Day: 24 April 2023

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. As part of Templeton Global Equity Group, the European equity desk is manned by a team of professionals based in Edinburgh, Scotland, 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

The global equity market felt a little rudderless last week as investors digested a glut of US corporate earnings and Fedspeak. In Europe, the hotter-than-expected March UK inflation print was a talking point, as was some mixed Purchasing Managers Index (PMI) data. Overall, indices saw muted moves, but there was a rotation into more defensive sectors, suggesting a more cautious mood amongst some investors. On the week, the MSCI World traded down 0.1%, The Stoxx Europe 600 Index was up 0.4%, while the S&P 500 Index was down 0.1% and the MSCI Asia Pacific Index was down 1.3%.

Week in review

Europe

Trading volumes and newsflow picked up in European markets after a very quiet couple of weeks, as US earnings news impacted the market and European earnings started coming through as well. The STOXX Europe 600 Index has had a sharp recovery since the SVB/Credit Suisse situation in mid-March, trading up 6% over the past month. Feedback indicates that this move was something of a “pain trade” higher considering how negative investor sentiment was back in March. It is worth noting the Index is back at levels last seen in January 2022. In addition, Friday’s close was the highest recorded since 12 December 2007 for the EURO STOXX 50, a benchmark of Europe’s largest 50 companies.

The French CAC Index has also been reaching record highs and was up 0.8% last week. Luxury heavyweights have performed well on the China reopening story.

In terms of sector performance, travel and leisure names outperformed last week, with some positive earnings in the space. A decline in crude oil boosted airliner stocks. There was a defensive bias too, with staples and utilities stocks both higher. This is actually a theme we have seen play out throughout the year.

European auto stocks had a torrid week, declining amid some weaker-than-expected earnings and talk of slowing demand in the second half of the year.

Looking at central bank chatter, European Central Bank (ECB) Chief Economist Philip Lane seemed to indicate policymakers are keeping options open. “As of now, two weeks away, I think the baseline is that we should increase interest rates in May but what we do in terms of scale, I’m not going to set a default number.” The market expects a 50 basis-point (bps) rate hike from the ECB at its next meeting.

Looking at macro data, the March UK Consumer Price Index (CPI) data was the main talking point. The year-over-year CPI came in at 10.1% vs. 10.4% prior. This higher-than-expected inflation print now sees the market pricing in a 25-bps rate increase in May and a terminal rate of 4.9% (the current rate is 4.25%).

Bloomberg gave us another example of the everyday impact of inflationary pressures for those who like a full cooked English breakfast. The Bloomberg “Breakfast Index,” which tracks the staples that make up a cooked breakfast, jumped to record highs, up 23% in the last year.

That all said, it is worth noting the market expects inflation to fall sharply in the second half of the year as low energy prices feed into the data.

United States

US equities remained rangebound last week, with the S&P 500 Index essentially unchanged, down 0.1%. During April, the S&P 500 Index has traded in a tight range between 4100 and 4150, the smallest monthly trading range for some time.

In terms of market themes, US corporate earnings dominated last week. Overall, earnings season has seen companies perform well. As we stand now, 88 companies in the S&P 500 have reported first-quarter 2023 earnings. About 75% of companies have beat expectations for earnings per share, and about 63% have beaten sales expectations. However, some market observers highlight that expectations were very low ahead of earnings season, with consensus expectations lower than historical averages.

In the commodity space, the price of West Texas Intermediate crude oil declined about 6% last week, the first weekly drop following four consecutive weeks of gains on excitement over the surprise OPEC production cut faded and recession fears resurfaced. Energy stocks thus declined in tandem.

In terms of sector performance, defensives also outperformed in the United States, with staples stocks and utilities rising. Communication services was the worst performing sector.

There were a large number of Federal Reserve (Fed) speakers last week, with the overall tone sticking with the hawkish narrative. The market currently expects a 25-bps hike at the next Fed policy meeting.

Something to keep on the radar: There is increasing chatter around the United States hitting its debt ceiling in the coming months. The US government is closing in on its US$31.4 trillion debt limit, and an extension requires Congress approval. We have seen these standoffs before, but with an election ahead in 2024 and the Republicans controlling the Senate, the political stakes are high.

