Notes from the Trading Desk – Europe

The Digest

Last week was unsteady for equity markets with much of the focus on inflation data out of the United States and China. The STOXX EUROPE 600 Index closed the week down 0.5% on lower volumes, with a few markets closed on Thursday for Ascension Day. US markets underperformed, with the S&P 500 Index down 1.4%. The majority of the Asia Pacific (APAC) region came under pressure, with the exception of mainland China, with the Shanghai Composite Index closing up 2.1%¹.

Volatility rose sharply in the latter half of last week, with the European Volatility Index (V2X) spiking on Thursday morning, up 50% vs the previous Friday’s close.² The V2X closed the week up 8%, with markets settling into the end of the week.

Inflation: Temporary or Here to Stay?

The huge jump in the US Consumer Price Index (CPI) was the key focus for investors on Wednesday of last week. The April US CPI saw its fastest increase since 1981, with the headline figure at +4.2% (vs. estimates of +3.6%). The core inflation figure was also higher than anticipated at +3.0%. Despite the noise around this report, it’s important to note that central banks and many market participants continue to focus on the transitory nature of inflation. The argument is that the number was largely driven by temporary factors, with energy +25.1% and used car/truck prices +21%. Commodities also played a part, with a +6.8% year-on-year (y/y) increase.

In addition, we would argue that this could not have been a huge surprise, given the recent rally we have seen across the commodity complex. Employment support measures throughout lockdown also led to a tightening of the labour market at the lower end, restricting supply and pushing up wages. It remains to be seen whether this is temporary, though. Mixed macro data elsewhere, for example, softer retail sales and industrial production, again suggest that the inflation risk could be limited. Finally, we would add that a summer boost in inflation feels inevitable, given the easing of lockdown measures.

Importantly, the Federal Reserve (Fed) has remained insistent that the current rise in inflation is temporary and will not likely trigger tightening policy early. Last week’s European Central Bank (ECB) minutes suggested that policymakers were relatively relaxed on the topic of inflation, with Bank of Finland Governor Oli Rehn saying that the central bank should accept an overshoot at this stage. Bank of England (BoE) Governor Bailey also weighed in, saying that drivers of inflation will not persist. This rhetoric should soothe concerns, but some investors still remain wary.

Some have noted that the commodity rally has not been restricted to the more typically talked about commodities. Alongside strength in oil, iron ore and copper, lumber has had a lot of mentions and is up 500% since 2020. If we see a more prolonged bout of inflation with the potential to dampen the post-pandemic recovery, we may see the Fed and other central banks come under pressure to move.

Any threat of movement on the historically low borrowing costs we have seen will hit risk assets, including equities. Some investors feel that the transitory idea around the recent inflation uptick is born from a large proportion of market participants who have never really seen inflation and are complacent as a result; meaning, a long-lasting pickup could take them by surprise. This will certainly be a theme to keep watching in the coming weeks and months.

Despite an initial selloff last Wednesday (led by the technology space), equities did recover a lot of lost ground later in the week.

The impact of the inflation data was even more prevalent in the bond markets, with sovereign bond yields higher on the week globally (US Treasury +5.1 basis points [bps], German bunds +8.5 bps, Italy +10.6 bps, Spain +9.8 bps³). This was supportive for the banks but put pressure on growth stocks—growth underperformed value in the United States as well as in Europe.

Retail Investors Dial Down Day Trading

We have talked a few times this year about the frenzy of retail trading that has been impacting broader markets, particularly in the United States. It seems that as economies start to reopen, appetite for the intense ‘at home day trading’ has fizzled out. Essentially, it looks like it was just a short-term hobby, and with offices, shops, bars, and other entertainment options reopening, these individuals have now found something else to do with their money. The proportion of trades coming from the biggest retail brokerages (vs. overall US equity volumes) dropped 10% between December 2020 and March 2021 (even with a fresh round of stimulus hitting accounts). In April, total trading volumes across the retail brokerage sector were down vs. March.

The Week in Review

Europe

The STOXX EUROPE 600 Index closed last week down 0.5% and value outperformed growth as the market unwound positions in recent winners. Sector divergence was significant once again, with the spread at 10% between top and bottom performers. Sector performance largely reflected the macro backdrop. The banks outperformed as yields moved higher. The sector is the best performer in Europe over the last month, but still trades 4% below its 2020 highs.

Outperformance for the banks meant Spain’s IBEX 35 Index and Italy’s FTSE MIB Index outperformed on a country index level, up 1.0% and 0.6% respectively. In terms of the laggards, basic resources underperformed as commodity prices came under pressure following its recent run, with the sector down 2.6%. Technology stocks also declined in Europe, with the sector largely taking its lead from US peers. Meanwhile, travel and leisure was the notable laggard, down 6.7% on the week.

Airlines declined amid concerns over a delayed reopening of international travel. Airlines had rallied the previous Friday in anticipation of the release of the UK government’s ‘Green List’, but only 12 countries were added (and the United States was not included), which led to some market disappointment.

There are also fears over the so-called Indian variant of the COVID-19 virus and whether it is more transmissible than previous variants. The UK’s vaccine rollout now is potentially being adapted to address any spike in cases.

Over the weekend, we saw headlines that Germany is now classifying the United Kingdom as an additional COVID-19 risk area because of the virus variant. There are questions over whether this will force Southern European countries, to rethink opening their borders to UK visitors. This may cause some division within the European Union (EU). We are seeing the impact of this and other negative headlines at the start of this week, with travel and leisure an early laggard despite a positive release from Ryanair, the Irish low-cost airline, showing a significant increase in booking (which should be positive for the sector as whole).

