Notes from the Trading Desk – EuropeAug 10, 2020

Franklin Templeton’s Notes from the Trading Desk offer a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

Notes From the Trading Desk – Europe


The Digest

An early rally on the back of strong manufacturing data helped the STOXX Europe 600 Index close last week higher, with the majority of gains made on Monday.1 US markets also continued their grind higher. Equities in the Asia-Pacific (APAC) region also advanced, with Hong Kong the underperformer amid the weight of political unrest. With earnings releases looking okay in general for the United States and Europe, investors appear to be looking to macroeconomic data as the main market driver. To that end, the United States saw a decent July employment report, released on Friday.

In parts of the United States and in Europe, (namely France, Germany and Spain) COVID-19 cases have surged. So, the shape of global economic recovery from the pandemic remains uncertain, but markets appear to have shrugged this off for now. In the United Kingdom, Thursday’s Bank of England (BoE) minutes had a slightly hawkish slant as the central bank continues to model for a V-shaped recovery.

Low Yields, Record Gold Prices, Dollar Weakness

Investors have a number of things to be anxious about, including second-wave virus fears and the uncertain economic impact, the upcoming US elections in November and the impasse in the US Congress over passage of a fourth stimulus package. Despite this, US equities kept on moving up, with the technology sector leading. The NASDAQ Index hit yet another record high last week.

As we might expect with all of those headwinds, many investors have looked to fixed income for safety. In addition, global central bank stimulus has spurred interest rates to move towards zero and aggressive bond buying has diminished returns on government debt. The US 10-year Treasury yield hit a record low of 0.52% last week, and real yields (adjusted for inflation) hit a record low of -1.2%. These ultra-low rates could spur investors to move into other assets in search of better returns.

In this low-yield environment, gold has surged to a historic level, breaking through US$2,000 last week. Inflation expectations have also ticked higher (although they remain low by historical standards), which also plays into this dynamic.

Much of the support for gold comes from investor buying of exchange-traded funds that track the price of gold, which often leads to buying of physical gold in order to match investor demand. Gold bulls believe that the asset is still under-owned by historical standards, meaning this move may have further to go. However, we think it will be important to keep an eye on whether inflation expectations are realised; gold investors were caught out following the 2008 crisis as inflation did not materialise as many anticipated.

US dollar weakness remains a key theme, with the currency continuing to weaken materially since spiking in February and March. The move then was the result of investors seeking a safe haven as the severity of the pandemic was realised. Despite the continued uncertainty, demand for the currency has faltered as equities recovered for a number of reasons.

The handling of the pandemic and its severity has delayed the reopening of economic activities in the United States longer than some other regions, which has the potential to hit the US economy harder relative to its European counterparts. The Federal Reserve’s (Fed’s) extreme monetary policy intervention has swollen its balance sheet to a greater degree than the European Central Bank (ECB), BoE, or Bank of Japan (BoJ), and the US central bank has also been clearer on its intentions to maintain easier monetary policy.

In addition, the European Union’s (EU’s) sizable fiscal recovery fund has led to hopes that European economies will be re-invigorated and perhaps more importantly is demonstrative of solidarity between member states. In contrast, the US Congress remains at an impasse over its own fiscal stimulus, weighing on the dollar’s appeal.

Week in Review

Europe

European equities generally rose last week, clawing back the majority of losses from earlier in the week, even when faced with a number of headwinds. Last week saw the fourth week in a row where COVID-19 cases increased in France, Germany, Italy, Spain and the United Kingdom, with the aggregate level looking likely to set a new high since the middle of May. Spain has been hit hardest, with cases rising by 72% as the effect of local lockdowns seems to be limited so far. This dynamic is likely to be a focus this week. Despite the increase in infections leading to tighter travel restrictions, the travel and leisure space managed to outperform, although this is clearly from a low base. The more defensive health care and food & beverage sectors underperformed, with supportive macro data seeing a slight tilt towards value and realised volatility factors. Momentum and growth underperformed.

Improving European Macro:

  • On 3 August, we saw upward revisions and positive surprises in the euro-area manufacturing Purchasing Manager’s Index (PMI), with the headline figure recovering from 33.4 in April to an expansionary 51.8 in July. In addition, the employment index went from 35.8 to 42.9. The release boosted sentiment and helped markets recover some of last week’s losses, with the Stoxx Europe 600 Index closing the day higher.
  • On 7 August, industrial output figures from France, Germany and Spain showed that levels are edging closer to where they were pre-pandemic Spain saw the biggest monthly gain, with output rising 14% in June vs. May. Spain had one of the hardest-hit gross domestic product (GDP) releases last week (-18.5% in the second quarter), so the better data has given investors some hope. Germany has benefitted from increased trade with China, with exports to the country up 15% in June. German factory orders also improved, jumping a record amount in June. Eurozone retail sales rebounded to better levels than last year, suggesting that consumer confidence seems to be on the rise.
  • With all of this, the Citi Economic Surprise Index for Europe hit an all-time high.

The data in Italy was less impressive. The rate of industrial output growth slowing significantly in June, dampening hopes of a V-shaped recovery there. Despite the positive data from other countries, there is clearly still a long way to go, and the resurgence of COVID-19 cases in some areas has also dampened the chances of a speedy recovery. With this, reactions to data on 7 August were more muted.