Asia Pacific

Last week was difficult in Asia, with most major markets in the red and only Japan in the green.

Hong Kong’s equity market started last week strong, but faded over the rest of the week to end down 1.78%, despite some better-than-expected data out from China.

Mainland Chinese equities traded off over the second half of the week even though China’s first quarter gross domestic product (GDP) came in at a higher-than-expected 4.5%.

US-China tensions remain a focus, as reports suggest US President Joe Biden is looking to sign an order within weeks to ban US investment in Chinese chip/AI/computing companies. As a result, artificial intelligence, semiconductor and telecommunications stocks were weaker on Friday, weighed down by concerns of further sanctions on key parts of the supply chain.

COVID-19 concerns were in focus on Friday after media reported new positive cases for the XBB variant. Anti-COVID drug stocks rallied.

Japan’s market was the outperformer on the week, closing the week up 0.25% as earnings season also started in Asia.

Ahead of this week’s Bank of Japan (BoJ) meeting, focus was on last week’s inflation data. Core CPI remained above the BoJ’s 2% target in March, coming in at 3.2%, adding pressure on the bank under its new Governor Kazuo Ueda to take steps to normalize monetary policy. However, ahead of his first monetary policy meeting on 27/28 of April, BoJ Governor Ueda reiterated the BoJ’s commitment to its easing stance until price stability is achieved. The BoJ is widely expected to make no changes to its yield curve control policy in April, with investors largely focused on the quarterly outlook report due after the monetary policy meeting, which includes inflation forecasts that could be revised upwards.

Japanese PMI data also came out last week and was largely in line with the prior readings. The services sector benefitted from the post-COVID-19 reopening.

The week ahead

Corporate earnings will continue to dominate this week, with tech heavyweights a focus in the United States. Microsoft, Alphabet, Meta and Amazon, all report this week. A large number of European and Asian companies also report earnings this week. In terms of macro data, a number of GDP and CPI data points will be in focus. Thursday’s BoJ meeting will be new governor Ueda’s first at the helm.

There are several upcoming market holidays, with all of Europe excluding Denmark closed on Monday 1 May.

Monday 24 April

• Germany IFO Expectations
• US Dallas Fed manufacturing survey

Tuesday 25 April

• Spain PPI
• US FHFA home prices
• US New home sales
• US earnings: Alphabet and Microsoft

Wednesday 26 April

• Germany GfK Consumer Confidence
• France Consumer Confidence
• US Durable goods
• Australia CPI
• US earnings: Meta

Thursday 27 April

• Eurozone Consumer Confidence
• US GDP & Jobless claims
• China Industrial Production
• Us earnings: Caterpillar, Amazon

Friday 28 April

• France GDP
• France CPI & Consumer Spending
• Spain CPI & GDP
• Germany GDP
• Italy GDP
• Eurozone GDP
• Germany CPI
• US Personal income & Core Personal Consumption Expenditures prices
• Japan Industrial Production and Tokyo CPI
• BoJ Meeting

 

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Key Points

Emerging market appeal: We are leaning into our preference for emerging market (EM) assets due to China’s restart, ending EM interest rate hiking cycles and a weaker U.S. dollar.

Market backdrop: Global stocks were flat on the week. PMI data showed economic activity holding up in the U.S. and Europe. Sticky UK inflation pointed to more rate hikes.

Week ahead: This week’s GDP data in the U.S. and euro area will help gauge the economic damage from rate rises. We see hikes hitting growth later this year.

Our new playbook calls for quickly shifting portfolios based on how much damage is priced in. We went overweight EM stocks and our long-held preference for EM debt in March on a six- to 12-month tactical horizon as they price in more rate hike damage than developed markets (DM). We took advantage of near-term events favoring EM assets: China’s economic restart, pausing EM interest rate hikes and a weaker U.S. dollar as the Federal Reserve nears the end of its rate hike campaign.

