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.
It was a quiet start to last week, with a number of markets closed on Monday for the Easter holiday. Equity markets moved higher, which largely reflected investor focus on the incremental positives regarding the COVID-19 situation despite the fundamental backdrop still looking both grim and precarious. With this, the STOXX Europe 600 Index closed the week up 0.5%, with the majority of the increase coming on Friday. The United States also outperformed, with the S&P 500 Index finishing the week higher, whilst the Asia-Pacific (APAC) region was stable, with equity markets in most regions closing higher.
Fundamentals Weak, Markets Strong?
As fundamentals seem to be pointing towards selling, asset prices have been rising; of note, the week before last we had the best week for the S&P 500 Index in 20+ years alongside the biggest outflows globally in 20+ years. Looking at catalysts for last week’s market moves, new coronavirus cases and deaths continue to fall in continental Europe, and there have been headlines regarding antibody tests as well as treatment and vaccine trials. It shouldn’t be understated how much existing central bank interventions remain a supportive backdrop as well. However, we’ve also seen some dire macro data (particularly from the United States and China), continued corporate struggles, and oil still remains at hugely depressed levels.
In addition to these concerns, we remain in uncharted territory given the fallout from the pandemic, despite a recent focus on trying to “look past” the crisis. Still, with those improving case numbers, talk of transition from lockdown in certain regions, and support for “coronabonds” from French President Emmanuel Macron, equities managed to close the week higher.
COVID-19: The Latest in Europe
There have been incremental positives in COVID-19 developments, as the daily death tolls in Spain and Italy continue to fall. We are yet to see a decline in the United Kingdom, although there is some evidence that the outbreak may now be peaking as we have seen a deceleration in hospital cases in the majority of regions. It is still too early to say if the situation in the United Kingdom has actually peaked, however. Recent reports showed new cases were actually lower in Spain, Italy, Germany, France, Holland and the largest US city, New York.
Whilst the United Kingdom has extended its lockdown for a further three weeks, with no government communication on how a transition towards relaxing the lockdown would look, continental Europe is making tentative steps. Denmark and Austria have announced plans to relax their restrictions in the coming weeks and France is set to reopen “progressively” after 11 May. Certain shops have been allowed to reopen in some Italian regions and some Spanish workers have returned to work (e.g., construction), with the country said to be proceeding with “utmost caution”.
Despite all of this, there was nothing incrementally new on the vaccine/treatment front over the weekend and the UK press also seem less supportive and questioning of the government’s response. That, and a further selloff in crude oil, saw equities struggle to make gains as the week kicked off on Monday 20 April.
Crude Oil Weakness
Oil prices slumped again last week (West Texas Intermediate was -20.4%, Brent -10.3%) despite the OPEC+ agreement for a cut to production of 9.5 million barrels per day. On Friday, WTI hit its lowest level since 2002. The cut itself was seen as a clear necessity for markets to try in some way to help the supply/demand imbalance that has developed this year. However, with the global economy under intense strain, it is not yet clear when demand for oil will return, and to what level it will get back to by the end of 2020.
The issue of storage capacity came to the forefront through last week, and that goes a long way to explain the divergence in pricing between WTI and Brent that we currently see. WTI is more exposed to capacity issues because it is landlocked crude supply, so it is not as easily transferred to other storage facilities. With both oil prices at heavily discounted levels, the market continues to face an unprecedented shock to demand in the near term. It is difficult to see how oil markets will find a more normalised equilibrium until economies fully reopen and we start to see economic growth again, albeit relative.
European Union (EU) Eurogroup: Political Tension Rises
The EU Eurogroup will meet this Thursday to once again discuss its response to the crisis. The situation is continuing to become increasingly political. The Hanseatic League (Hansa)—including Germany and the Netherlands—remain firm that European Stability Mechanism (ESM) is what should be offered to help troubled member states such as Italy, whilst the stigma and individual liability is a sticking point for those countries that may need to use it. Italy’s Prime Minister Giuseppe Conte last week said Italy would not be using the ESM credit line, despite a Eurogroup decision to lower the conditionality.
This statement saw the yield on the Italian 10-year government bond move back above 1.9% midweek. The spread over the 10-year Bund widened to 2.4%, wiping out over half of the narrowing we saw after European Central Bank President Christine Lagarde stepped in back in mid-March. There was a little more hope on Thursday after Conte clarified that Italy would make a decision on whether or not to approve ESM only after it is fully approved and conditions are set; with this, all eyes are on commentary from Thursday’s Eurogroup meeting. Note: Italy’s gross domestic product (GDP) fell 5% in the first quarter, according to the Bank of Italy.
Alongside the ESM discussion is the controversial question of jointly issued so-called “coronabonds”, which we have touched on over the past few weeks. Whilst the Hansa group have rejected the idea, Macron seemingly gave his support one again last week, warning of the collapse of the EU as a “political project” unless more support is given to stricken economies. Conte reiterated his call for the joint EU bonds over the weekend, setting the stage for a clash this weekend with Germany and the Netherlands. The perceived failure of core countries to support those on the periphery could lead to huge political upset in the future and play into Southern populism.
