Notes from the Trading Desk – Europe

The Digest

Last week many equity markets again advanced as investors appeared relaxed around inflationary pressures, and dovish rhetoric from central banks eased any nerves caused by stronger macro data. Last Thursday, the focus was on the US Consumer Price Index (CPI) data and the European Central Bank (ECB) meeting. The MSCI World Index traded up 0.5%, the STOXX Europe 600 Index +1.1%, the S&P 500 Index+0.4%, and the MSCI Asia Pacific Index, -0.2%.¹

Inflation Remains the Key Talking Point  

As has been the case for much of 2021, the debate over rising inflationary pressures and the reaction from central banks dominated headlines last week as we had key US inflation data and an ECB meeting.

US CPI data came in at +5.0% year-on-year (y/y), which was the largest annual gain since August 2008. Core CPI (excluding food and energy) was at the highest level since 1992.

However, looking into the numbers, there did appear to be temporary factors driving this, something that tied in with the Federal Reserve’s (Fed) recent narrative that the current inflation surge is “transitory.” Within the data, “previously owned cars and trucks” accounted for about one-third of the total monthly advance, which is being driven by the chip shortage which should eventually correct itself. Air travel was also a factor, due to the reduced capacity that airlines are running. Finally, there was a slower month-on-month (m/m) pace of increase, with headline CPI up 0.6%, and excluding food and energy up 1.1%. There do seem to be some signs inflation could be easing.

Given the presence of some temporary factors driving inflation data, the markets are telling us investors are happy to run with the Fed’s narrative that inflationary pressures are transitory. We see this view reflected across asset classes. US equity markets remain near all-time highs and US bond yields tightened last week, with the US 10-year Treasury yield at 1.49%, its lowest level in three months. Often a “canary in the coal mine,” credit markets are not showing signs of stress either, with high-yield spreads remaining tight.

This Wednesday we have the June Fed meeting, so we will have further clarity on Chair Jerome Powell’s thinking. However, with steady performance across asset classes it feels like investors are not expecting much of a change in tone. Looking ahead, the key dates may be the central bankers’ summit in Jackson Hole, Wyoming, at the end of the summer, and the September Fed meeting.

ECB Remains Dovish Despite Improving Picture

The ECB stuck with its accommodative stance last week, keeping policy unchanged despite an improving economic outlook for the region. Interest rates stayed on hold and the ECB stated that the pandemic emergency purchase programme (PEPP) asset purchases would be significantly greater than the first quarter (as stated before) and around the current pace of €20 billion a week (in line with expectations).

In terms of outlook, the ECB now projects a “sizeable improvement in activity in the second quarter” followed by further robust recovery in the second half of the year. The central bank sees gross domestic product (GDP) of 4.6% (up from 4.0% in the March projections) for 2021 and 4.7% (instead of 4.1%) for 2022. The ECB now expects 1.9% (instead of 1.5%) for 2021 and 1.5% (up from 1.2%) for 2022. For 2023, the ECB left its call unchanged at 1.4%. These predictions are below its 2% target for inflation.

Last week also saw positive outlook from Germany’s Bundesbank, which upgraded its growth forecasts to 3.7% this year versus prior 3.0% estimate, and 5.2% for 2022 versus 4.5% prior.

This sets up a supportive backdrop for European equity markets and, with the European Recovery Fund due to impact in the second half of the year, many investment banks continue to push European equities, noting rising vaccination rates should support economic activity as the European Recovery Fund kicks in.

The Week in Review

Europe

This week saw European equities grind higher to make fresh all-times highs, with the STOXX Europe 600 Index up 1.1%. This was the fourth consecutive week of gains. Once again, European equities outperformed other regions, with continued focus on an improving macro backdrop thanks to accelerating European vaccination programs, declining COVID-19 cases (excluding the United Kingdom) and the imminent distribution of the European Recovery Fund. With that, European equities saw a ninth straight week of inflows. The main talking point was last Thursday’s ECB meeting which saw accommodative policies remain on hold, despite a more optimistic outlook.

