Notes from the Trading Desk – Europe

The Digest

Global equity markets were buoyant last week, as news of further economic stimulus in Europe, better-than-expected US employment data and a continued easing of lockdown measures all helped boost market sentiment. With that, we saw a continued rotation into beaten up cyclical/value names. As the week closed, the MSCI World index gained 5.5%, the US S&P 500 Index was up 5%, the Stoxx Europe Index 600 was up 7% and markets in the Asia Pacific (APAC) region was up 5.5%.¹

“Rocket Ship”: US Jobs Data Better Than Expected

Friday’s US employment report for May aided the strong equity market finish last week. The non-farm payrolls component came in significantly better than analysts had been forecasting, with 2.5 million jobs added vs. an expected 7.5 million in job losses. In addition, the US unemployment rate was far better than anticipated, coming in at 13.3%. The better-than-expected numbers  were due to the economy’s reopening, with the majority of jobs added in the leisure & hospitality, transport and retail sectors.

This data is fueling hopes that the US economy may see a more V-shaped recovery, with a swift rebound in growth. On the back of this news, US President Donald Trump was exuberant, stating that the jobs report was a “rocket ship” and “a big step in our comeback”. He also tweeted he had “built the greatest economy in the world”.

With this data in mind, it will be interesting to see what comes from the Federal Reserve (Fed) meeting this Wednesday. Major policy changes are unlikely at the June meeting, but a new Summary of Economic Projections and Chair Jerome Powell’s press conference should provide additional insight in regard to the outlook for policy, particularly in light of last Friday’s jobs data.

Further European Stimulus

Last week saw some notable increases in support for the European economy from the European Central Bank (ECB) and German government, both of which were larger than expected.

ECB Headline Policy Update Constructive: Last Thursday, the ECB did not disappoint as the Pandemic Emergency Protection Package (PEPP) was increased by €600 billion (vs. the €500 billion widely expected) to €1.35 trillion and extended to June 2021 (from end 2020). The ECB also specified that maturing PEPP assets will be reinvested (previously it was unclear whether this would be the case or whether the ECB’s balance sheet would wind down as assets matured).

German Fiscal Stimulus Agreed: In addition to the ECB announcement, we also had news of an €130 billion stimulus package from the German government. The aim of the package is to stimulate consumer demand as Germany comes out of the coronavirus-related lockdown and public life gradually returns to normal. The package of extra spending and tax cuts is equivalent to approximately 4% of expected 2020 gross domestic product (GDP).

One of the main measures are value-added tax (VAT) cuts. From 1 July until the end of 2020, the standard rate of VAT will be reduced from 19% to 16% and the lower band cut from 7% to 5%—a measure that will cost €20 billion.

Rotation into Value Continues Apace

In recent weeks, we have seen aggressive rotation out of well-held growth names into beaten up cyclical and value names, both in the United States and Europe.

The aggressive rotation from European momentum names into European value names continued this past week. Value’s year-to-date underperformance had been extreme, so value was certainly due some respite, but it’s interesting to look at the numerous possible drivers we have seen suggested as reasons for the recent rotation.

Reasons cited for moves in Europe include:

• Additional fiscal stimulus: Larger-than-expected ECB measures, German stimulus, European Union (EU) green recovery package. The German stimulus package adds approximately 350 basis points² to domestic GDP over 2020-2021 as well.
• Signs of economic recovery as lockdowns end: A sharper-than-expected recovery in data as economies have reopened. For example, air cargo volume decline rates improved in May (Frankfurt, the largest EU cargo hub).
• No second wave of infection across Europe: Spain saw its first day without a COVID-19 fatality for months. Even in hard-hit United Kingdom, new cases and death continue to creep lower. This has fuelled dramatic gains in the travel & leisure sector.
• Political picture improving in Europe: With unity on bailout, contrasting the divisive picture in United States. Europe is benefitting from a perception of relative stability (first time ever?!).
• Credit markets continue to improve, thanks to swift action by the ECB, etc.

The energy market is more constructive, with West Texas Intermediate crude oil (WTI) up 10% last week.

What next: We have been here before with value rebounds, and recent history suggests these moves tend to run out of steam. However, there does seem to be some momentum to the recent move, and the longer-term underperformance is extreme in our view.

