Quick Thoughts: Why Our Managers Disagree on Inflation, Rates, and GrowthApr 26, 2021

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Franklin Templeton’s Notes from the Trading Desk offers 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.

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The Digest

Equities globally were lacklustre last week, with Europe underperforming amidst a position-driven selloff. The STOXX EUROPE 600 Index closed down 0.8% on the week, the S&P 500 was down 0.01%, and the MSCI APAC Index down 0.24%.1 Outside of the obvious continuing focus on the pandemic and vaccine rollouts, there was little in the way of broad market themes, which in turn saw focus shifting to technical factors and company specifics amidst the first-quarter earnings season.

European Positioning Drives Underperformance

European equities traded lower after a sharp reset earlier in the week, which saw the STOXX EUROPE 600 Index trade down as much as 1.9% on Tuesday, 20 April. Positioning was thought to be behind the move in the absence of other clear market drivers and after seven straight weeks of gains for European equities, valuations were beginning to look stretched.

Subdued market volumes also likely exacerbated the move. The reopening trade came under pressure again as COVID-19 cases exploded in India and and there was little sign of any dramatic improvement in Europe, although the vaccine rollout is picking up pace with Germany nearly doubling its efforts. With focus on the risks, the Goldman Sachs ‘Going Out’ basket was down 2.4%—representing 20% of its year-to-date gains.2 UK reopening stocks were also weaker but did outperform their global peers, still pricing in better vaccine progress. The reflation trade was heavy, whilst it appears the bond selloff may have run out of steam.

Defensives outperformed, with the move again likely driven by a reversal of the overextended positioning in the cyclicals. The more technical nature of the selloff was clear to us, as the move was largely contained to Europe equities and markets subsequently stabilised throughout the week.

Data Point to Recovery

Despite the lacklustre equity performance, the macro picture was encouraging last week. Eurozone Purchasing Managers’ Index (PMI) data showed a return to expansion in the services sector for the first time since July 2020. New orders and employment also improved, according to the composite reading.

We can expect a further boost to Europe soon after Germany removed its opposition to the EU Recovery Fund package last week. This should mean we see the first payments as early as July. Earnings in Europe have generally been supportive so far, with the pace of releases picking up this week. Refinitiv IBES data highlighted that European earnings are expected to have risen a record 61% on aggregate in the first quarter of 2021. The US composite PMI reading was the highest since records began in 2009.

It was a busy week for UK data, with signs pointing towards a strong economic recovery as the vaccine rollout progresses and lockdown restrictions begin to lift. The high level of excess savings and record household net wealth set the stage for this recovery to continue at pace. Retail sales rose 5.4% in March, well ahead of the 1.5% expected and 1.6% above pre-pandemic levels.

Hiring also accelerated at the fastest rate since 2017, driven largely by new recruitment (not just workers returning from furlough). Consumer demand surged in April, pushing the services PMI comfortably into expansionary territory at 60.1, the highest level in almost seven years.

The manufacturing PMI reading was also close to a record high at 60.7. Consumer confidence rose to its highest level since the first lockdown and industrial production was ahead of expectations. Headline inflation rose to 0.7% in March vs. 0.4% in February. While slightly lower than expected, it is still welcome after the value-added tax cut in the hospitality sector and as depressed oil prices pushed inflation towards zero in 2020.

It’s worth noting that the UK’s response to the pandemic has pushed UK borrowing to the highest level seen since the Second World War. The UK borrowed £303.1 billion in the 12 months ending this March, an increase from £57.1 billion the prior year. That said, the figures published last Friday were not as bad as had been anticipated.

Week in Review

Europe

As we’ve discussed, European equities were broadly lower, with just Spain holding up and managing to close the week near flat. Equities in Italy underperformed, with the FTSE MIB Index down 1.5%.  Germany’s market closed down 1.2% and the UK FTSE 100 declined 1.2% as the pound gained 0.32% vs. the US dollar.

Renewables stocks finished the week on a positive note, bouncing back on Earth Day (22 April), but the sector performance remains very choppy. Sector divergence widened again after being tight the prior week, with the defensives outperforming the cyclicals. Food & beverage and health care were among the outperformers, trading higher. Technology stocks also rose as the week went on, and finished with mild gains. At the other end of the spectrum, autos declined, not helped by the cyclical underperformance and some single-stock weakness following strong runs into earnings releases. The financial services and banks also weakened.

The European Central Bank (ECB) meeting was a ‘nothing doneevent and provided little insight regarding any change to purchase pacing in June. ECB President Christine Lagarde did say she felt European and US economies are ‘not on the same page’, explaining that she did not see the ECB and The Federal Reserve (Fed) acting in unison.

United States

US equities closed lower last week despite a late rally on Friday, with the S&P 500 Index and Dow Jones Industrial Average both closing down. The tech-heavy NASDAQ Index also closed lower on the week. For the first time since December, the US dollar was weaker for the third straight week. Earnings were firmly in focus for investors as first-quarter reporting continues apace.

Like Europe, positioning was a key talking point last week in the United States, which saw choppy trading patterns. The CBOE VIX Index was up 6.6% on the week.3 The climate agenda was also in focus as the US pledged new, stronger targets. Potential tax increases were also a talking point stateside, with President Joe Biden’s infrastructure plan to be funded partly by near-doubling of the capital gains tax for Americans earning over US$1 million.

Momentum stocks sold off last week, and in terms of sectors, the year’s outperformer, energy, lagged (down 1.8% on the week), but is still up 25.4% year-to-date. Meanwhile, defensive plays outperformed on the week, with real estate investment trusts (REITS), and health care closing higher.