Health care outperforms: There was a less familiar look to sector performance. Health care stocks had a rare day in the sun as this sector has been a major underperformer over the past year for well-documented reasons. It felt like the Biogen Alzheimer drug news was a catalyst for some to look at the sector, particularly considering the underperformance. Tighter US yields this week have also helped. The feedback is that a lot of faster money is chasing the space this week given it is a big underweight, so it remains to be seen whether the move has legs to last longer.

Resources, chemicals and banks were the laggards on the week, with headwinds in tightening yields and the ECB remaining accommodative for banks. The banking sector remains second best year-to-date (automobiles are in the lead) so an element of investor profit- taking isn’t a surprise.

From a country perspective, Switzerland’s equity market was an outperformed thanks to health care strength. Italy’s FTSE MIB Index broke out to levels not since the 2008 global financial crisis last, as optimism regarding Italian equities grows.

The German DAX was left behind last week with meagre gains of 0.3% as the reflation trade ran out of steam. A clear example of this dynamic was the Goldman Sachs EU Reflation basket, which was one of the worst performing factors last week, down 0.4%.

In the United Kingdom, we continue to see decent macro data, with the UK economy growing 2.3% in April m/m (in line with expectations). However, it is worth keeping an eye on the rising COVID-19 cases driven by the new Indian/Delta variant, which is 40% more transmittable. The United Kingdom reported 8,125 more COVID-19 cases last Friday vs. an average 2,000 a day around a month ago. This wave will be a key test for the vaccination programme and whether the country can succeed in breaking the link between rising cases and hospitalisations.

Numbers in hospital are still low but edging higher, so it looks likely the further easing planned for UK lockdown on 21 June will be pushed out by about four weeks. The market feels relaxed that reopening will continue steadily, and we won’t see a return to lockdowns, so any shocks here could see sharp pull backs for reopening names.

United States

The S&P 500 Index edged higher in what was a quiet week aside from the noise around the CPI data last week.  Evidence of this muted performance is the limited number of days with moves over 1% in recent months.

Looking at sector performance, health care outperformed (+1.9%) thanks to the strength in Biogen. Financials lagged (-2.4%) as yields tightened.  

In last week’s update, we highlighted some data around the improving finances of the average US household and how that could boost the US economy. On Thursday, the Fed released data that showed the net worth of US households climbed to new heights as 2021 began and the effects of the COVID-19 pandemic began to fade. Thanks largely to a surge in the stock market, the total balance sheet for households and non-profits rose to US$136.9 trillion in the first quarter, a 3.8% gain from the end of 2020, according to the Fed.

The G7 summit, held in the United Kingdom last week, was notable. We saw high levels of engagement from the United States, a sharp contrast to the prior administration. Much of the focus was on climate change and efforts to counter the influence of China.

Asia and Pacific

Last week was quiet for Asian markets with the MSCI Asia Pacific Index down 0.2%. Index performance was tightly grouped with the Japanese Nikkei unchanged, Shanghai Composite down 0.1% and the Hang Seng down 0.3%.

In Japan, the focus is on the vaccination program where the pace has picked up. With that, the reopening theme was back in play with sectors like transport, real estate, and land transport showing strong gains. We also had Japan’s first-quarter gross domestic product down 1.0% quarter-on quarter.

The tone of the G7 conference was a focal point, as G7 nations took a strong stand against China’s economic aspirations and human rights practices. US President Joe Biden declared there’d been “plenty of action” on Beijing, including offering an alternative to the sweeping “Belt and Road” initiative.

That said, there were talks last week between China’s Minister of Commerce, Wang Wentao, and US Secretary of Commerce, Gina M. Raimondo. According to press reports, Wang and Raimondo stressed the importance of dialogue and communication between China and the United States in the business field and agreed to promote the healthy development of pragmatic cooperation on trade and investment while properly handling differences. The two sides also agreed to maintain communication in their working relationship.

The Week Ahead

It should be a quiet start to the week with a number of markets in Asia (including China) closed Monday. Focus for the week will no doubt be on the Fed meeting, which concludes on Wednesday. In Europe, Norway and Switzerland are set for monetary policy decisions.

