Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what their 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.
The Digest
Global equities were mixed last week on a regional, sector and factor basis. The MSCI World Index closed the week down 1.3%, dragged by performance in the United States, with the S&P 500 Index down 2.5% amidst a holiday-shortened week. The MSCI Asia Pacific Index closed the week down 0.2%, whilst European equities outperformed, with the Stoxx Europe 600 Index up 1.7%. Globally, momentum stocks were down 2.4%, whilst value stocks were down a more muted 0.6%.
Technology stocks continue to drive the US equity markets, with the sector down 4.4% last week and down 11% in the last six sessions. In the same six sessions, the NYSE FANG+ Index was down 12.3%. In August, 10 stocks accounted for >50% of the 7.2% monthly return on the S&P 500 Index, with the vast majority of those 10 coming from the technology space. Interestingly, despite the selloff, the US tech sector is still larger in terms of market capitalisation than the entire European stock market.
United Kingdom in Focus
The United Kingdom is firmly back in focus for investors in Europe. Brexit risk is on the increase as we edge closer to the deadline of the European Union (EU) Council Summit on 15 October with no real positive movement towards an agreement. Sterling, a proxy for Brexit risk, was weaker once again, trading at US$1.28 at the close on Friday last week, down 3.7% on the week. The British currency traded as high as US$1.348 on 1 September, showing how sentiment on the chances of a deal being reached has changed so far this month.
The key headlines last week focused on the UK government’s publication of its Internal Market Bill (UKIM) on 9 September as well as both sides ramping up the rhetoric on the chances of a deal. The UKIM bill is designed to ensure unrestricted trade between the four nations of the United Kingdom.
However, by the UK government’s own admission, the bill will break international law with regards to protocol on Northern Ireland agreed upon in last year’s Withdrawal Agreement. This relates to the powers the UK government would have to create regulations around trade between Northern Ireland and Great Britain. Those powers, if used, would be in direct contravention of rules around state aid and customs provisions of the Northern Ireland protocol.
The comment from the Northern Ireland Secretary Brandon Lewis that this would break international law in a “specific and limited” way, was met with derision. Leaders at the European Commission (EC) were very critical of the publication. Vice President Maros Sefcovic stated that in addition to breaking the law, it also “undermines trust and puts at risk the ongoing future relationship negotiations”. European Commission President Ursula von der Leyen also said she was “very concerned” about these developments.
It was then reported that the EU could consider legal action against the United Kingdom over these plans to breach the Withdrawal Agreement with the bloc setting a deadline of the end of September for the bill to be withdrawn. The United States also waded into the situation, with House Speaker Nancy Pelosi saying that the United Kingdom can forget about a free trade deal with the United States if the bill goes forward. UK Cabinet Minister Michael Gove said the United Kingdom would not back down. There will now be five days of debates on the bill in the UK parliament.
As noted, the pound dipped last week, with many economists raising the probability of a no-deal Brexit. In terms of equity markets, the exporter-heavy FTSE 100 Index outperformed last week as a result, up 4.0%, but remains down 20% year-to-date. Even the more domestically focused FTSE 250 Index benefited from the weaker pound, up 1.2% last week.
The UK’s economic recovery is uncertain. As recently as last month, Bank of England (BoE) Chief Economist Andy Haldane was sticking to his argument that UK data was rebounding in a “V” shape, which to most implies that output recovers as fast as it fell. Data so far show the United Kingdom has in three months recovered just half of what it lost in two months. Gross domestic product (GDP) in July, when almost all lockdown easing measures were in the data, was 11.7% below January.
Even after full lockdown was relaxed, the situation remains far worse than recessions in the previous 50 years. With more localised lockdowns reintroduced in the last week, we are certainly not out of the woods yet.
The Week in Review
Europe
European equities outperformed last week, with the STOXX Europe 600 Index trading higher. Even though the market was up, the focus has been on an escalation in trade tensions between the EU and the United Kingdom, which saw sterling close the week down lower vs the US dollar. Last week the ECB meeting also captured some investor attention. Momentum stocks outperformed in Europe, whilst value stocks were down. The UK FTSE 100 Index outperformed last week given its exporter-heavy skew and sterling weakness. Germany’s DAX Index was also strong, given gains in automobiles. Spain’s IBEX Index was a laggard, following weakness in banks and travel and leisure stocks. Overall, European equities seem to remain in a holding pattern with the 200-day moving average, a key technical indicator, acting as a strong resistance.