US economic data was strong last week as sentiment continues to improve around a successful vaccine rollout and as the economy picks up steam as a result. The US Composite PMI report came in at 62.2 for April (vs. 59.7 prior), marking the highest reading since records for the data series began in 2009. The components were also stronger, with services at 63.1 and manufacturing at 60.6. Sentiment was helped further at the end of the week after the US Food and Drug Administration (FDA) said on Friday that the Johnson & Johnson vaccine could resume being administered in the United States, as the benefits outweigh the risks.

US markets sold off last week on Thursday following a rise in fears over tax hikes, as noted. Biden is considering several tax increases on wealthy Americans, including the significant hike in the capital gains tax for those earning over US$1 million, to pay for an increase in funding for childcare and education. The economic package, which is worth more than US$1 trillion, could be announced this week, when Biden is scheduled to address a joint session of Congress for the first time since becoming president. The tax increases would reverse some of the tax cuts made by Biden’s predecessor back in 2017 and are in line with campaign pledges made, which targeted Americans earnings over US$400,000 per year.

Approximately 25% of S&P 500 companies have now reported first-quarter earnings, and have shown earnings growth of 33.8%, which would be the highest since the third quarter of 2010. Earnings are running 23.6% above estimates with 94% of companies beating expectations; both metrics are at new highs since FactSet records began in 2008. Blended revenue growth is at 7.5%, which is the highest since the third quarter of 2018. It’s another big week of earnings this week, with 179 companies in the S&P 500 reporting.

APAC

Last week was mixed for Asian equities, with COVID-19-related headlines in the region dominating. Chinese equities did outperform, although they have been somewhat rangebound in recent weeks and trading volumes have been lacklustre), so conviction seems muted for now.

Meanwhile, Japan’s Nikkei fell -2.2%, as Japanese Prime Minister Yosihide Suga recommended a State of Emergency for Tokyo and some other regions due to COVID-19 numbers. With this news, questions over viability of the Olympics going ahead this summer inevitably become a focus.

Clearly, the desperate COVID-19 situation in India also dominated and the Indian equity market was down 1.9%. With India setting new records for daily cases and the health care system at breaking point in the worst-affected regions, it’s inevitable that lockdown measures will continue to be extended, and hopes for economic growth will be revised lower.

There was some positive news regarding the fight against COVID-19 in Asia, however, with a quarantine-free air travel bubble between Hong Kong and Singapore starting on May 26, following setbacks that led to the plan being delayed last November.

Tensions with China and Australia continue to simmer, after Australia scrapped Victoria’s ‘Belt and Road’ agreements with China, prompting harsh words from Beijing. The Chinese Belt and Road initiative invests in infrastructure projects globally.

Finally, it was interesting to see the Financial Times highlight that retail investors in South Korea are becoming an increasingly important factor for the equity market, suggesting they account for almost 60% of flows there.4 In addition, the article suggests the retail investing lobbying group had convinced the regulator to maintain the short selling ban which has been in place since 2019, something that is seen as another factor behind the strong gains for Korean equities. However, this short selling ban is now due to end in May, so any impact from that will be closely watched.

Week Ahead

In Europe, earnings season will continue to be in focus alongside a number of macro releases including the eurozone economic survey on Thursday and eurozone inflation and Gross Domestic Product (GDP) data on Friday. In the United States, the focus will be Wednesday’s Federal Open Market Committee meeting and subsequent press conference. Note: Fed Chair Jerome Powell has said policymakers are in no hurry to withdraw support even as the US economy rebounds. We get US GDP data on Thursday.

In the APAC region, we get the Bank of Japan (BoJ) interest-rate announcement on Tuesday as well as China PMI data on Thursday and Japan industrial production data on Friday. The dire COVID-19 situation in India will of course continue to dominate headlines in the region.

It’s also a busy week for earnings in the United States, with a number of heavyweights reporting. Tesla kicks off the week, then tech takes over tomorrow with Alphabet, Microsoft and AMD posting results; Facebook and Apple follow on Wednesday. Twitter, Amazon and Samsung Electronics close out the week.

Monday 26 April

  • German Ifo Survey
  • Spain PPI
  • ECB Chief Economist Philip Lane is due to make a keynote speech at the European Statistical Forum
  • US: March preliminary Durable Goods, April Dallas Fed

Tuesday 27 April

  • Riksbank interest-rate decision
  • Sweden unemployment rate
  • Italy: (April) Consumer Confidence, Manufacturing confidence, Economic Sentiment
  • Riksbank’s Deputy Governor Anna Breman speaks
  • Switzerland Credit Suisse Survey Expectations
  • US: April Conference Board Consumer Confidence, April Richmond Fed Manufacturing

Wednesday 28 April

  • Germany: May Gfk Consumer Confidence
  • France: April Consumer Confidence
  • US: March preliminary Wholesale Inventories
  • FOMC meeting; interest-rate announcement & Jerome Powell press conference

Thursday 29 April

  • Spain Harmonised Index of Consumer Price (HICP) inflation
  • Sweden first-quarter GDP Indicator
  • Germany HICP Inflation
  • Turkey Inflation Report
  • ECB’s Holzmann speaks
  • US: first-quarter, advance GDP, PCE, Personal Consumption, April 24 Initial Jobless Claims, March Pending Home Sales

Friday 30 April

  • France/Spain/Germany/Italy/Euro-area first-quarter GDP
  • France Consumer Price Index (CPI) inflation
  • Euro-area Flash CPI inflation
  • Italy CPI inflation
  • US: March Personal Income & Spending, March PCE Deflator, April MNI Chicago PMI

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1. 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.

2. 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.

3. The CBOE Market Volatility Index measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. 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 performance.

4. Source: Financial Times, ‘South Korea’s retail investor army declares war on short-sellers,’ 24 April 2021.