Week in Review
European equities traded higher overall last week, with quite notable divergence in terms of sector and country performance. Defensive sectors outperformed in Europe, with health care, food and beverage, technology and retail all increasing. Meanwhile, oil and gas stocks lagged as they continued to fight the effects of heavily discounted oil prices.
The banks also had a poor week. US banks began to report weak quarterly earnings, and Italian banks were hit particularly hard as the Bank of Italy said the most fragile of the nation’s banks may need state support. With this, the German DAX Index outperformed, whilst the hard-hit and economically precarious Italian market underperformed. Liquidity was poor again last week, as short-selling bans remain in place across Europe and as any conviction remains low.
US equity markets continued to recover ground last week, with the S&P 500 Index finishing 3% higher. Hopes over a potential COVID-19 vaccine from US biopharmaceutical company Gilead Sciences and rhetoric from President Trump around ending the lockdown lifted investor sentiment. In addition, some investors were following the “don’t fight the Fed [Federal Reserve]” mantra, as the central bank had announced an asset-purchase programme to help restore some market confidence and liquidity.
Looking at sectors, consumer discretionary stocks led the way higher, with Amazon, accounting for a significant part of the sector’s outperformance. The S&P 500 index concentration in the largest stocks is something we have discussed in these notes before, and it’s important to note the concentration in the S&P 500 Index’s top five stocks is larger than ever before. Microsoft, Apple, Amazon, Alphabet and Facebook account for over 20% of the S&P 500 Index market cap, whilst Netflix also outperformed from the current lockdown.
A number of US banks reported corporate earnings last week. The theme was generally that trading was strong, but provisions were higher. For example, JP Morgan took a provision for credit loss of US$8.29 billion, (much bigger than expected) with most coming from the consumer card segment.
Despite the move higher in markets generally last week, macro data were bleak, suggesting investors may have become numb to poor data and happy to focus central bank stimulus. As expected, retail sales in March saw a notable decline. Weekly initial jobless claims rose 5.245 million, which was actually slightly “better” than consensus estimates, but contributed to the 22 million rise over the past four weeks.
Asian markets were broadly stable last week, with Hong Kong’s equity benchmark index essentially flat on the week, Shanghai’s benchmark index +1.5% and Japan’s Nikkei Index +2%. The main focus was Chinese macro data, with first-quarter 2020 GDP coming in at -6.8% year-over-year, China’s first economic contraction since 1992. Despite this, markets held up as a weak GDP number had been expected, and there are some tentative signs that economic activity is restarting in China. For example, on the production side, industrial production year-over-year data beat expectations. In addition, hopes of further government stimulus also helped sentiment.
Corporate stock buybacks have been subdued this year, tracking the lowest first three months of the year compared to the last seven years, More than a fifth of the companies in the Stoxx 600 Index have announced dividend cuts since the start of the year, so we shall see how earnings pan out. But it does feel to us as if the risk is still to the downside.
Monday 20th April:
- EU: Bank of England’s Andrew Haldane and Ben Broadbent speak; ECB Current Account SA; Brexit talks resume: EU and UK to hold the second round of post-Brexit trade agreement negotiations all week; Germany PPI, Italy CA Balance, Eurozone Trade Balance
- US: Chicago Fed Activity
- APAC: Japan Trade Balance
Tuesday 21st April
- EU: UK Jobless Claims Change & ILO Unemployment Rate, Switzerland Swiss Watch Exports, Netherlands House Price Index, Switzerland Money Supply, Sweden Unemployment Rate, Spain Trade Balance, Eurozone & Germany Survey Expectations
- US: Existing Home Sales
Wednesday 22nd April
- EU: Netherlands Consumer Confidence & Spending , UK CPI & RPI & PPI , France Business Confidence, Italy Industrial sales & Orders, Eurozone Govt Debt/GDP Ratio , Eurozone Consumer Confidence
Thursday 23rd April
- EU: EU leader meeting: EU leaders discuss the EU COVID-19 response, focus will be on potential joint bond issuance, Global Flash Manufacturing and Services PMI, Germany Consumer Confidence, Norway Unemployment Rate & Industrial Confidence, UK Public Finances PSNCR, Sweden Consumer Confidence, Eurozone Industrial Production, UK CBI Business Optimism, UK Consumer Confidence
- US: Initial Jobless Claims, New Home Sales, Kansas City Fed Manufacturing report
- APAC: Taiwan IP
Friday 24th April
- EU: Russia CBR Meeting (expect no change); Italy Sovereign Debt to be rated by S&P; UK Sovereign Debt to be rated by S&P; Greece Sovereign Debt to be rated by S&P, DBRS, Spain PPI , Sweden PPI, Germany IFO Business Climate
- US: Durable Goods, University of Michigan Sentiment survey
- APAC: Japan CPI and All Industry Activity
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