Friday Wrap-Up (24 February)

(Maksymilian Mucha - Investment Director of UCLIF & Lead Editor)

Welcome to the Friday Wrap-Up, our weekly summary of events from the financial world that have had the greatest impact across asset classes. As UCLIF Asset Specialists are working hard on their Symposium report, this week Analysts made a takeover, with all the stories written by them. So what's moving markets?

Markets

In the US equities,?S&P 500?declined?-2.67%?while?DJIA?was down?-2.99%. Investors weighed further rate hikes, as FOMC minutes from the last meeting showed that all members supported a 25bp hike, with some pointing towards 50bp. It is important to remember the meeting took place before extremely tight labour-market data. This was further exacerbated by Initial Jobless Claims coming at 192,000, below last week’s reading and expectation of 200,000, as well as CORE PCE Inflation at 0.6% MoM in January, above last reading and expectation of 0.4%. US 10y Treasury?yield added 13bp?to?3.95%?this week.

In Europe, the?FTSE 100?sold off?-1.57%?and?EURO STOXX 600?declined?-1.40%. Similarly to the US, investors are preparing for further rate increases, as ECB board members Isabel Schnabel and Joachim Nagel hinted that significant rate hikes will be required. UK 10y Gilts yield?rose?15bp?to?3.67%, while?German 10y Bunds yield?added?10bp to?2.54%.

In Asia, the?Nikkei 225?was down?-0.22% while the?Hang Seng?decreased?-3.43%. The Alibaba Group showed stronger than expected profits, however, its share price continued to decline by the end of the week.

Equities

Healthcare?(Joshua Sim)

With the covid 19 emergency in the rearview mirror and much of the world returning to normalcy, Pandemic darlings such as Pfizer,? who benefited greatly during the pandemic, are seeing the demand for their vaccines and antiviral medicine fall. Pfizer expects that revenues generated by its vaccine and Paxvaloid, their antiviral pill, will fall by around 62%, to 21.5 billion, compared to last year. The pharmaceutical giant is also facing additional headwinds as it hits a patent ‘cliff’, where it is seeing the expiry of exclusive rights for a few key drugs, including cancer drugs Xtandi and Ibrance. In response to this, the company has a record 19 drugs in the pipeline, ready to be launched in the next 18 months. This is expected to help the company to gain an additional 20 billion dollars of annual revenues until 2030, making up for the losses that expiring patents of its key drugs will bring.

The problem of a patent cliff is not limited to just Pfizer. Other American pharmaceutical giants, including Abbvie, Johnson and Johnson, Merck and Novartis will also face a loss of exclusivities in the coming years, with expected losses of up to 200 billion in total leading up to 2030. Unlike Pfizer, many of these companies have not set up their pipelines to make up for these losses. Therefore, an uptick in M&A activity is expected for the pharmaceutical industry. To cope with loss of exclusivities, larger pharmaceutical companies often acquire smaller competitors who will come up with similar drugs that undercut them, or look to find smaller companies that possess the potential to make new ‘blockbuster’ drugs that will help to make up for the loss in revenue.

Another source of pressure that the pharmaceutical sector is likely to face is from the changing regulatory political landscape. In Mid February, the health secretary of the United States gave the green light to test a payment model to place a cap on out-of-pocket expenses to $2 a month for generic drugs. This is a follow up on news that Medicare is considering making pharmaceutical companies pay up through rebates in 2025, if they raise drug prices higher than the rate of inflation. In the short term, these regulations can affect both the top-line and the bottom line, placing downward pressures on stocks. Over the longer term, the company’s business model and execution will likely matter more. Given that new drugs can take around 12 years to hit the market from the point where they are conceptualised, companies have sufficient time to make adjustments.