In terms of macro data, UK and EU CPI data will be a focus, and European industrial production will be closely watched, too.

The Biden-Putin summit on Wednesday could provide us with some drama.

Monday 14 June

• Eurozone industrial production (IP)

Tuesday 15 June   

• Germany CPI
• UK claimant count and International Labour Organisation unemployment rate
• France CPI
• Italy CPI EU harmonised
• Eurozone trade balance
• US Purchasing Managers’ Index (PPI) final demand
• US industrial and manufacturing production

Wednesday 16 June 

• UK CPI & Retail Price Index (RPI)
• US FOMC Projections
• Chinese retail sales and IP
• Japanese trade balance
• US President Joe Biden will meet Russian President Vladimir Putin in Geneva

Thursday 17 June

• Norway policy rate decision
• Eurozone EU27 new car registrations
• Eurozone CPI core and construction output
• US Jobless claims

Friday 18 June    

• UK retail sales
• Germany PPI
• ECB current account
• Japanese CPI

Important Legal Information

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the team and the comments, opinions and analyses are rendered as of publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market.

Companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. The companies and/or case studies shown herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton.

Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.

Issued in the U.S. by Franklin Templeton Distributors, Inc., One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com—Franklin Templeton Distributors, Inc. is the principal distributor of Franklin Templeton’s U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.

What Are the Risks?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.  Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.

Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

Links to External Sites

Franklin Templeton is not responsible for the content of external websites.

The inclusion of a link to an external website should not be understood to be an endorsement of that website or the site’s owners (or their products/services).

Links can take you to third-party sites/media with information and services not reviewed or endorsed by us. We urge you to review the privacy, security, terms of use, and other policies of each site you visit as we have no control over, and assume no responsibility or liability for them.

Views You Can Use

Consumer Clout Driving ESG Efforts

Franklin Equity Group’s Sara Araghi, Martin Currie’s Zehrid Osmani and Western Asset’s Bonnie Wongtrakool speak with Franklin Templeton Chief Market Strategist Stephen Dover about how consumers are more in control than ever before, putting companies and brands under the microscope when it comes to environmental, social and governance factors. Read More.

Quick Thoughts: A Very Hot Housing Market Globally

Rising housing prices often reflect a country’s economic growth and health. This may be a type of “good inflation,” but wages and other metrics may not keep pace. Our Chief Market Strategist and Head of Franklin Templeton Investment Institute, Stephen Dover, discusses how the pandemic may have globally fueled inflation in housing and the supply chains that build them. Read More. 

Tech Opportunities Abound Amid Economic Reopening

As more people are getting vaccinated and economic conditions return to normal, Franklin Equity Group’s Jonathan Curtis says the digital transformation themes that accelerated during the COVID-19 crisis are still just getting started. He still sees plenty of opportunities ahead in the technology sector, despite a recent falloff in investor interest in the first quarter. Read More.

Value and Growth: The Indivisible Dichotomy

Franklin Mutual Series’ Director of Research Grace Hoefig sits down with us to explain how value investing involves more than just computing ratios, and why the answer to the age-old question “growth or value” should be “yes.” Read More.

Pent-Up Consumer Demand Fuels US Market Recovery

As the US recovery gains momentum, Franklin Equity Group’s Grant Bowers explains why pent-up consumer demand should present a fertile environment for stocks and highlights some opportunities he sees in the US equity market. Read More.

Muni Market View of The American Jobs Plan

US President Joe Biden recently announced an ambitious new US$2 trillion infrastructure plan, which touches many areas of the US economy. Jennifer Johnston, director of research, Franklin Templeton Municipal Bonds, outlines some highlights of this sweeping legislation, and how it could impact the muni market. Read More.

Update on India’s Second COVID Wave

While the COVID-19 situation in India is serious with case numbers spiking across the nation, reaction to the recent second wave has been swift, with the population being much more vigilant and following COVID protocols. Our Emerging Markets Equity team’s Murali Yerram weighs in on why the economy should be able to bounce back. Read More.

_____________________________________________

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.