Notes from the Trading Desk—Europe

The Digest

Last week saw a quiet end to a memorable month, as the US Thanksgiving holiday brought lower global trading volumes. That said, there was a bit of noise around Brexit, signs of a more orderly transfer of power in the United States, and more vaccine headlines to keep market watchers busy. Last week, the MSCI World Index traded +2.4%, the S&P 500 Index +2.3%, the STOXX Europe 600 Index +0.9% and the MSCI Asia Pacific +2.2%.¹

Record November

Markets saw a remarkable rally in November as vaccine news gave us light at the end of the COVID-19 tunnel and some uncertainty ended around the US election outcome. The MSCI World Index had its best monthly performance on record, +13%, as did the STOXX Europe 600 Index, +14%. Other global indices also saw impressive gains, with the S&P 500 Index +11% and MSCI Asia Pacific Index +12.5%.

As we have highlighted in recent weeks, the rotation out of growth/momentum names and into beaten-up value names has been stark. In Europe, value names were +13% month-to-date versus momentum -20% month-to-date.²

Commodities also saw notable gains, with West Texas Intermediate crude oil +23% month-to-date and copper +13%.

With month-end today, it will be interesting to what extent we see any profit taking now or into the new month. Asian markets did give up some ground today. The moves in the next few days will be a good barometer of investor sentiment going into the end of the year.

Brexit Update

There was little meaningful progress last week in talks between the United Kingdom and European Union (EU), with the issues of fishing rights, level-playing field business rules and enforcement still outstanding. There was some excitement earlier in the week following reports the fishing rights issue could be resolved by using ‘review clauses’ to break the deadlock, with the possibility that parts of the deal could be revisited several years after they take effect.

We’ve had mixed signals from the EU, with EU Commission Chief Ursula von der Leyen stating ‘genuine progress’ had been made on several issues ‘with an outline of a final text’. To temper that enthusiasm, EU Chief Negotiator Michael Barnier said last Friday the ‘same significant divergences persist’, but at least he is in London for talks (the EU team is now out of COVID-19 quarantine). Over the weekend, UK Foreign Secretary Dominic Raab stated we are in the ‘last leg’ of talks.

European Banks: Dividend D-Day on 10 December

It’s been a busy week for newsflow on the European banks’ ongoing dividend debate: Will they or won’t they? Could they or should they? Various European Central Bank (ECB) members continue to signal a desire to relax the current dividend ban—Fabio Panetta (ECB), François Villeroy de Galhau (Bank of France Governor) and Luis de Guidos (ECB) have all made supportive comments over the past 24 hours ahead of the next ECB meeting on 10 December .

It seems that many investors have tended to err on the side of caution, and thus the current rally across the sector has perhaps been driven by other factors, as opposed to simply increased optimism on a resumption of payouts. However, there is no doubt that a consensus is forming around the return of payouts, albeit capped at around 20%-30% of 2020 earnings in the first instance, with the situation being reviewed at the half-year stage post the next Stress Test, which will start on 21 January and published 21 July.

As things stand, a number of banks have excess capital of 30% and upwards of current market capitalisation, and have been reserving 2019 payouts in additional to accruing out of current year earnings.

In next week’s meeting, the ECB could opt to extend the dividend freeze, lift the ban entirely, or limit dividend payouts. Given the recent comments by various senior euro bank officials and the +5% move in the sector this week (although still -32% year-to-date), we think there may be some light at the end of the tunnel. A likely outcome is that the ECB will lift the ban, but perhaps only for some of the better-capitalised banks and with some restrictions, and to allow dividends to be announced with fiscal year 2020 results. If that happens, then the key beneficiaries should be the French and Benelux banks, as well as Intesa Sanpaolo.

Finally, British regulators have signalled to banks that they will consider softening their resistance to dividends payouts on a case-by-case basis by early next year, as Bloomberg reported earlier this month. Elsewhere, the United States opted for the more pragmatic option of capping bank payouts while Switzerland asked banks to split them over two payments spread over 2020.