United Kingdom and BoE

  • The UK PMI figure released last week was disappointing, revised down from the preliminary release.
  • There was nothing too surprising from the BoE on 6 August, with interest rates unchanged at 0.1%, although there was a hawkish slant to the minutes as it suggested that the BoE’s next move could be monetary tightening. The central forecast said the economy has had more than enough stimulus, spare capacity will be eliminated by the second half of 2021 and inflation will likely rise above target. BoE Governor Andrew Bailey did try to manage any panic, emphasising the downside risks to the recovery after the report was published, and stating that the central bank was ready to “lean in” to do more. He also said that negative rates are in the central bank’s toolbox, but that there are currently no plans to use them. Overall, it was a bit of a confusing picture.
  • The Monetary Policy Committee (MPC) continue to model for a V-shaped recovery, though it did push back achieving pre-COVID output levels to late 2021. Inflation expectations are to see the 2% target met in two years on current policy. The BoE is more optimistic than independent economists on the short-term path of recovery although it does note that there are high risks of the path being thrown off course. It also appears that there is high degree of uncertainty about the BoE’s forecasts, with the MPC split in its views, adding to the lack of clarity.
  • On 7 August the Financial Times reported that the Chancellor is likely going to face renewed pressure to extend the UK furlough scheme following the BoE outlook statement.2 The BoE supports the end of the scheme as planned in October, but political opposition remains.

United States

US stocks managed to outperform global equities last week, with much of the focus on politics and corporate earnings. The S&P 500 Index, Dow Jones Industrial Average and the NASDAQ all advanced, but it was the small-cap Russell 2000 Index which outperformed, up nearly 6% on the week.3 All sectors were better off last week, but the growth sectors generally outperformed and the more defensive sectors generally lagged. Industrials led the way, followed by financials and energy. Meanwhile, real estate investment trusts, health care and utilities were underperformers last week.

By the end of last week, stimulus talks had reached an impasse as the White House and the congressional Democrats struggled to agree on a support package. Speaker of the House of Representatives Nancy Pelosi had said that the US government was failing to face up to the gravity of the crisis whilst Treasury Secretary Steve Mnuchin recommended that President Donald Trump takes executive action to break the stalemate. Time is in limited supply with jobless benefits and a federal moratorium on evictions now expired. Whilst Mnuchin called Pelosi’s latest proposal of a US$3.5 trillion stimulus bill a “non-starter”, Trump also weighed in on the debate, calling the Democrats’ plans “radical left-wing policies”.

Over the weekend, the White House (via executive order) partially extended unemployment benefits, suspended payroll taxes and expanded unemployment benefits (at the lower figure of US$400, of which US$100 needs to be paid by state) and a series of other fiscal measures. This is temporary, however, and talks on the support package will resume soon.

Corporate earnings continue to be supportive for markets, with 89% of the S&P’s market capitalisation having reported on second-quarter earnings by the end of this week. So far, earnings have exceeded estimates in aggregate, and most companies have beaten earnings projections, albeit with estimates at decimated levels. Stock moves have been more muted than normally would be based on the earnings reports.

In terms of data, the July employment report was the key release last week, showing a larger-than-expected increase of 1.763 million nonfarm payrolls vs. +1.48 million expected. The Institute of Supply Management manufacturing data was also supportive, coming in better than expected. New orders also grew more than anticipated.

APAC

Asian equities were mixed last week, with the MSCI Asia Pacific Index closing the week up 2% overall. The KOSPI outperformed last week, grinding higher as the week went on, helped by the move into value stocks. Hong Kong’s Hang Seng Index lagged, with investors remaining very concerned over the autonomy of the region amidst a tightening on national security from Beijing. In terms of sectors in Asia, it was the materials which outperformed, with energy and consumer discretionary also strong. The utilities lagged on the week, along with consumer staples.

The Shanghai Composite Index came under pressure towards the end of the week as President Trump ramped up trade tensions with China by signing an executive order which will prevent US residents doing business with Chinese-owned TikTok and WeChat. Trump claims that the two apps are a threat to national and economic security. (Note, it was only last week that Microsoft was rumoured to be in talks with current owners ByteDance to buy Tiktok.) The restrictions will be put in place in 45 days from Friday. Restrictions on WeChat, owned by Tencent, were a surprise for markets, with Tencent down 10% at one point on 7 August.

In terms of data last week, Japan’s consumer price index  came in ahead of expectations, up 0.6%.China Caixin Services PMIs for July came in behind expectations, whilst Japan’s Jibun Bank Services PMIs for July were ahead of expectations but not yet in growth territory, coming in at 45.4. Finally, the Reserve Bank of Australia kept interest rates on hold.

The Week Ahead

Although it is the summer holiday season and market volumes will likely be lower than average, there are still a few events to keep an eye on this week. With the presidential election in the United States set to dominate market sentiment in the coming months, watch for Democratic candidate Joe Biden to announce his running mate in coming days.

In terms of macro data, as COVID-19 cases creep up in Europe, the ZEW sentiment surveys may give a good insight into the mood in Germany. UK GDP to be released on Wednesday and eurozone GDP on Friday will also be important to keep an eye on. Elsewhere, 14 August is a big day for Chinese data, with retail sales and industrial production to be released.

Market holidays: Monday: Japan, Singapore, South Africa

Macro Highlights

Monday 10 August: In Asia we saw China’s producer price index (PPI) come in at -2.4% and the CPI at 2.7%.

Tuesday 11 August: German ZEW Sentiment Survey. US PPI data.

Wednesday 12 August: A big day for UK data, with UK GDP data due. Industrial production month-over-month (MoM) (June); UK manufacturing production MoM (June). Eurozone industrial production SA MoM (June). Japan machine tool orders. US CPI.

Thursday 13 August: Japan PPI.

Friday 14 August: Chinese retail sales and industrial production. Eurozone employment and GDP data. US retail sales and Michigan Sentiment Survey.

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1. Indices are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.
2. Source: The Financial Times, “Pressure grows on Rishi Sunak to extend UK furlough scheme”, 07 August  2020.
3. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.