD
EUR/AUD
EUR/INR
EUR/IDR
30/06/2014
30/09/2014
% Change
Q3
1.369
0.800
1.461
1.452
82.21
16,213
1.263
0.779
1.414
1.444
77.71
15,435
-7.7%
-2.7%
-3.2%
-0.5%
-5.5%
-4.8%
30/06/2014
30/09/2014
Yield Change
Q3
0.24
2.355
1.245
2.67
2.530
-0.001
1.650
0.947
2.425
2.489
-0.24
-0.71
-0.30
-0.25
-0.04
30/06/2014
30/09/2014
% Change
Q3
112.4
1327.3
21.12
320.1
598.3
94.67
1208.16
17.06
300.8
477.8
-15.7%
-9.0%
-19.2%
-6.0%
-20.1%
Table 6: Bonds
Name
Yield Level
Irish 2-year
Irish 10-year
German 10-year
UK 10-year
US 10-year
Table 7: Commodities
Name
Price Level
Oil (Brent)
Gold
Silver
Copper
Wheat
Table 8: Sector Performance
Name
Health Care
Tech
Insurance
Banks
Media
Food & Beverage
Utilities
Telecommunications
Travel & Leisure
Real Estate
Basic Resources
Industrial Goods & Svcs
Personal & Household
Chemicals
Financial Services
Oil & Gas
Retail
Construction & Mats
Autos & Parts
31/12/2013
Price Level
30/06/2014
30/09/2014
% Change
Q3
YTD
Fwd P/E
Div Yield
586.96
290.51
228.22
194.21
253.97
495.7
278.33
297.6
187.73
136.17
400.71
413.88
583.21
757.33
343.57
335
325.08
319.5
481.95
657.3
281.1
228.2
192.3
248.1
528.2
321.1
300.1
198.5
153.2
409.3
409.7
610.9
776.4
359.9
371.9
314.8
350.9
513.4
710.62
296.79
239.75
200.12
252.73
534.82
324.67
301.8
198.22
152.45
405.49
401.66
597.77
759.37
348.37
349.31
291.47
322.29
455.51
8.12%
5.58%
5.06%
4.06%
1.87%
1.25%
1.12%
0.57%
-0.15%
-0.47%
-0.94%
-1.96%
-2.14%
-2.19%
-3.21%
-6.08%
-7.42%
-8.14%
-11.27%
21.07%
2.16%
5.05%
3.04%
-0.49%
7.89%
16.65%
1.41%
5.59%
11.96%
1.19%
-2.95%
2.50%
0.27%
1.40%
4.27%
-10.34%
0.87%
-5.49%
19.1x
21.9x
10.9x
13.6x
18.1x
19.9x
15.4x
17.5x
17.2x
20.8x
13.1x
16.4x
16.9x
17x
15.2x
12.5x
16.2x
16.9x
9.9x
2.83%
1.87%
4.52%
3.52%
3.27%
2.85%
4.58%
4.78%
2.42%
3.88%
3.49%
2.91%
3.07%
2.67%
3.67%
4.43%
3.24%
3.28%
3.20%
Source: Bloomberg
12
C A N T O R F I T Z G E R A L D I R E L A N D LT D O C T O B E R 2 0 1 4
R
Quarterly
Outlook Q4-14
Fixed Income
We expect the prospect of significant quantitative easing by the ECB to
provide a further bid to European sovereign debt this quarter, driving Irish
sovereign yields lower to more closely match the soft core. Conversely,
the prospect of interest rises in the US should see Treasury yields rise.
Q3 Review
European bond prices continued to
make new highs through the third
quarter. 10-year German yields hit a low
of 88bps in early September, before
drifting a little higher to end the month
at 94.7bps. As we anticipated, peripheral
bonds continued to outperform the
core; 10-year Portuguese debt ended the
quarter at just 3.16% compared with
Spain at 2.14%, Italy 2.33% and Ireland
1.65%. Yield curves in general flattened,
as investors switched into longer
maturities in a relentless hunt for yield.