The Week in Review

United States

US markets outperformed their European counterparts in a holiday-shortened week, with the Dow Jones Industrial Average hitting a record 30,000 and all major indices higher. Factor rotation continued, with the energy sector the week’s clear outperformer, up 8.9% on the week, also boosted by gains in crude oil, although we would note that the sector remains down 37% year-to-date. The financials also outperformed. Defensives underperformed again last week, with real estate investment trusts (REITs) down slightly, but utilities and health care able to make small gains.

US President Donald Trump’s legal efforts to overturn the recent election results continue to prove unsuccessful, and Trump finally said that he would relinquish the presidency if the Electoral College affirms President-elect Joe Biden, but  also signalled he may never ‘formally’ concede defeat and may skip the inauguration. With this, Joe Biden has now started to plan for his transition into the White House.

Janet Yellen looks likely to be Biden’s Treasury Secretary. Yellen in particular has a high level of support amongst the Democrats (as well as some Republicans), having proven her level of command over economic issues during her time at the Federal Reserve (Fed).

Current Fed Chair Jerome Powell would likely keep monetary policy easy, which would tie up well with Yellen’s approach and allow Biden to go on a large stimulus drive. There is also speculation that the (historically) even more dovish Lael Brainard could potentially head up the Fed. This combination would see monetary and fiscal policy working well within sync. With these options on the table, it looks like the US reflation trade might be back in play. Last week saw the US Treasury 10-year yield up 1.4 basis points,³ with gold down 4.5%.

Macro data was supportive last week, with the November Flash Purchasing Managers’ Index (PMIs) coming in stronger than expected. The manufacturing reading was 56.7, whilst services stood at 57.7.

Europe

European equities traded higher overall over what was a much quieter week in terms of both trading volumes and newsflow. There were very few market-moving headlines throughout the week, with the Brexit stalemate persisting and with markets generally quieter due to the US Thanksgiving holiday.

One of the more notable headlines came on Thursday, with reports that pharmaceutical company AstraZeneca’s COVID-19 vaccine may require further testing if it is to be approved by regulators.

Factor rotation continued last week, with European value stocks up 2.3%, whilst momentum stocks were down 4.1%. The Italian FTSE MIB and the Spanish IBEX outperformed, up 3.0% and 2.7% respectively, both helped by the strength of the banks. The UK FTSE 100 Index lagged once again, up just 0.3%. Its large health care weighting and UK sterling strength didn’t help matters.

Given the factor rotation, the year’s underperformers led the way last week. Oil and gas stocks were up 6.2% on the week amid a rally in crude oil (up 6.7%). Banks and travel and leisure stocks were also strong, with a potentially successful vaccination programme across Europe helping sentiment. Health care stocks underperformed, weighed on by the weakness in AstraZeneca.

There continues to be a cloud over the AstraZeneca COVID-19 vaccine. Last week, Bloomberg reported the company may need an additional trial to investigate the use of a lower dose schedule.⁴ The company reported interim phase III data on Monday, but given a lack of clarity on the trial results, AstraZeneca’s CEO Pascal Soriot suggested the US Food and Drug Administration (FDA) will not likely approve the current dosing schedule, but that the European Medicines Agency (EMA) and the United Kingdom may still do so. On Thursday, he suggested the company will perform an additional trial. It isn’t yet clear what impact potential further testing by AstraZeneca will have on the timescale of the vaccination programme globally.

The number of COVID-19 cases continues to show signs of improvement across Europe. Restrictions are expected to be eased in the United Kingdon, France and elsewhere this week. However, though daily case counts are trending lower across the region, we now head into winter with temperatures set to drop again after what has been a reasonably mild autumn.

Also, a break to restrictions over Christmas has been a hot topic across Europe. Restrictions are likely to be eased to allow households to mix more freely than they have been used to in recent weeks and months. It has been suggested that this is especially risky at this time, and we may pay for this brief relaxation with even tighter measures again in January and February.

The UK Spending Review was also announced last week. UK Chancellor Rishi Sunak set out how much money the government would be spending on public services on the year from April 2021. This particular review comes at a time of significant fiscal challenges for the government. Sunak presented a miserable outlook for the UK economy and public finances. Of note, Sunak announced spending on ‘economic infrastructure’ such as roads, railways and broadband totalling £27 billion in 2021-22. The Review also noted that the United Kingdom is forecast to borrow £394 billion this year, equivalent to 19% of gross domestic product (GDP) and the highest recorded level in peacetime.

