Notes from the Trading Desk – Europe

The Digest

Last week saw equity markets continue their grind higher, with the familiar theme of US technology stocks leading the way higher. Volumes and news flow were once again fairly light due to the summer holiday season. Focus on the upcoming US election remains heightened after last week’s Republican Party convention. On the week, the MSCI World Index traded +2.7%, S&P 500 Index +3.3% (NYSE FANG+ Index +4.7%), MSCI Asia Pacific Index +2% and the STOXX Europe 600 Index +1%.¹

ESG Focus: Will We See a Move from Momentum to Fundamental?

We’ve seen plenty of discussion around environmental, social and corporate governance (ESG) exchange traded funds (ETFs) recently, with a particular focus on Europe. According to a recent Morningstar report, global ESG ETFs have attracted more than US$35 billion of net inflows so far in 2020, and assets across all types of ESG funds topped US$1 trillion for the first time in the second quarter (Q2).² In the EMEA region, ESG net flows have already surpassed the elevated levels seen over the entire year in 2019.³

Some observers have argued recently that certain pockets of ESG are becoming Europe’s version of US technology. This is quite a punchy statement, but with the realignment of political and fiscal drivers in the region, there is certainly a decent argument that this dynamic will continue.

In the United Kingdom, the government is said to be considering new legislation to help prevent deforestation, one example of how the theme is spreading at the political level. The proposed law would target big companies, which would face substantial fines if they cannot prove that their supply chains are not linked to illegal deforestation practices.

European regulators are also looking to amend MiFID II, with one aim to require finance companies to ask clients for their preferences on ESG, bringing this into focus for investors who may have not previously seen it as a key area.

The increase in the prevalence of such regulatory, fiscal and political decisions will impact corporate earnings more and more over time (both positively and negatively), likely leading to division between companies that appeal to investors from an ESG perspective and those that don’t. Definitely something to watch in the changing world.

Elsewhere, Germany is set to sell its first-ever green investment bond in coming days. The aim is to raise €6 billion from the sale of a 10-year “green debt”, with proceeds earmarked for green projects. Whilst Germany has lagged other countries (France and Netherlands, amongst others) in getting started in this area, this move is significant as it will eventually lead to issuances of two-, five-, and 30-year debt, building the first “green curve”.

The Week in Review

Europe

European equities traded broadly higher last week, but still underperformed major equity benchmarks both in the United States and Asia. Aside from the virtual Jackson Hole Symposium featuring the US Federal Reserve (Fed), rising COVID-19 infection cases and the market rotation into value were in focus.

France’s CAC 40 Index outperformed in the region, driven by banks. Spain’s IBEX index wasn’t far behind, with banking stocks also leading there. The UK FTSE 100 Index once again was a laggard among market indices in the region, as UK equities remain unloved and sterling strengthened against the US dollar.

There were a few interesting sector moves last week amid a rotation out of momentum and into value stocks. Travel and leisure stocks led the way higher in Europe (particularly airlines) amidst supportive headlines tied to COVID-19 testing and vaccinations. Banks were also strong last week. It was a couple of the year-to-date outperformers that finished bottom of the pile last week, health care and utilities.

United States

US equities outperformed their global peers last week, continuing their grind higher through the summer months. Each day brought about record highs for the Nasdaq Index whilst the Dow Jones Industrial Average erased all of its losses for 2020. Much of the focus through the week was on the virtual Jackson Hole meeting, with Fed Chair Jerome Powell’s speech on Thursday closely watched.

S&P 500 sector moves were interesting last week, with shares of department stores and airlines moving up amid news surrounding the rapid testing of COVID-19 and potential vaccines. Homebuilders were the clear laggards on the week, erasing most of their gains from the previous week.

As noted, Jackson Hole was the key focus for markets last week, with Powell’s comments around the Fed’s new stance on inflation the highlight. He announced a new approach to monetary policy that allows the Fed to flexibly target “averages” of 2% inflation over time. So, for periods where inflation is below that level, the US central bank would then target a period of above 2% inflation. The Fed later reiterated that any inflation overshoots would be moderate.

The markets didn’t make drastic moves after the announcement, but the yield on the 10-year Treasury did hit 0.78% for the first time since June. The US dollar also sold off. Correlation between the dollar and the S&P 500 Index is now at its most negative in years.

Earnings season is all but over in the United States, and of the 98% of S&P 500 companies that have reported for Q2, 84% have beaten consensus expectations for earnings per share. In addition, 65% have surpassed consensus sales expectations. So whilst earnings reports have been “less bad” in Q2, stock markets continue to march higher in August, with the “FAANG” stocks leading the way.

Asia and Pacific (APAC)

Asian equities were higher overall last week, with the MSCI Asia Pacific closing up 2%. Japanese equities were the notable laggard, erasing all their weekly gains last week after Prime Minister Shinzo Abe’s resignation was confirmed mid-session. Hong Kong’s Hang Seng outperformed in the region, up 1.2%, despite reports of the first case of COVID-19 reinfection.

Despite Abe’s health concerns of late, his resignation on Friday was still a shock to markets in Japan. The mid-session announcement caused the Nikkei and the TOPIX to drop, but both recovered their losses in the early session on 31 August. The initial concerns were around any changes to economic policy, nicknamed “Abenomics” during the hawkish Prime Minister Abe’s tenure. He is considered to have given markets stability through some tough times in recent years, so policy continuity with  successor will likely be key to keeping markets steady in Japan.

This morning as the trading week kicked off, we saw some reassuring Chinese Purchasing Managers’ Index (PMI) data. The August manufacturing PMI reading was of 51.0, and although a modest miss against consensus estimates, it still suggests ongoing recovery to manufacturing. In addition, the Composite PMI was 54.5 vs. 54.1 prior and Non-Manufacturing PMI came in at 55.2.

Week Ahead

A quiet start to the week in Europe, with the UK Bank Holiday on 31 August. The main focus will be on the Global Manufacturing and Services PMI for August on 3 September. Of note in the United States, we get the Fed Beige Book report on 2 September and US monthly employment data on 4 September.

Market holidays

Monday – UK (Summer Bank Holiday)

Calendar

Monday 31 August

• Data: Italy: (Aug, Preliminary) Consumer Price Index (CPI); Germany: (Aug, Preliminary) CPI

Tuesday 1 September     

• Data: Global: (Aug) Manufacturing PMI; Eurozone: (Aug, Preliminary) CPI; Australia interest-rate decision and Q2 gross domestic product

Wednesday 2 September    

• Economic/Political: EU’s Michel Barnier speaks: Barnier will address the IIEA and discuss the EU-UK negotiations
• Data: US Fed beige book

Thursday 3 September   

• Economic/Political: Riksbank’s Ingves speaks
• Data: Global: (August) Services & Composite PMI; Eurozone: (July) Retail Sales; Turkey: (August) CPI

Friday 4 September    

• Economic/Political: Spain Sovereign debt to be rated by DBRS
• Data: Germany: (July) Factory Orders, US employment report (August)

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1. 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 a guarantee of future results.

2. Sources: Financial Times, “ESG funds attract record inflows during crisis,” 9 August 2020.

3. Sources: Bloomberg, Morningstar, as at 10 August 2020. Please see www.franklintempletondatasources.com for additional data provider information.