Update from the Equities Desk - 2Q 2013
Equity markets were mixed over the quarter, rallying strongly through to late May before suffering sharp falls into June. The selloff was caused by the U.S. Fed signaling that its extraordinary monetary stimulus policy is coming to an end as the U.S. economy shows continued signs of sustainable growth. Another factor was a liquidity squeeze by the Chinese central bank as it tries to curtail credit growth, causing concern among investors that Chinese economic growth will be negatively impacted. These events took markets by surprise with investors concerned that the flood of central bank liquidity that has been driving markets higher will be withdrawn and interest rates will rise. Markets did recover some of their losses by the end of June, after officials in the U.S. and China played down any imminent tightening of monetary policy. The Japanese market reached a May high after the Bank of Japan announced an aggressive stimulus plan for the economy, before suffering a particularly large correction, falling 20% and entering into a technical bear market after investors took the view that prices were ahead of fundamentals and were therefore due for a correction.
The increased market volatility did generate borrowing demand. Emerging markets like Thailand, Malaysia and Poland, which were hit particularly hard by the selloff, and emerging market ETFs like iShares, J.P.&Nbsp;Morgan USD Emerging Markets Bond Fund and iShares S&P U.S. Preferred Stock Index Fund, all saw increased borrowing demand. However, this was not enough to offset a sharp fall in directional borrowing demand in several key markets. The U.S. in particular saw fees decline in several long-term specials such as Tesla Motors, Coinstar, InterOil and Westport Innovations. Short sellers conceded defeat in the face of a rising equity market and because prices in some of the most crowded shorts had risen higher than the broader index. Hong Kong continued to experience weak demand and borrower refinancing, with reduced fees in key revenue generating specials like Byd, GCL-Poly Energy, Anhui Conch Cement and China Yurun Food, as did Australia, with fees easing in stocks like JB Hi-Fi and Mesoblast as their share prices rallied. Markets in which we saw an increase in revenue included Singapore, on the back of the Olam International special; Taiwan, as hedge funds shorted the tech sector; Finland, as directional demand for Nokia more than offset the fact that the company did not pay a dividend; Canada, due to specials in Blackberry and Westport Innovations; and Brazil, on increased specials activity and more profitable IOC trades. In terms of deal activity, the big story was the completion of the Glencore Xstrata merger in the U.K., one of the most profitable lending trades of the last 12 months. Loans were returned quickly once the deal closed in May. Regarding new deal activity in the quarter, in the U.S., Pfizer’s spin-off of Zoetis through a voluntary exchange offer was a profitable deal for clients. In Australia, demand increased for News Corp shares as it split its TV and publishing businesses. In Europe, the story was all about capital raising, with rights issues in Banco Popular Español and Bankia in Spain, Koninklijke KPN in the Netherlands, Commerzbank in Germany, Firstgroup and Thomas Cook in the U.K., CDON and Hakon in Sweden, Meyer Burger in Switzerland, and RCS MediaGroup in Italy.
The second quarter was the peak European dividend season. Germany and France traded in a wide range depending on dividend yield, and the Italian financial transaction tax had a significant impact on demand for Italian equities. Finland, Norway, Sweden and Switzerland traded strongly, matching or exceeding prior years in terms of trading levels. Incremental revenue was generated for clients that elected to receive cash rather than stock on French and Dutch dividends that offered investors the scrip option. In general it was a tough and volatile season. A pull back in appetite from several big banks, an increased focus on balance sheet costs, tax changes and a lack of funding for hedge funds all contributed to a more volatile market. We also saw some activity in South African stocks being traded for dividend. These include Vodacom and Foschini. Outside of Europe, Japan was active from a dividend perspective, with balances initially falling as March record date trades unwound, and then rising as borrowers took low dividend stock for the June dividend. Unfortunately, Australia has had a weak dividend season, as several companies, like NAB and ANZ, did not offer a discount on their drip dividends, removing the arbitrage opportunity.
We continued to grow our book of business against Japanese Government Bond collateral, which is proving to be one of the most successful collateral initiatives of recent times. In the U.S., overnight repo rates continued to trade at very low levels, making general collateral loans particularly challenging for clients with restrictive cash reinvestment guidelines. U.S. equity general collateral traded at negative rebates from the end of May through to the end of the quarter, (i.e., borrowers paid a fee for cash collateral loans).
Dividend activity will be significantly lower in the third quarter, as the second quarter marked the peak period in Europe. Japan’s September dividend record date will likely be the big event of the quarter.
We expect that events in China and the U.S. will drive markets, with uncertainty over the strength of their respective economies and what that means for monetary policy. How markets react to economic data and central bank action will likely determine the level of directional shorting and borrowing demand.
We expect to continue to enhance our product offering. Same day loans in Asia, including Japan, will go live in July (receiving non-cash collateral and delivering loan securities on the same day), providing our broker counterparts with same day borrow cover, for instance, if they need to cover a fail.