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 Cantor Fitzgerald Ireland Ltd (Cantor) is regulated by the Central Bank of Ireland. Cantor Fitzgerald Ireland Ltd is a member firm of the Irish Stock Exchange and the London Stock Exchange. Cantor Fitzgerald International A leading global investment bank with 33 offices worldwide. Hong Kong NORTH AMERICA Atlanta Boston Chapel Hill Charlotte Chicago Conshohocken Dallas Darien Denver Houston Las Vegas Los Angeles Memphis Miami Montreal Naples New Orleans New York (HQ) Singapore Puerto Rico Purchase Rochelle Park, NJ San Francisco Seattle Shrewsbury Summit Toronto York EUROPE Cork Dublin Limerick London Milan Nyon Paris Zurich Tel Aviv Sydney Established in New York in 1945 as an Investment bank and brokerage business, Cantor Fitzgerald has become known for its strengths in the equity and fixed income capital markets. Recognised as being at the forefront of development, best practice and innovation, we service our clients from over 30 locations worldwide. At Cantor Fitzgerald Ireland we pull together the expertise and experience of Analysts and Investment Professionals from across three continents. An office network that spans from New York to Hong Kong provides us with a uniquely global perspective on the investment goals of our clients, which we service through our local offices in Dublin, Cork and Limerick. DUBLIN: 75 St. Stephen’s Green, Dublin 2, Ireland. Tel : +353 1 633 3800. Fax : +353 1 633 3856/+353 1 633 3857 CORK: Dolmen House, 45 South Mall, Cork. Tel: +353 21 422 2122. LIMERICK: Theatre Court, Lower Mallow Street, Limerick. Tel: +353 61 436500. email : [email protected] web : www.cantorfitzgerald.ie 2 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 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 3 R 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 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 O C T O B E R 2 0 1 4 R 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 5 R 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 6 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 R 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 !"#$" 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 7 R 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 R 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 9 R 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 R 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 19 Regulatory Information Cantor Fitzgerald Ireland Limited This material is approved for distribution in Ireland by Cantor Fitzgerald Ireland Ltd (“Cantor”). 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