Eurozone inflation is running well below
the 2% target at just 0.4%. As a result the
ECB cut the refinancing rate by 10bps to
0.05%, and the deposit rate to -0.20%.
Further stimulus was launched in the
form of an ABS (Asset-Backed Securities)
and
Covered
Bond
purchase
programme, both due to start in early
October. ECB President Draghi insisted
that these latest measures are taken with
the aim of underpinning inflation
expectations, and will have a sizeable
impact on the Central Bank’s balance
sheet. Q3 also saw the first targeted
long-term
refinancing
operation
(“TLTRO”), an ECB policy announced near
the end of Q2. This first auction, aimed
at providing banks with funds to lend to
specific areas of the economy including
small businesses, met with muted
demand, with take-up of just €82.6bn.
Meanwhile in the US, the Fed tapered its
monthly bond purchases by a further
€10bn at both the July and September
meetings (leaving a final $15bn to go in
October). The 10-year US Treasury yield
was little changed over the quarter,
finishing at 2.49%. Short-dated yields
rose a little more (the 2 Year climbed to
56.7bps) on rising interest rate
expectations, leading to a slightly flatter
yield curve overall.
Bond Outlook
The ECB’s supportive monetary policy
backdrop should keep Eurozone bond
yields low for the foreseeable future in
our view. Moreover, we believe that the
ECB will eventually have to capitulate
and deliver full quantitative easing in
early 2015, further depressing yields in
the region. The ECB’s stated aim of
expanding its Balance Sheet by €1trillion
appears unlikely without a wider QE
programme. The disappointing take-up
of the first TLTRO, and stringent
conditions around ABS purchases pose
too many hurdles to achieve the
balance sheet goal using these methods
alone.
As mentioned, inflation at just 0.4% is
some way off the 2% target. Eurozone
economies, while recovering, still
possess a lot of slack. Aggregate
unemployment remains at an elevated
11.5%, growth outlooks for the region
have been recently downgraded as a
result of the Ukraine crisis, and reform
efforts in France and Italy have stalled.
Though the healing of peripheral debt
markets has gone a long way since the
peak of the crisis in 2011, we still believe
there is scope for modest further
outperformance of 10-year peripheral
bonds versus the core, and continued
switching out of shorter-dated bonds
into longer maturities. In contrast, we
Figure 9: 10 year bond yields
3.62
3.42
3.22
3.02
2.82
2.62
2.42
2.22
2.02
1.82
1.62
US
Ireland
UK
Source: Bloomberg, Cantor Fitzgerald Ireland Research
OCTOBER 2014
C A N T O R F I T Z G E R A L D I R E L A N D LT D
13
R
Quarterly
Outlook Q4-14
see a moderate upward bias for US
Treasury yields.
Irish Sovereign
Irish bond yields have traded in a strong
downward trend since September 2013.
The Irish 10-year yield has repeatedly
traded to record low levels since its
issuance at 3.54% on 7th January 2014
(ending the quarter at 1.65%). Ireland now
has a median rating of A-, with both
Standard and Poor’s and Fitch having
upgraded in recent months. Moody’s,
however, passed up its latest opportunity
to upgrade Ireland on 12th September,
and kept it one notch lower at Baa1. The
macroeconomic backdrop in Ireland has
improved considerably following stellar
GDP growth (1.5% QoQ in Q2 following
2.8% in Q1), and we now expect the
economy to grow by more than 5% in
2014. Finance Minister Noonan is
predicting the government will record a
Deficit/GDP ratio of 3.5%, comfortably
beating its 4.8% target. This would allow
the Government to announce a broadly
neutral budget on October 14th, and still
deliver a Deficit/GDP reading below 3% in
2015, thereby allowing the exit from the
Excessive Deficit Procedure.
