This trade has not worked from day one. There are still telco’s we like stand alone and there is still great value and stories in the sector. VOD/TIT & DTE but we step aside on this spread trade and lick our wounds.

Have a good day.

Closing for -14.60% abs.



Tuesday • 20th September 2016 • 11:37

Since the market found its YTD lows in early FEB the telcos have underperformed the industrials by 22%. Considering the global hunt for yield this makes little sense to us  considering the lackluster global economic growth and the fact the SXKP yields 5% as a sector.

Telcos have faced a number of hurdles. Consolidation has been an issue with failures in France & Denmark and benefits in Italy potentially nullified with the emergence of ILD as a 4th player. The loss of roaming revenues have made headline numbers look poor (That’s just optically and underlying trends are still solid). Rates potentially bottoming. And positioning is always a headwind, (see latest MLFMS).

Industrials have benefited from a pickup in economic activity – both CESIUSD and CESIEUR improved markedly from FEB. Fears of a Chinese devaluation and severe economic slowdown were alleviated by intervention and a massive credit surge in later Q1/early Q2. And more recently the emergence of the view that fiscal easing is imminently taking the baton from monetary has driven another leg higher.

These are now in the price. Positioning still is not helpful for telcos but the roaming issues are out there and understood for Q3. There are new noises of French consolidation and yields are likely to be contained by the Fed not raising and Draghi coming back before December. At 5% div yield and 6.5x EBITDA, the sector is too cheap vs the market to underperform materially from here.

By contrast industrials look expensive historically at over 11x EBIT. This is at a time when the economic data appears to be rolling with Manuf ISM in recessionary territory, German IP posting the biggest MoM decline in 2 years in August and because China has stabilised, it is likely to feel the lack of credit impulse and further stimulus that would have happened amid weakness, in the next couple of quarters. We also believe that although the shift to fiscal policy is ultimately where we should be going in order to stimulate the DM economies it is likely to face significant hurdles from national governments, due to deficit rules and them facing political uncertainty.

Bond yields will be a driver into year end, but telcos didn’t rally with spread compression in any case and therefore should not be affected by any widening. And in the event that there is industrials would likely underperform with the subsequent market weakness. So regardless of market direction and bond yield moves from here into year end we expect this trade to work.