Notes from the Trading Desk – Europe

The Digest

Last week, markets did feel more orderly and moves were more muted for the most part. The STOXX Europe 600 Index closed down just 60 basis points (bps),¹ although all relative in these times. The exception was in the oil space, where we saw some eye-watering moves, leading to overall weekly outperformance for the oil and gas sector. A drop off in volumes (coupled with a notable decline in futures/cash ratios) suggests that the majority of de-risking has now happened, with investors now looking for signs of stabilisation. Health care names outperformed last week with the dividend angle helping to support the space.

This morning a continued improvement in the death toll and signs of stablisation in continental Europe is helping to boost sentiment, although we would note that volumes are subdued so the move higher in European equities may be lacking in conviction. Recent COVID-19-related underperformers are outperforming at the start of the trading week, including  travel and & leisure and autos.

European COVID-19 Update: Spain Starts to Flatten the Curve, the United Kingdom Trajectory Continues

We spoke last week about the desperate need for Spain to “flatten the curve”, and the latest figures show that this is beginning to happen.

On 3 April, the Spanish COVID-19 death rate declined for the first time in four days, although this still meant 932 deaths in the prior 24 hours. Deaths in Italy are also plateauing; we had seen some evidence of this last week, but this week it is much clearer. Italy’s growth rate of new daily cases has faded from 40% in early March to just 4% and on 3 April, a release from the hard-hit Lombardy region was <3% for the entire week.

France and Germany are also showing early signs that the exponential increase in new cases is coming to an end. Daily death tolls in both are still accelerating, but new infections are starting to stabilise. There are also signals from some governments that they will consider easing lockdowns in the next few months, raising hopes that economic activity can begin the slow road towards some kind of normality. However,  those in power still need to decide when it is time to move. New cases and fatalities may be slowing globally, but deciding when they have slowed “enough” is a difficult and controversial matter.

It may seem far off, but as we consider looking through the crisis, it is worth noting some statements we have heard from individual companies. Last week, Accor Hotels said it expects two-thirds of its European hotels to be closed over coming weeks, and also said 80% of its budget hotels in China are open again and occupancy has risen to 50%. We also heard from BMW this morning; it is seeing its first signs of recovery in China with strong order intake. Signs of light at the end of the tunnel in the areas first hit with the virus seems to also be helping to lift sentiment in early trade in Europe as we start the new trading week.

The UK death toll is still accelerating as we enter the third week of lockdown  and the number of new cases also continues to rise, with no signs of slowing. It’s also worth pointing out that the United Kingdom is far behind other nations when it comes to testing. Prime Minister Boris Johnson was admitted to hospital Sunday, 10 days after being diagnosed with COVID-19, suggesting his condition has deteriorated. The line from Number 10 is that he is in for monitoring purposes at the recommendation of his doctor and Johnson remains in control of the country.

Claims for Universal Credit Benefits have surged to 950,000 since the lockdown began, with years of UK job growth wiped out by the impact of the virus. The minority of those applying  have not lost their jobs, but rather, self-employed and unable to work, on lower pay or applying for other measures such as child tax credit or housing benefit. Nevertheless, the impact is huge.

Crude Oil Volatility

Oil prices were volatile towards the end of last week as markets tried to predict whether the major global players could strike a deal to curb production. The North American benchmark, West Texas Intermediate crude oil, closed the week up 38% to US$27.63. Prices had spiked 20% late on 2 April after a headline suggested the US government was seeking a 10 million-barrels-per-day (mbpd) production cut. US President Donald Trump tweeted that he had spoken with both Russia and Saudi Arabia and he would “expect and hope” they would cut production by “10 mbpd and maybe substantially more”. However, Thursday’s gains were pared after a report that Russian President Valdimir Putin was yet to meet his Saudi counterparts threw doubt on whether a deal could be done.

Pre-European open on 3 April, we received news that OPEC+ members² were to meet virtually on 6 April, whilst prices were further supported by a report that Russia was willing to agree to a cut if the United States and Saudi Arabia join. Historically, Russia has not cut production meaningfully, only contributing a relatively minor amount to the recent OPEC+ production cuts.

Nonetheless, the overall rally in oil prices saw sector stocks close higher, but in a week with mixed signals, any future direction is still ultimately still unclear.

Over the weekend, the OPEC+ meeting, which was initially arranged for 6 April was pushed back to 9 April as the rift between Saudi Arabia and Russia continued. This, in turn, dampened expectations over the weekend that a deal could be agreed. Crude oil futures sold off as a result, albeit recovering a bit in European morning trade.

Looking to Thursday, investors should like the cut in excess of the 10mbpd Trump quoted; however, it would still leave the market in oversupply. Whilst demand estimates vary, whether a cut of 10mbpd is ultimately enough to counter the unprecedented drop in demand is not clear. We have also seen a lot of commentary on storage, with some predicting that supply could overwhelm global storage before the end of April.