As valuations remain stretched, it does feel like investors were looking for a reason to trim some positions which remain at lofty levels. The rotation continued out of ‘Stay at Home’ stocks last week, with the equivalent index from Goldman Sachs down 7.2%. Weakness in the food delivery names weighed on the index, with concerns rising over increased competition in the space. The equivalent ‘Going Out’ basket was also down -1.7% on the week, suggesting this was more to do with a market unwind rather than COVID-19 themes. Finally, last week was big for share placings in Europe.

Asia

Last week saw most Asian markets trade lower as similar themes to other regions weighed on sentiment. Concerns over rising commodity prices and global inflation saw technology stocks decline. In addition to inflation concerns, fears of rising COVID-19 cases also weighed on sentiment. A rise in cases in Taiwan and fears of tighter restrictions saw Taiwanese equities particularly hard-hit, trading down 8% on the week. India, Japan and parts of Southeast Asia also saw an increase in cases.

Chinese equities were a rare positive performer last week, up 2%, after bouncing sharply on Friday. Having underperformed in recent weeks, it felt like a bit of reversion. Earlier in the week, Chinese inflation data saw CPI at + 0.9% y/y and producer price index (PPI) of 6.8%. The National Bureau of Statistics (NBS) said the gain in producer prices was due to a steady recovery in domestic production and rising prices of iron ore and non-ferrous metal. Consumer inflation, meanwhile, remained relatively subdued amid lower pork prices, a key element in the country’s CPI basket.

United States

US equities saw their most meaningful spike in volatility since late January last week as inflation concerns weighed on the market. The S&P 500 Index closed the week down 1.4%, recovering some of its earlier losses on Thursday and Friday. The CBOE VIX Index was back above 28 for a spell for the first time since early March.⁴ Volumes were low and there were little signs of panic selling as such. Nonetheless, we do note that the CNN Fear & Greed Index, which tracks seven indicators of investor sentiment is now pointing to investor fear, from a neutral rating a week ago. As noted, last Wednesday’s inflation report was the key focus, with core inflation up 0.9%, the highest monthly increase since 1982.

In terms of sectors, technology stocks were worse off, but did recover most of their midweek losses to close down 2.2% on the week. Consumer discretionary stocks lagged, however, finishing the week down a sizeable 3.7%. Nevertheless, there were three S&P sectors to finish higher last week, with consumer staples up 0.4%, financials up 0.3% and materials up 0.1%.

On the political front, US President Joe Biden met key Republican Party (GOP) senators on Thursday in an effort to make progress toward a bipartisan infrastructure package, following a White House meeting between Biden and the ‘big four’ congressional leadership (Charles Schumer, Nancy Pelosi, Mitch McConnell, and Kevin McCarthy). However, even though both sides were voicing a desire for compromise, there is little sign so far of clear progress in bridging the gap between Biden’s US $2.3 trillion infrastructure proposal and GOP willingness to deal in a lower range of US $600-800 billion. McConnell and McCarthy highlighted a shared interest in a bipartisan solution but stressed that dismantling 2017 tax cuts to pay for infrastructure would be a ‘red line’.

The majority of companies in the S&P 500 Index have reported first- quarter earnings, and it has been a very strong earnings season. Earnings have surpassed estimates by 21.9% in aggregate, with 85% of companies topping projections. In terms of sectors, the financials have exceeded forecasts by 33.6% versus an 18.5% beat for the rest of the market. Earnings-per-share (EPS) have been quite strong for consumer discretionary retailers.

Macro Week Ahead Highlights

A further easing of restrictions in parts of the United Kingdom and Europe should help build on the recovery we’ve seen so far. England will allow people to meet indoors at pubs, restaurants and cinemas from Monday 17 May. France is due to reopen outdoor hospitality from Wednesday 19 May. German states with low infection rates are also loosening rules, with shopping becoming easier in Berlin from Wednesday.

Inflation data from the UK and the Euro area will be in focus on Wednesday following last week’s US release.

Key Events

Tuesday 18 May: UK unemployment rate (three month)

Wednesday 19 May: UK CPI inflation (y/y); Euro Area final CPI inflation (y/y)

Friday 21 May: UK retail sales month-on-month; Euro Area Flash Composite PMI; UK Flash Composite PMI

Monday 17 May  

• UK – England will see a further easing of lockdown restrictions when people will be allowed to meet indoors, at pubs, restaurants and cinemas
• Spain trade balance
• Italy CPI EU harmonised
• Sweden Public Employment Services (PES) weekly unemployment
• US total net Treasury International Capital (TIC) flows

Tuesday 18 May 

• Netherlands trade balance
• UK claimant count rate & International Labour Organisation (ILO) unemployment rate
• Norway trade balance
• Netherlands gross domestic product (GDP)
• Italy trade balance total
• Eurozone trade balance & GDP

Wednesday 19 May 

• UK CPI & Retail Price Index (RPI)
• Eurozone EU27 new car registrations
• Eurozone CPI
• US Federal Open Market Committee (FOMC) minutes (28 April meeting)

Thursday 20 May

• Netherlands unemployment rate
• Germany PPI
• Eurozone ECB current account
• Italy current account balance
• Eurozone construction output
• US jobless claims

Friday 21 May    

• Switzerland industrial output
• UK retail sales
• France manufacturing PMI
• Germany manufacturing PMI
• Eurozone manufacturing PMI
• UK manufacturing PMI
• US state employment

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1. Indexes 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. The Euro Stoxx 50 Volatility Index (V2TX) measures implied volatility of near term EuroStoxx 50 options, which are traded on the Eurex exchange. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

3. One basis point is equal to 0.01%.

4. The CBOE Market Volatility Index measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. 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 performance.