Figure 10: Irish GDP YoY
15
10
5
0
-5
-10
-15
Source: Bloomberg
Ireland has also secured agreement from
its EU partners to repay the majority of its
expensive IMF loans (on which it pays
interest of more than 4% compared with
implied market rates of less than 1%). This
will deliver interest savings in the region
of €450m per annum. We believe roughly
75% of this will be market funded, with
the remainder covered by running down
excessive cash balances (€20bn) to more
normalised levels. A new syndicated 15year deal could be forthcoming, and
would satisfy strong investor demand for
longer paper, while also building out the
Irish yield curve. As such, we expect
continued convergence of Irish sovereign
bond yields towards the soft core (France,
Belgium).
14 C A N T O R F I T Z G E R A L D I R E L A N D L T D O C T O B E R 2 0 1 4
R
Quarterly
Outlook Q4-14
Currencies & Commodities
The divergent pace of recovery between the Eurozone and that of the UK and US has begun to significantly
impact the euro versus sterling and the dollar. We expect this to continue, and believe weaker growth
expectations in Europe will continue to weigh on Commodity prices in the region.
Currencies
US Dollar
The dollar remained strong against its
major currency pairs during the quarter,
particularly versus the euro. We have
long maintained that the divergent
pace of recovery in the US and Eurozone
should result in a significant weakening
of the euro versus the dollar. Investor
flows into European equities in the early
part of the year prevented this from
happening, as demand for the euro
remained high. However, our thesis
came to fruition in the third quarter, as
the relative attractiveness of European
assets dwindled in the face of further
monetary policy easing by the ECB, as
well as economic and earnings
headwinds as a result of sanctions on
Russia.
Meanwhile in the US, the end of QE3
draws nearer, and we expect the final
taper of asset purchases to come at the
Fed’s October meeting. A rise in the
frequency of hawkish comments from
Fed officials, and an increase in those
calling for higher rates, led the market to
begin pricing in monetary policy
tightening. The prospect of higher
yields in the US has attracted investor’s
funds, boosting demand for the dollar.
This resulted in a 7.75% decline in the
euro over the course of the quarter,
falling from a high of $1.3692 to $1.2631.
Fundamentally we expect the euro to
remain depressed against the dollar
during the 4th quarter, as the divergent
central bank policies continue to impact
each currency’s relative attractiveness.
From a Technical perspective, we see
primary support for the euro/dollar
around $1.2708. Given the pace of the
euro’s decline versus the greenback in
recent months, we would like to see a
period of consolidation around current
levels for a time. However, should the
$1.27 level be firmly broken, we see little
in the way of support until the €1.2150
region.
Figure 11: EUR/USD
1.37
1.36
1.35
1.34
1.33
1.32
1.31
1.3
1.29
1.28
Pound Sterling
Uncertainty regarding Scotland’s future
within the UK weighed on sterling in the
closing weeks of the quarter. However,
similar to the US, the UK’s economic
recovery is far outpacing that of Europe.
As mentioned in our Economic Outlook
section, we expect rate rises could come
as early as this quarter in the UK, which
is in sharp contrast to the looser policy
being pursued by the ECB. These
competing factors resulted in significant
volatility of sterling versus the euro
during the quarter, counter-balancing
each other so that the currency pair
finish just 2.67% lower at the end of the
quarter.
With the overhang of a potential
Scottish independence now removed,
we believe sterling should continue to
strengthen against the euro, as the full
effects of the divergent central bank
policies in each region begin to be felt.
However these may be tempered by
any form of wider QE programme in the
Eurozone. Such initiative would create
demand for European assets which
would themselves be boosted by the
greater liquidity provided by the ECB.
From a Technical viewpoint, we expect
Source: Bloomberg
Figure 12: EUR/GBP
0.805
0.8
0.795
0.79
0.785
Source: Bloomberg
Figure 13: GBP/USD
1.73
1.71
1.69
1.67
1.65
1.63
1.61
1.59
Source: Bloomberg
O C T O B E R 2 0 1 4 C A N T O R F I T Z G E R A L D I R E L A N D LT D
15
R
Quarterly
Outlook Q4-14
the currency pair to receive support
around the £0.7782 level in the near
term.