Asia Pacific (APAC)

Equities in the APAC region also took part in last week’s rally, with the MSCI APAC Index +2.2%. Japan’s Nikkei Index was a regional leader, up 4.4%. As we saw in the United States and Europe, energy and materials names outperformed, whilst the defensive REITs, utilities and consumer staples saw more muted gains.

Helping sentiment was an announcement midweek that China and Japan have agreed to resume business travel by the end of December. The two nations have also agreed to move ahead with multilateral trade deals in an attempt to strengthen their relationship ahead of the start of the new US administration.

COVID-19 cases continue to rise in certain areas, with Hong Kong now set to suspend all in-person classes at schools as of Wednesday, while South Korea tightened virus restrictions outside of Seoul. Japan kept its view of economic conditions as ‘severe’ for a fifth month. It raised its outlook for production but lowered it for capital expenditure as new cases there also rise to record levels.

Diplomatic friction and trade tensions between China and Australia remain a potential headwind for the region. Relations have soured amid Chinese President Xi Jinping’s leadership, as Australia has pushed back against Xi’s more aggressive foreign policy and after Canberra called for an inquiry into the origins of the pandemic. On Friday, Beijing announced it would impose tariffs on Australian wine imports. This comes as 82 ships with cargo of Australian coal remain marooned off China’s coast, due to apparent concerns from China over ‘environmental standards’. Australia has warned that it may seek retaliation at the World Trade Organization.

Stock market gains were more muted in Australia, with some disappointing macro data also weighing on sentiment. Business investment fell 3% in the third quarter from the previous one, following a revised 6.4% decline in the prior period. Total spending fell 13.8% year on year, including a 15% drop in expenditure for buildings and a 12.3% decline for plants and equipment.

In last week’s quarterly report, the People’s Bank of China (PBOC) pledged to stick to normal monetary policy for as long as possible, while making it more flexible and targeted. There have been concerns recently over a bout of bond defaults in China. This prompted the PBOC to inject US$30.4 billion of 1-year liquidity in order to soothe nerves.

The Week Ahead

At the start of this week, we saw Chinese PMI data. The composite figure come in solidly at 52.1, pushing the index to its highest level since October 2017. A rise in domestic orders and increased raw materials prices helped drive the better-than-expected figure.

Any news on Brexit talks will be crucial for UK and EU sentiment. Another potential catalyst for markets is any news around vaccine approval.

Monday 30 November

– Euro-area finance ministers meet, with all 27 EU ministers gathering on 1 December

– The Organization of Petroleum Exporting Countries (OPEC) meeting: final decision on whether a production supply hike should proceed as scheduled in January is expected (through 1 December)

– North Atlantic Treaty Organization (NATO) foreign ministers meet

– Key speakers: ECB’s Christine Lagarde (@ European Policy Centre Forum); Bank of England’s (BoE’s) Silvana Tenreyro

– Data: China PMIs; Japan industrial production, retail sales; Spain consumer price indices (CPIs); Italy CPIs; Germany CPIs; US pending home sales

Tuesday 1 December

– OPEC+ meeting

– The Organisation of Economic Development publishes its latest economic outlook

– Key speakers: ECB’s Christine Lagarde

– Data: Japan jobless rate, vehicle sales; eurozone manufacturing PMIs, CPI; Germany unemployment; Italy GDP; US manufacturing PMI, ISM manufacturing, ISM new orders, ISM employment, construction spending

Wednesday 2 December

– US Federal Reserve release Beige Book

– England’s national lockdown end and tiered restrictions are introduced

– Key speakers: ECB’s Lane; BoE’s Haskel

– Data: UK Shop Price Index; Japan CPIs; Germany retail sales; Eurozone unemployment

Thursday 3 December

– Data: Global PMIs; Eurozone retail sales; US jobless claims

Friday 4 December

– Data: Germany factory orders, Italy retail sales; UK car registrations; US November unemployment rate and monthly non-farm payrolls

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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. Source: Berenberg Research, Eikon.

3. One basis point is equal to 0.01%.

4. Source: Bloomberg, ‘How AstraZeneca Can Recover From Its Vaccine Stumble’, 30 November 2020.