Key risks are obvious: a second wave of infection, macro data disappointing, a drawn-out recovery rather than a sharp V-shaped one, a fresh US/China trade war or a hard Brexit at the end of 2020. Furthermore, it feels like this is some way off, but if the picture continues to improve, how central banks adapt their stance will be crucial as markets have been consistently twitchy around any tightening.

Crude Oil in Focus

Oil prices were on a slow march higher as last week went on, helped by hopes of an OPEC+³ production cut extension as well as more supportive macroeconomic data. Brent crude oil traded up 19% on the week, at US$42, whilst WTI was up a more modest 9.5%, trading at US$39. The OPEC+ meeting was in focus through most of the week and it hit a snag last Wednesday after it was reported that Saudi Arabia and Russia were demanding tighter compliance to production cuts by other members.

The Kremlin announced that Russian President Vladimir Putin had no intentions of meeting OPEC+ counterparts whilst this question was outstanding. Naturally, this created some uncertainty around whether an extension could be agreed upon, and oil prices sold off temporarily on the back of these headlines. With Saudi Arabia and Russia receiving the assurances they needed, the meeting was arranged for 6 June. Market expectations for a 1-month extension to existing cuts until the end of July and a promise of tighter adherence to these restrictions by existing members were realised at the meeting. OPEC+ agreed to a one-month extension to their (now) 9.6 mbpd⁴ supply cut.

Elsewhere, oil inventories continue to rise. Nonetheless, the US employment report on Friday of last week brought hope of continued return of demand, and oil prices peaked into the European close that day.

Last Week in Review  

Europe

European equity markets were broadly stronger last week, with a number of risk-on themes at play. ECB stimulus, economic data surprising to the upside, as well as improving data around the management of COVID-19 all helped push equities higher through the week. The rotation was stark, with value significantly outperforming momentum. This led to some interesting sector moves with the year’s underperformers—banks, insurers, oil & gas and travel & leisure—leading the way. At the other end it was those sectors which had fared well year-to-date which lagged. These included health care, food & beverage and personal & household goods.

Lockdowns continue to be eased across Europe without any obvious uptick in infection or death rates. In Germany, shops reopened with social distancing applied, schools are now open for young children and those with exams, whilst border controls are expected to be lifted on 15 June.

In Italy, borders were re-opened last week. In France, nearly all of the country is now classified as a “green zone”, with phase two beginning last week in these zones, allowing bars and restaurants to reopen. The United Kingdom remains fragmented, with lockdown measures devolved to each country’s respective government. However, data does continue to improve, with Scotland and Northern Ireland reporting no new COVID-19 deaths on Saturday.

Brexit was back in focus, with the latest round of talks taking place through last week. Recall, June is a pivotal month in negotiations as 1 July represents the deadline for mutually agreeing to an extension to the transition period. The EU remains “open” to an extension; however, the United Kingdom has previously stated that there will not be one. Thus, by the end of the month we should be clearer on whether a free trade agreement will be in place or whether we begin to prepare for a “no deal” exit.

On Friday, we heard from the EU’s Chief Negotiator Michel Barnier, who said no material progress had been made in last week’s talks. Barnier stated that the United Kingdom had continued to “backtrack under commitments undertaken in the political declaration”. He went on to say that a deal must be signed off by 31 October at the latest, and that the next round of talks will likely be the end of June/start of July. Before then, there will be a meeting between UK Prime Minister Boris Johnson and the presidents of both the European Commission and the EU Council.

In terms of markets, UK sterling continues to find some strength, closing the week up 2.6% vs the US dollar. The exporter-heavy Financial Times Stock Exchange (FTSE) 100 Index defied those moves in sterling to trade up 6.3% on the week; however, it was still the key underperformer vs. the broader market in Europe. Meanwhile, the more domestically exposed FTSE 250 Index was also strong, up 6.8%.⁵ Hopes of a swift easing of lock-down measures is overshadowing Brexit fears for now.

In terms of data, the focus was primarily open the purchasing managers indexes (PMIs) last Monday and Wednesday. The reports were supportive and showed slight improvements with the Eurozone June Composite PMI revised upwards to 31.9 from the flash estimate of 30.5. This turning in economic data will of course be closely watched in weeks to come as hope builds of a turn to an upward trajectory.