The rotation into momentum stocks fueled broader sector moves last week. Autos outperformed, with auto sales in China looking better in August. Health care was also strong, helped by positive headlines around COVID-19 vaccines. With value stocks lagging, it was the year-to-date underperformers which fell to bottom of the pile. Oil and gas stocks were down in Europe, along with banks. Further additions to the UK quarantine list (Portugal and Hungary last week) and new local lockdowns around Europe also played into the travel and leisure sector’s poor performance.
Nothing too exciting came from last week’s European Central Bank (ECB) meeting. As expected, there was no change in policy or stance, and the staff projections were more optimistic than the June projections. 2020 GDP was seen falling 8%, with inflation still at +0.3%. The 2021 inflation forecast was revised upward to +1.0%. Notably, ECB President Christine Lagarde seemed unconcerned by the strength in the euro. She said that the council had extensively discussed the currency’s recent appreciation, but in terms of policy, reiterated that the central bank does not target the exchange rate. The euro did spike initially after the meeting but retraced its steps close to near flat on the week versus the US dollar.
United States
In a holiday-shortened week, we saw further profit taking in the United States, with the technology heavyweights leading the market lower. The S&P 500 Index and the NASDAQ Index both traded down on the week. The tech-driven FANGS Index was -5.6%, with Apple trading lower and Alphabet and Tesla also down. The materials and industrials were the best-performing sectors, while energy and information technology were the worst performers.
The price of crude oil declined 6% on the week (falling to US$37.39 per barrel at the close last week), the lowest prices since June as OPEC+ returned some supply to the market. In addition, BP stated it sees demand as no better than “broadly flat” for the next two decades.
With the move lower last week, the S&P 500 Index has now fallen 4.5% since the start of the month. However, it is important to keep the decline in context. The S&P 500 Index was up 7% in August alone and is still up 3.4% year-to-date.
The US presidential election campaign remains a focus for investors, which any notable moves in the polls likely to impact markets. Whilst presidential candidate Joe Biden leads in the national polls, there has been a rise in support for President Donald Trump in some key “swing” states, such as Florida. Over the weekend, entrepreneur and three-term mayor of New York City, Mike Bloomberg, pledged US$100 million in support for Biden’s Florida campaign.
ASIA Pacific
The MSCI APAC Index closed with small losses last week, with mainland China and Hong Kong the underperformers. It has been a little quieter on the US-China trade front, but last week’s US blacklisting of Semiconductor Manufacturing International Corporation (SMIC) did hurt Huawei-exposed names and weighed on Chinese equities.
Over the weekend, China banned pork imports from Germany after the country reported its first case of African swine fever. The ban on German pork is said to be on concerns over disease outbreak, but there is feeling amongst some analysts that this is really about politics, especially given that Chinese President Xi Jinping is set to discuss trade with German Chancellor Angela Merkel on 14 September as part of an EU-China trade and investment summit.
Outside of this, political tensions between China and India remain an overhang for the region. Whilst an understanding between the two countries’ foreign ministers was reached last week regarding border clashes, the underlying issues have not been fully addressed, suggesting we may see further flare-ups.
Japanese equities outperformed last week ahead of the election of a new leader. Outgoing leader Shinzo Abe’s closest ally, Yoshihide Suga, won a landslide victory over the weekend and is now set the become the next prime minister of Japan. This means we are likely to see continued support for Bank of Japan stimulus and a close security alliance with the United States.
Also in focus last week was Japan’s new trade deal with the United Kingdom. The bi-lateral agreement was announced in principle last week and interestingly, commits the United Kingdom to tougher restrictions on state aid than the ones it is currently offering the EU, which could undermine the UK’s negotiating position with Brussels.
Looking at macro data, China’s economy continues to show evidence of a rebound with auto sales looking better in August. This release helped the sector outperform globally last week. Officials said last week that China’s next five-year plan (beginning in 2021) will call for increases to its mammoth state reserves of crude oil, strategic metals and farm goods.
Week Ahead
Monday 14 September:
Macro: Eurozone Industrial Production
Tuesday 15 September:
Macro: China Industrial Production & China Retail Sales; German ZEW, UK Unemployment Rate, US Industrial Production
Wednesday 16 September:
Macro: UK Consumer Purchasing Index (CPI); US Retail Sales
US Federal Open Market Committee meeting: The Fed looks to adopt its 2% average inflation-targeting framework and no major change expected to its forward guidance and quantitative easing purchases.
Thursday 17 September:
Monetary Policy: Bank of England and Bank of Japan meet
Friday 18 September:
Macro: Japan CPI; UK Retail Sales; US University of Michigan Confidence
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