Insights from Our Equities Desk - 3Q 2013
Equity markets ended the quarter higher but saw volatility within the time period, coupled with low volumes during the Northern Hemisphere vacation season. Good economic data out of China, Europe and the U.S., plus decent company earnings, were all positive for equity markets, reflected in the fact that the S&P 500 hit a record milestone in August, closing above 1,700 for the first time. There was concern that the Federal Reserve would begin to taper its extraordinary monetary stimulus and put equity markets under pressure. However, when the Federal Reserve did not announce that it would begin tapering, it created further uncertainty about the future direction of U.S. monetary policy. The threat of military action in Syria also negatively affected markets, which responded positively to a deal between the U.S. and Russia. The end of the quarter was dominated by the threat of a budget and debt ceiling showdown in the U.S., plus a potential Italian government collapse. Risk assets, however, held up reasonably well, with investors of the opinion that these political issues would ultimately get resolved.
Borrowers continued to refinance down fees on specials, with hedge fund appetite to short stocks coming under pressure as share prices continued to rise. This trend was particularly noticeable in Asia, Australia, the U.S. and Brazil. Amongst the most affected stocks were GCL-Poly Energy Holdings, ZTE, PICC and China Minsheng Banking in Hong Kong; Celltrion in Korea; Olam International in Singapore; JB Hi-Fi and Mesoblast in Australia; Sharp in Japan; HTC in Taiwan; and InterOil, Herbalife, Arena Pharmaceutical, VirnetX and Solazyme in the U.S. Although fees were in decline, balances remained strong due to rising share prices and increased General Collateral loans from borrowers, with the U.S. equity balance hitting a high for the year, to date. In Taiwan, additional downward fee pressure was placed on specials due to increased market supply (as more lenders enter the market) and daily short-sell quotas, which make it difficult to execute shorts. Demand remained strong for emerging market ETFs such as iShares Trust MSCI Emerging Market ETF, iShares Trust Emerging Market Bond ETF and Vanguard FTSE Emerging Markets ETF. Directional demand eased for Brazilian equities as the market rallied and the August Bovespa futures contracts expired, with a large portion of the reverse cash and carry positions (long futures/short stocks) not being rolled and shorts getting covered. Specials that saw a reduction in demand and fees included Multiplus and Lojas Americas.
Companies were active in raising capital in the third quarter, taking advantage of strong equity prices to strengthen balance sheets or to fund takeovers. In Europe, J.P. Morgan lent shares off the back of capital raisings by Soitec, Maire Tecnimont and Royal Imtech. In Japan, we had demand to borrow shares in Ezaki Glico, Kintetsu, IBJ Leasing, Kenedix, Maeda, Mitsubishi Motors and Sharp. M&A was also active, with the following deals generating borrowing demand: Kazakhmys/ Eurasian Natural Resources, Loblaw/ Shoppers Drug Mart, and Deutsche Wohnen/ GSW Immobilien. The big M&A news of the quarter was Microsoft's offer to buy the mobile phone business of Nokia. Nokia has been a long-term directional short, but borrower demand eased and shorts were closed as the stock price rallied after the takeover announcement. The other big deal was Verizon Communications Inc's ("Verizon") agreement to buyout Vodafone's share of their joint wireless venture for $130 billion, making it the third-largest deal in history. Unfortunately, there was not a noticeable pick-up in borrowing demand in what are two very liquid stocks. Also in the news was Blackberry, another long-term directional short, which announced a big loss and a possible takeover by a consortium led by Fairfax Financial. Finally, in the U.S. tender offers by Halliburton and WebMD Health generated borrowing demand for shares that clients had elected not to tender.
European dividend activity slowed down after the peak second quarter period. The last remaining German Dax names were traded, including ProsiebenSat.1 and Suedzucker. Spain was also active, with BBVA, Red Electrica de España and Indra Sistemas, plus the scrip option trades in Iberdrola and Banco Santander. In September, we had Italian dividend paying stocks including ENI and Snam, and Dutch scrip dividends in Aegon, Royal Dutch Shell and DSM, with clients taking the cash election earning premium lending fees. This dividend season, borrowers in Australia and Japan swapped out of high-dividend domestic stocks and into low-dividend foreign held shares, seeking to lower their borrowing costs over the dividend record dates. Balances in Japan peaked over the end of September, having more than doubled from their pre-dividend level. In Australia, J.P. Morgan also lent shares for the drip dividend arbitrage including Tatts, AGL Energy, Qube and Mermaid. In addition, there was scrip dividend trading in Asia and the U.K., including Bank of East Asia, Standard Chartered and HSBC in Asia; and BP, Standard Chartered, HSBC, Royal Dutch Shell and Barclays Bank in the U.K.