United States

US markets continued on their positive streak, with the S&P 500 Index gaining 4.9%.⁶ This is the third week running we have seen gains of over 3%, which hasn’t happened for 38 years!

Continued easing of lockdowns and further stimulus hopes helped risk-on sentiment, whilst the market largely ignored the social unrest as Black Lives Matter protests continued throughout the United States. The energy sector was the week’s outperformer following hopes of an extension to production cuts, but not far behind were the financials and industrials. These moves came as the impressive rotation into value and cyclical names continued, similar to what we had seen in Europe. The health care sector was the week’s clear underperformer following recent strength.

Data continued to suggest that the economy has likely bottomed, with the employment data a positive surprise, as discussed. Automobile sales in the United States also rebounded more than expected in May. The Citi Global Economic Surprise Index saw a sharp jump last week and is now back in positive territory. The index measures the number of data releases that beat expectations vs. the number of negative surprises.

Asia Pacific

Markets in the APAC region also took part in the global rally, with the MSCI APAC closing the week up 5.5%. Hong Kong was the standout performer, up almost 8%, although this does follow a lacklustre performance the prior week and comes as the offshore yuan approached May highs.

Improving economic data from China helped the Shanghai Composite gain almost 3%. Purchasing Manager Index data was surprisingly strong and returned to expansion five months from the point of lockdown. This may also give some hope elsewhere of economic bounce following the easing of lockdowns across the globe. The South Korean equity market was the other standout performer as the government announced further stimulus.

The impressive equity performance came despite continuing tensions between the United States and China. Last week the United States limited Chinese airlines to just two weekly flights, which cuts the current number from China in half. The Trump administration has complained that China has violated the rights of US airlines by restricting flights.

The United States also announced it will impose restrictions on additional Chinese media outlets. There was some positivity, however, as Trump said he was not considering sanctions on China’s President Xi Jinping over actions in Hong Kong.

Tensions have also risen between China and Australia, as the latter called for an investigation into the outbreak of COVID-19. The Chinese Ministry of Culture and Tourism issued a warning to its citizens not to travel to Australia, citing safety concerns. The warning follows the imposition of tariffs on Australian barley and beef. Australia had announced severe screening measures on foreign takeovers, affecting the telecoms, energy, technology and defence sectors, which prompted fears of asset sales from a potential sharp reaction from Beijing. This ongoing dispute will be something to keep an eye on in the coming weeks and months.

Week Ahead

The focus at the start of the week in Europe is the German industrial production figure for April. The report showed production was down 17.9% on the month, which was a bit lower than expected. However, we think this to mark the bottom of the trough, as the report is based on the time of the peak of lockdown measures.

Monday 8 June

• Economical/Political: ECB’s Christine Lagarde in European Parliament hearing
• Data: Germany: (April) Industrial Production (IP)

Tuesday 9 June

• Economical/Political: OPEC Meeting, ECB’s Olli Rehn speaks
• Data: Germany: (April) Trade Balance; US: (April) Job Openings and Labor Turnover Survey (JOLTS); Japan: (April) Machine Orders; China: (May) Consumer Price Index (CPI)

Wednesday 10 June

• Economical/Political: US Federal Open Market Committee (FOMC) meeting and interest-rate decision, OPEC/non-OPEC Meeting, OECD Publishes Economic Outlook, ECB’s Isabel Schnabel and Luis de Guindos speak
• Data: France: (April) IP; US: (May) CPI

Thursday 11 June

• Economical/Political: Eurogroup meeting to discuss recovery package
• Data: Italy: (April) IP; US: (6 June) Jobless Claims

Friday 12 June

• Economical/Political: UK Sovereign debt to be rated by DBRS Morningstar, Germany sovereign debt to be rated by Fitch Ratings.
• Data: Eurozone: (April) IP, UK: (April) IP & Manufacturing Production, (April) Trade Balance; Japan: (April) IP

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1. Indices are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.

2.A basis point is a unit of measurement. One basis point equals 0.01%.

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

4. MBPD is a unit of measurement of crude oil and petroleum products produced, processed or consumed on a daily basis.

5. 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 guarantee of future results.

6. Ibid.