Figure 14: US Crude Oil Industry
125
9000
115
Oil
110
Ongoing economic sanctions against
Russia, and the resulting headwinds
these have created for the Eurozone
economy, weighed on Brent prices
during the quarter. Fears that slower
growth would diminish demand led
Brent prices to decline nearly 14% from
the quarter’s high to low. Though a
tentative peace deal has been
established in Ukraine, weak growth
expectations in the broader European
economy continue to act as an
overhang to the benchmark.
Critically, militants in Iraq have been
prevented from making advances
toward the oil rich southern regions of
the country. International military strikes
against militant targets have halted the
rapid advances that were previously
made from Western Iraq and into areas
of the Kurdish north. Though a number
or large refineries reside in these areas,
it is Iraq’s south, near the Kuwait border,
where the vast majority of oil reserves
are situated.
Equally, growing supply in West Texas
Intermediate has pushed prices in the
US lower, though at a slower pace than
the declines seen in Europe. As the
accompanying chart shows, crude
production in the US (right axis) has
increased steadily over the last two
years, as the Shale Oil boom provided
new supplies. This has resulted in a
significant reduction in the premium to
which Brent Oil trades to WTI; the spread
halved in price between late August and
mid September.
From a Technical perspective, we are
bearish on Brent at these levels, even
after the poor run in recent weeks. We
see primary support at $90.98, with key
resistance levels at $99.65 and $105.12
16
Crude Oil Prices ($)
Commodities
8500
8000
105
100
7500
95
90
Crude Oil Production ('000 b/d)
120
7000
85
80
6500
Crude Oil Prices
US Crude Oil Production
Source: Bloomberg
Gold
A benign global inflationary
environment continues to weigh on
Gold prices, and we retain a bearish
view on the precious metal. Despite
strong economic recovery in both the
US and UK, inflation remains at, or near,
target levels in both economies. At the
same time, the Eurozone is struggling
with potential disinflation, prompting
yet more monetary policy loosening
by the ECB. In emerging markets,
where inflation levels led to gold
purchasing as a hedge, economic
slowdown is affecting demand. For
example, India experienced 10.92%
inflation in 2013, however this is
expected to be a much lower 7.2% in
2014.
The “risk-off” trade saw Gold catch a bid
for a time during the quarter, as reports
of Russian troops openly crossing the
border into Ukraine prompted the
market to expect a significant increase
C A N T O R F I T Z G E R A L D I R E L A N D LT D O C T O B E R 2 0 1 4
in hostilities. A wider escalation in
tensions was not forthcoming
however.
We remain bearish on gold, but look
for the price to receive some support
around the $1203 level. Gold has
tested this price twice in the last two
years, and as such it represents key
support.
R
Quarterly
Outlook Q4-14
of values to date.
Q4 Theme
Irish Recovery
As the economic backdrop in Ireland continues to improve, this quarter
we highlight some of our preferred Irish names that we feel offer
exposure to this theme: Bank of Ireland (BUY, Target Price €0.35), Ryanair
(BUY, Target Price €9.00), FBD (BUY, Target Price €19.46) and Irish
Continental Group (Not Covered).
Overview
Economic recovery in Ireland is
gathering pace. Figures released
recently showed that GDP surprised to
the upside for the second quarter in a
row and expanded by 1.5% in Q2 after a
2.8% rise in the first quarter. In annual
terms GDP was up 7.7%. Ireland's
economy is now growing at the fastest
rate in seven years. The major
components of the economy are all
picking up; consumer spending,
investment and exports improved, while
the positive trends in PMI data,
employment, retail sales and property
prices all remained intact in Q3. This
suggests that the momentum is set to
carry over in H2/14.
As such, below we highlight some of
our preferred Irish names that we feel
offer exposure to the improving macro
backdrop in Ireland.