It may seem an unusual time to favor EM after major central banks’ rapid interest rate hikes. Yet we’ve seen a clear resilience in EM economic activity (yellow line in chart) even as rising rates have slowed DM activity. Total returns for EM debt have jumped above returns for DM credit since mid-2022 ( dark orange line) as a result. A key difference: EM central banks kicked off rate hikes as much as a year before DM peers. Some already stopped hiking, while DM central banks have more to do and likely won’t cut rates soon given stubborn inflation. Brazil’s central bank has held its policy rate at 13.75% since September. Central banks for India, South Korea and other nations have paused policy rates more recently. Rate cuts would help ramp up EM economic growth sooner than in developed economies. The International Monetary Fund still sees EM GDP growth about three times higher than for advanced economies this year and next, its April forecasts show.

We don’t think EM central banks will need to keep up with DM central banks’ rate hikes to avoid currency depreciation. EM currencies have, in fact, gained against the U.S. dollar as the Fed nears the end of its hiking cycle. Plus, EM debt is now more concentrated in local currencies than the dollar, JP Morgan index data show. We think that makes any future weakening in EM currencies easier to handle. This means EM central banks have paused and can begin cutting rates sooner than DM counterparts. We see DM central banks keeping rates higher for longer to fight sticky inflation, making rate cuts this year unlikely. This will all help EM economies keep outpacing developed economies this year, in our view. We turned overweight EM local-currency debt again in March, after having a relative preference for most of last year. While fund flows show investors have favored EM stocks since 2022, flows into EM local debt remain more muted and have the potential to increase.

EM stocks’ near-term appeal

Even with investors leaning into EM shares, they’ve underperformed DM stocks for over a decade. We don’t think EM shares are reflecting the likely growth outperformance of emerging economies this year. We went overweight EM stocks in February to get short-term exposure to China’s restart. The restart helped China’s Q1 GDP beat market expectations last week, in line with our view of growth around 6% for the year. It’s also helped EM economic activity outpace DM economies since the year started. We expect policy in China to stay supportive given very low inflation, and that benefits EM stocks: Chinese companies make up a large share of major EM equity indexes. The pickup in Chinese demand and tourism should especially boost Asian firms’ earnings and shares. Renewed demand for commodities is another positive helping emerging economies such as in Latin America.

Longer term, China’s powerful restart doesn’t change structural trends like aging populations and tensions with the U.S that will drag on long-term growth. We think the geopolitical risk of holding Chinese assets has risen. We see investors demanding more compensation to reflect that and risks from regulatory and government intervention.

Our bottom line

We like EM stocks and bonds over DM in the short run. We also prefer higher-rated countries within EM debt such as Mexico, similar to our overall quality preference – especially within DM equities and credit. Higher-rated countries have falling inflation, more balanced external accounts, adequate currency reserves and lower debt-to-GDP levels. Yet EM assets wouldn’t be immune to a risk asset selloff and U.S. dollar surge from more Fed hikes. Our relative views flip on a horizon of five years and over. We see geopolitical risks weighing on EM risk-adjusted returns, so we prefer DM equities in the long run. We also think DM economies will benefit more from the transition to a lower-carbon world than EM on that horizon.

Market backdrop

U.S. stocks paused as European stocks hit a 14-month high last week. U.S Treasury yields largely steadied after a recent rise on expectations for the Fed to hike rates in May. The March UK inflation data showed how sticky inflation is proving across major economies. Sticky inflation and the April PMI data showing economic activity holding up in the U.S and Europe suggest major central banks have more work to do to fight inflation. We don’t see them coming to the rescue with rate cuts this year.

GDP data in the U.S. and euro area this week will help gauge the economic damage from rate rises. We see hikes hitting growth later this year and no rate cuts in 2023 from major central banks. We expect the Fed to stop hikes when the damage is clear but think the European Central Bank will keep going to get inflation to target regardless of the damage that entails.

Week Ahead

April 25:U.S. consumer confidence

April 27: U.S. Q1 GDP

April 28: U.S. PCE and Employee Cost Index; euro area GDP; Bank of Japan policy decision

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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of 23^rd April, 2023 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

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This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Information Document (KID), which may be obtained from MeDirect Bank (Malta) plc.