Eurogroup Meetings: The Political Implications of “Coronabonds”

The Eurogroup meets on 7 April, with member-state finance ministers coming together virtually to discuss how to fight the impact of COVID-19 and work on a coordinated response. As we discussed last week, the form of the coordinated response is a hot topic and has become highly political.

Headlines in the German press on Friday suggest that the fiscally conservative powerhouse has not moved its stance on jointly issued so called “coronabonds”, and is set to reject them. The notion is rapidly becoming more important politically than economically; 14 out of the 19 eurozone countries are now asking for Eurobonds, with the more precarious southern countries (Spain and Italy) likely to suffer if they are not issued.

Germany still prefers European Stability Mechanism (ESM) loans, but these are an exclusive liability for the individual member states requiring them, and have stigma attached. Should the more fiscally conservative countries such as Germany continue to reject the notion, the perceived failure of the European Union (EU) to provide coordinated aid will have far-reaching political impact unfavourable to the EU.

Dividend Fallout

A theme we touched upon 30 March, is the focus on companies cutting dividends and the rapidly changing environment for income distribution. Last week saw UK banks dropping dividends in the near term—with that, there was an increasing focus on the politicisation of dividend payments. On 3 April, the European Insurance regulator urged the sector to temporarily suspend all discretionary dividends and share buybacks. It feels that action will offer support for those that can maintain dividends as the hunt for yield intensifies, with the likes of pharmaceuticals, staples and tobacco stocks likely to benefit.

Environmental, Social and Governance (ESG) Resilience

Another interesting market dynamic has been the general outperformance of ESG funds throughout the downturn. The Financial Times ran a short but interesting article on the shorting of companies relying on gig workers as the pandemic shifts social and political attitudes in this area.

United States

US equities were lower last week, with the S&P 500 Index -1.5% as the COVID-19 crisis escalated across the country. Sentiment was cautious as cases surged, with New York particularly hard it. President Trump warned of a tough two weeks to come. The economic impact was clear to see in the employment data, with the weekly jobless claims soaring and the monthly employment numbers for March also significantly worse than expected. The monthly non-farm payroll figure came in at -701,000, whilst the unemployment rate rose to 4.4%.

Looking at sectors, US banks were extremely weak as fears over the economic impact weighed on sentiment. As in Europe, US banks’ dividend payments are in focus. The banks have tried to defend their income payments, stating that scrapping them would be “destabilising to investors”. We expect this to remain a focus this week.

Whilst sentiment remains extremely cautious, the CNN Fear/Greed index—which shows which emotion is driving the market—is showing a small improvement in sentiment from the levels of “extreme fear” we saw recently.³

Week Ahead

It’s a relatively quiet week on the economics/macro front as most of the data this week is backwards-looking (for February), so arguably not that relevant. Note that it is a market holiday for the majority of European bourses on Friday 10 April (Good Friday).

As discussed, the OPEC+ meeting on 2 April/Eurogroup meeting on 7 April are probably the most important events this week.

Also worth noting: in Germany, Tagesspiegel is reporting that Germany mulls EU€300 billion in no- check loans for firms. EU€300 billion would be roughly 8.7% of Gross Domestic Product (GDP) and would be added to the up to EU€1.3 trillion in government loan guarantees that have been announced so far.

The Calendar: What to Watch This Week

Saturday, 4 April

• The UK’s opposition Labour Party announced favourite Kier Starmer as its new leader over the weekend.

Monday, 6 April

• OPEC+ emergency meeting
• UK – Construction PMI
• EU – Germany Factory Orders month-over-month
• China – holiday (Ming Festival)

Tuesday, 7 April

• Eurogroup meeting – “The Eurogroup will work further on the coordinated response to the economic fallout of the COVID-19 pandemic, following the invitation by EU leaders on 26 March 2020.”⁴
• EU – Germany Industrial Production month-over-month; Italy retail sales.
• Australia – Reserve Bank of Australia interest-rate decision

Wednesday, 8 April

• US Federal Reserve publishes meeting minutes

Thursday, 9 April

• UK – GDP month-over-month; Industrial Production month-over-month; Manufacturing Production month-over-month; RICS house prices.
• EU – ECB minutes; German export data; Italy Industrial Production month-over-month.

Friday, 10 April (Good Friday holiday in some countries)

• Most European markets closed excluding Russia & Turkey; US markets closed.
• US March CPI
• China March Consumer Price Index

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1. A basis point is a unit of measurement. One basis point is equal to 0.01%. Indices are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges.

2. OPEC+ is an alliance of oil producers, including members and non-members of the Organization of the Petroleum Exporting Countries.

3. Source: CNN, as of 6 April 2020. The CNN Fear & Greed Index tracks seven indicators of investor sentiment. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

4. Source: European Council, Council of the European Union, video conference of the Eurogroup meeting 7 April 2020.