Bank of Ireland
Bank of Ireland offers investors a pure
play on the recovering Irish macro
environment. The bank has returned to
profitability, posting a €399m profit
before tax in the first half of 2014, driven
by a reduction in impairment charges
and a strong net interest margin, which
remains robust at 2.05%. The bank also
reported an increase in Net Interest
Income of €193m, while benefitting
from a €70m write back on its NAMA
subordinated debt. We also see the
potential for further accretive write
backs in house prices, noting the bank’s
conservative “peak to trough” treatment
Figure 15: Bank of Ireland Net Interest Margin Drivers
3.50%
!2,250
!2,250
!2,000
!2,000
!1,750
!1,750
1.75%
2.50%
1.25%
2.00%
0.75%
0.25%
N
NIM
IM
A
Asset
ss et Y
Yield/COF
ield/COF
!2,500
!2,500
2.25%
1.50%
The robust performance of the
economy should aid Bank of Ireland in
its goal to increase the size of its loan
book by €33 billion on top of the current
level of €83 billion over the next 5 years.
To achieve this, management is
targeting the bank’s core markets of
Consumer, Mortgage and SMEs in
Ireland, as well as international
Corporate
lending.
Elsewhere,
management plans to utilise the bank’s
partnership with the UK Post Office,
which offers Bank of Ireland access to
200 branches across the UK. We reiterate
our BUY recommendation with a target
price of €0.35 based on FY17 projected
earnings.
Figure 16: Impairment Charge on Loans
2.75%
3.00%
Bank of Ireland’s overall financial health
has significantly improved from the
depths of the financial crisis, and we
expect the bank to have comfortably
passed the ECB’s Asset Quality Review
when results are announced later this
quarter. Among other drivers, the bank
is benefitting from a lower cost of funds
as a result of loose monetary policy from
the ECB. The uptick in the Irish economy
has had positive effects on Bank of
Ireland’s Balance Sheet, as loan write
downs have reduced 43% YoY. Equally,
the recovery in the housing market has
resulted in further reductions in
impairments.
!1,500
!1,500
!1,250
!1,250
!1,000
!1,000
!750
!750
!500
!500
!250
!250
1.00%
-0
-0.25%
.25%
Asset Y
Asset
Yield
i el d
Source: Bloomberg
Cost
Cost of
of F
Funds
u nd s
!0
!0
NIM
N
IM
Source: Bloomberg
OCTOBER 2014
C A N T O R F I T Z G E R A L D I R E L A N D LT D
17
R
Quarterly
Outlook Q4-14
95%
7.0%
90%
5.0%
85%
3.0%
Load Factor
80%
1.0%
75%
-1.0%
70%
Passenger Growth
Figure 17: Ryanair's recent passenger growth and rising load factor
-3.0%
65%
-5.0%
60%
Jan
Feb
Mar
Apr
Load Factor '13
May
June
Load Factor '14
July
Aug
Pass. Growth y-o-y
Source: Cantor Fitzgerald Ireland Research
Ryanair also entered the bond market in
June, selling €850m in 2021 bonds at a
coupon of 1.875%. The company was
assigned a BBB+ by Fitch and Moodys,
the highest rating in the airline industry.
The offer was 8x oversubscribed,
highlighting the markets confidence in
management’s new strategy. The
proceeds are in part expected to pay for
175 new Boeing 737-800’s which the
company is due to start taking delivery
on shortly. In addition, Ryanair plans to
18
Management have also committed to
returning funds to shareholders,
through a special dividend of €0.375 in
Q115, implying a dividend yield of ~5%.
Ryanair remains our preferred name in
European aviation, and we reiterate our
BUY rating with a target price of €9.
Figure 18: Ryanair’s Fleet and passenger growth forecasts
150
550
500
140
450
400
130
350
120
300
250
110
110
200
100
150
100
90
50
80
0
FY14e F
FY19e FY20e
FY20e F
Y21e F
Y22e F
Y23e FY24e
FY24e
Y15e F
Y16e F
Y17e FY18e
FY18e FY19e
FY14e
FY15e
FY16e
FY17e
FY21e
FY22e
FY23e
Year-end
Y
ear-end ffleet
leet (n
(no.
o. Ai
Aircraft)
rcraft)
Pa
Passengers
ssengers N
Num
um (m)
Source: CFE Research estimates. Note: Navy shaded columns are the periods of growth driven by deliveries of 737800's, light blue shaded are the new 737 MAX-200s periods.
