Update from the Equities Desk - 1Q 2013
Equity markets ended the quarter mainly higher with Japan, the U.K. and the U.S. being amongst the best performers. Expectations of Bank of Japan monetary stimulus drove the Nikkei to a 19.25% gain, and the U.S. continued its recent strong rally with the Dow Jones Industrial Average and S&P 500 hitting record highs. Better economic data and the search for yield lead to greater investor interest in equities. Despite losing its AAA rating from Moody's, the U.K. also turned in a good performance for the quarter, up 8.7%. European peripheral markets faired badly as Cyprus negotiated a bailout which involved a levy on bank deposits over €100,000. Despite the EU stating that Cyprus is a special case and is not a template for future bailouts, investors took fright on concern about the safety of financial assets in Europe.
Across the lending book we continued to see weaker demand to borrow for directional shorts, particularly in the U.S. and Asia. Despite a stagnating equity market, the level of short selling activity and borrowing demand has continued to decline in Hong Kong, with loan returns and refinancing by borrowers driving fees lower. In the U.S. the equity market rally has caused investors to reduce bearish bets to the lowest level since 2007, instead adding to long positions. This has of course led to a reduction in borrowing demand. Rising equity markets, strong corporate profits, low cost of debt and growing confidence among CEOs led to an increase in M&A activity. Companies including Dell, H.J. Heinz, Liberty Global/Virgin Media, Office Max/Office Depot, SCBT Financial/First Financial and US Air/American Airlines, all announced deals in February. Although not all resulted in demand to borrow shares, we hope this is indicative of an increase in deal activity this year and could ultimately lead to an increase in borrowing demand.
Dividend trading activity picked up towards the end of the quarter. Balances increased significantly in Japan as borrowers swapped out high-dividend domestically held shares for low-dividend foreign shares for the end-of-March dividend. Australia was active, trading the arbitrage opportunity in dividend reinvestment plans, as was the U.K. for scrip dividends. In Europe, January was a good revenue month for dividend trading, with loans of Siemens in Germany. February was quiet but activity picked up strongly in March as Swedish, Finnish, French and Swiss dividend trades settled. Sweden and Finland in particular have traded well this year, with strong borrower demand and consistently high levels. Switzerland has traded higher than last year, although levels are low relative to other markets. Dividend payouts also increased, including Nordea Bank and Swedbank of Sweden and Roche Holding of Switzerland, all of whom increased their March dividends for 2013. However, market demand remains volatile in the key markets of France, Germany and Italy, with Germany in particular experiencing a fall off in demand towards the end of the quarter. In general across the dividend business, borrower balance sheet constraints, increased funding costs and tax changes have impacted demand and supply, making for a particularly challenging trading environment.
Sectors in demand (in order of size):
- Asia-Pacific – consumer cyclical, financial, industrial, then a big drop to consumer non-cyclical, basic materials, communications, and another drop to technology;
- Europe, Middle East and Africa – industrial, consumer non-cyclical, then a big drop to financial, basic materials, communications and consumer cyclical;
- Americas – consumer non-cyclical, then a big drop to financial, consumer cyclical, then another drop to communications, tech and industrial.
Second Quarter 2013
The second quarter will mark the height of the European dividend season, with revenue peaking in May. As already mentioned, demand has been volatile this year, making for a challenging market. We have, however, traded the majority of the book, with levels agreed and loans booked for future settlement.
Unfortunately, we do not foresee an increase in directional trading activity given the strong U.S. equity market, the uncertainty in Europe and strength of the Chinese economy. We hope to see more deal activity, whether that be capital raising or M&A, which should lead to more borrowing demand.