Financial Institutions?(Max Cheng)

This week the European Central Bank published their financial positions at the end of 2022 and showed that they have made no profits; the first time in 15 years. Since the 2008 financial crisis, central banks have executed quantitative easing by buying up vast amounts of bonds to increase money supply in the economy. With the ECB stepping up interest rates by 0.5% up to 2.5%, the central bank is faced with increasing costs going towards the deposit facility rate which has outstripped the low interest paid by the long maturity bonds held by the ECB – their main source of income. Although central banks are not profit driven, dividends are usually passed down to national central banks and eventually taxpayers. Since 2012, the ECB alone has transferred €13 Billion of profits down to taxpayers.?

After a brutal freeze in the credit market in 2022 due to rising interest rates, reduced concerns about inflation and a US recession have allowed private equity firms to continue to take on new debt and pay private investors/shareholders despite high interest rates. This type of transaction is known as dividend recapitalisation and allows owners to pay themselves while re-levering their portfolio company. According to figures from Leveraged Commentary and Data, these types of transactions did not occur in 2022, however, recently private equity firms Cerberus and Dragoneer gained $2Billion from total dividend recapitalisation.

Industrials & Materials (Mayank Dasannacharya)

In the past week, the Dow Jones Industrial Average was down 2.77% over the past five days. Much of this is not only due to inflationary concerns but also, Liz Ann Sonders (Chief Investment Strategist at Charles Schwab) believes, an air of speculation is kicking back in. In brighter news legislation (green subsidies) in the US and Europe is expected to boost activity in the wind industry. In contrast, multiple manufacturers are pessimistic about the economic outlook of the wind industry in the first months of 2023 due to high materials costs and slow approvals for new wind power projects in Europe. However, executives and analysts remain hopeful about the longer-term outlook due to the $369 billion earmarked by the US Inflation Reduction Act for clean energy projects (which has also given a push to European policymakers.

On the materials side, the US materials market is down by 0.83%, and the UK materials market is down by 7.82%. There is big news in the Lithium sector, as Beijing is adding lithium mining to its long list of crackdown targets. For reference, miners in Yichun, Jiangxi province, produce around a tenth of the global lithium supply. As the demand for lithium has never been higher due to the surge in the EV market and China pushing down on the supply, this could spell disaster for companies such as Ganfend Lithium and Tianqi Lithium, however, it could create a relative advantage for others. CATL, the world's largest manufactures of EV batteries which controls 2/3s of the world's processing capacity, is better hedged. This is, however, prompting the West to question its dependence on China for a globally abundant mineral.

Alternatives

Real Estate?(Sofia Buono)

The Bank of England raised interest rates on 2 February, from 3.5% to 4%, in an attempt to keep inflation under control (prices are rising at 10.5%, more than 5 times the 2% inflation target).??This put the bank rate at its highest level since 2008 and has applied further upward pressure on the cost of borrowing. Mortgage costs also rocketed following the release of the UK Mini-budget, which aimed at boosting economic growth through unfunded tax cuts, due to increasing sterling volatility and market uncertainty.?

The prospects do not look good for individuals on a variable rate mortgage, who are also fighting higher fuel and energy prices. The estimated two million homeowners on variable rate deals, such as?base rate trackers, will see an almost immediate rise in their monthly repayments. As an example, a tracker rate rising from 4.5% to 5% costs around an extra ￡50 a month on a ￡200,000 loan. Higher monthly payments could increase the possibility of defaults and foreclosures. Still, about 6.3m UK mortgages are fixed-rate loans and these borrowers will be insulated until their deals expire. When this will come, mortgages available are likely to be more expensive. David Hollingworth, an associate director at L&C?Mortgages, recently stated that “rates remain higher than the lows of recent years and those coming toward the end of a fixed deal will need to plan ahead.”

Rising mortgages rites accompanied by the cost-of-living crisis resulted in a slowdown of the UK housing market. In fact, higher borrowing costs have added to stretched housing affordability at a time when household finances are already under pressure from high inflation. House prices dropped 0.6% in January, marking the fifth monthly decline. The housing market is closely tied to the broader economy, and its slowdown could certainly have negative effects on UK economic growth. The high inflation and the cost-of-living crisis, together with rising mortgage prices, significantly reduced people’s disposable income, which could have a ripple effect on the broader economy, decreasing consumer spending and slowing down economic growth.