C A N T O R F I T Z G E R A L D I R E L A N D LT D O C T O B E R 2 0 1 4
Passenger
Passenger Numbers
Numbers (m
(m))
Ryanair continues its charm offensive,
having changed its ‘no frills’ offering to a
more customer focused approach.
Initiatives such as allocated seating, an
extra carry-on bag on flights and a
streamlined, customer-friendly website,
combined with 2013/14 winter fare
discounting, has seen load factors
increase to ~93% in recent months.
Ryanair has also overhauled its route
offering; moving away from secondary
airports and focusing on primary slots in
major European cities in a bid to attract
additional business travellers. In
conjunction with the updated routes,
the company has launched ‘Ryanair
Business Plus’ which affords greater
flexibility for ticket changes, airport fast
tracking, premium seating and less
restrictions for carry-on luggage.
expand the fleet further, having placed
a $22bn order for 200 Boeing 737 Max
aircraft, with delivery expected in 2019.
The newer aircraft will be significantly
more fuel efficient than older planes,
allowing Ryanair to further discount
fares, and aiding in its attempts to
double passenger numbers to 150m by
2024.
Aircraft
Aircraft number
number
Ryanair
R
Quarterly
Outlook Q4-14
Irish Continental Group
Irish Continental Group (‘ICG’) is a
leading shipping, transport and leisure
group. It operates between Ireland, the
UK, France, Belgium and Holland. The
company’s passenger business is
conducted under the Irish Ferries brand,
while its freight and transport business
is split between Eucon and Irish Ferries
Freight.
ICG offers investors a play on the
recovering UK and Irish economies
through its importance in the freight
and holiday market. Roll on Roll off
freight (“RoRo”), a convenient way of
tracking trade flows, has seen a 20% rise
year to date, ahead of market trends. On
the passenger side of the business,
increased consumer discretionary
spending has also seen cars carried up
6% this year again ahead of the market.
The improving trends have led the
company to add additional capacity in
freight and leisure travel, with the
purchase of the ‘Epsilon’ vessel. This is
the first such addition since 2001, and
allows ICG greater capacity on the busy
Holyhead route.
We believe ICG possess a skilled
management team, and the balance
sheet remains robust. The group should
also benefit from any further declines of
the euro versus sterling, given that
c.60% of group revenues are
denominated in the currency. In
addition, management is targeting 5%
YoY increases in the dividend over the
medium term. The shares are trading an
expected FY15 P/E of 18.1x. This,
although not cheap, is attractive in our
view, given its growth prospects and
strong dividend.
primary beneficiaries of an uptick in the
Irish economy. Though claims frequency
tends to be highly correlated with
economic activity, an improvement in
growth allows the insurer to more easily
pass through premium rises to offset the
higher claims. As such, even though
economic recovery may be somewhat
painful in the short term to earnings, it
should have a very positive effect in the
medium term once premiums have a
chance to catch up.
Though results at the start of the year
were negatively impacted by poor
weather and higher car insurance
claims, FBD still managed to report an
operating profit of €5.4m. This was
driven by the successful attraction of
new business which saw gross written
premiums rise 5.1%, thereby implying
an increase in FBD’s market share.
It will take time for FBD to push through
its premium rises. As such, there will be
little impact to results in the first half of
2015. However, we expect profits to fully
recover in late 2015 and early 2016. In
addition, FBD’s Balance Sheet and
solvency remains robust, opening up
the possibility of further increases in the
dividend on top of the 8% YoY rise in the
interim dividend. We also believe there
is the possibility of a special dividend in
2016, once the new Solvency II
regulations are released, and the
company has a better clarity on the
extent of its overcapitalisation. We have
a BUY rating on FBD, and a target price
of €19.46
FBD
We believe, FBD is the best placed nonlife insurer in the Irish market. The
company benefits from 100% autonomy
over its capital allocation, low fixed costs,
solid relationships with its core farming
client base, and under-penetration in
urban areas. FBD should be one of the
OCTOBER 2014
C A N T O R F I T Z G E R A L D I R E L A N D LT D
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