Notes from the Trading Desk – Europe

The Digest

Last week saw a rough ride for most global equity markets as investors appear increasingly focused on the trajectory of the US Federal Reserve (Fed) tightening. Several additional factors weighed on investors’ already brittle nerves, including geopolitical concerns, some lacklustre corporate earnings and continuing inflationary pressures. With that, we saw de-risking in equities, with the MSCI World Index down 4.7%; the S&P 500 Index down 5.7%, the STOXX Europe 600 Index down1.4%; and MSCI Asia Pacific Index down 1.7%.¹

“Wall of worry” spooks investors

Last week we had pressure on equities from several different factors, and technology and growth stocks continued to lead the US market lower. It is helpful consider the factors at play.

To put some of the moves in context, the S&P 500 Index had its worst start to a year since 2009. The small-cap Russell 2000 Index has also had a torrid time, down 8% last week, slicing through key support levels and now trading at levels last seen in 2020. The tech-heavy Nasdaq Index, which entered correction territory on Wednesday, in now off to its fourth worst start to a year ever. In the past three weeks, we have had two of the worst weekly performances since March 2020.

Rotation from growth names and into value names has been extreme.

There were a number of moving parts driving these market dynamics.

Heightened Inflation concerns and widening bond yields: In the United States, we saw the 10-year Treasury yield remain near 1.75% throughout the week, maintaining pressure on the TINA (there is no alternative) argument for investing in equities for yield. Inflation data was in focus in Europe last week. The UK Consumer Price Index (CPI) came in at 5.4% and eurozone CPI at 5%. This is the highest level of UK inflation since 1992 and a record high for the eurozone. With that, the market expects four interest-rate hikes from the Bank of England (BoE) in 2022 and, despite the European Central Bank (ECB) trying to stick with its dovish narrative, the market does expect one ECB hike by year end. Unsurprisingly, government bond yields continue to edge higher, with 10-year UK gilts (1.23%) and Bunds (-0.03%) at levels last seen in 2019. It was notable the 10-year Bund yield actually edged into positive territory.

Corporate Earnings: US earnings didn’t offer many reassurances, and heavyweights Netflix and Goldman Sachs both slumped post earnings releases. Lockdown darling Peleton also slumped on earnings, adding to the unease in the tech space.

Energy prices: The price of crude oil rose again, with West Texas Intermediate (WTI) crude oil up 2.2% on rising geopolitical tension in the Middle East, and on news that Russia is amassing more troops along the Ukrainian border. This adds to inflationary concerns and fears over input costs.

Geopolitics: Tensions between the West and Russia over the Ukraine remain high, despite talks between the United States and Russia.

Buybacks on hold: Recall US corporate buybacks, a key support for markets in recent years, are largely on hold as we head through earnings season.

Technical levels: The S&P 500 Index failed to hold a key technical support at its 50-day moving average and closed below its 200-day moving average on Friday. These declines through support levels often see selling pressure accelerate as stop losses kick in.

Central bank policy: No “Fedspeak” last week as Fed policymakers were in black-out period ahead of this week’s Federal Open Market Committee (FOMC) meeting.

Recall, a lot of the nerves stem from the fact that a key pillar of the strength of equities markets since the global financial crisis has been the “Fed Put”—that is, central bank rate cuts, quantitative easing and short-term financing operations. Now we are in a tightening cycle, that support has been taken away. Central banks are looking to reduce rather than expand balance sheets, and nerves over this appear to have taken hold. Furthermore, investors see a risk the Fed makes a policy mistake and hikes into a slowing economy and inflation.

What next: A big couple of weeks are in store for markets as we have a Fed policy meeting on Wednesday and both the ECB and BoE meetings next week. The tone from these meetings will be key for investor sentiment. Macro data will be closely watched, starting with this week’s Purchasing Managers Index (PMI) data, with fears of a policy mistake in mind. Corporate earnings will be crucial for sentiment too, with some tech heavyweights to report this week.

There is not a great sense of optimism from some of the investment banks on a market rebound, and whether the value/growth rotation will run out of steam.

Looking beyond equities, credit markets remain a key barometer to monitor. High-grade US bond spreads widened for a second day on Thursday of last week, and the benchmark credit risk gauge rose. Analysts are increasing calls for wider spreads as heavy supply and declining risk appetite hit corporate debt markets. However, it appears credit markets are not signalling a red flag for now as spreads remain fairly tight compared to what we saw in March 2020.

The Week in Review

United States

Last week, US equity markets capped their worst trading week since March 2020. As noted, the S&P 500 Index closed the week down 5.7%, trading below its 50-day moving average all week and even closed below its 200-day moving average. That represents the worst start to a year for the index since 2009, now with losses of 7.7% year-to-date. The Nasdaq, which was down 7.5% last week, entered correction territory and is off to its fourth worst start to a year ever. Yet, of the main indices, the laggard was the Russell 2000, down 8.1% last week and now approaching a bear market. There was a clear defensive skew to sector moves last week. All sectors finished in the red, but utilities, consumer staples and real estate investment trusts (REITs) were the relative outperformers. Meanwhile, consumer discretionary stocks finished the week lower. The CBOE VIX Index rose 50% on the holiday-shortened week, a sign of increased trepidation.² In terms of notable movers, Netflix closed last week down 24% following disappointing first-quarter guidance. Peloton closed the week down 14% on demand fears. Bitcoin closed down 11% on Friday alone, now trading below US$35,000 and nearly 50% below its highs of November 2021.

The risk-off theme continues to dominate the headlines and the markets. The Fed is in blackout period ahead of its meeting on Wednesday of this week. The hawkish Fed policy shift has dominated as a driver of market sentiment so far this year; however, dampened fiscal policy support is another area of worry and plays into broader policy mistake fears.

Last week, US President Biden backed the Fed policy shift to combat inflation and repeatedly flagged high prices as one of country’s biggest problems. On the fiscal policy front, his “Build Back Better” legislation would likely have to be broken up into pieces in order to pass Congress. Biden also added that we are “not there yet” on possible easing of tariffs on Chinese goods. Some strategists believe that tariff relief from the Biden administration could be one of the few meaningful levers it has to address inflation concerns.

In terms of earnings, 13.9% of the S&P 500’s market capitalisation has reported. Earnings have beaten estimates by 5.9% so far, with 75% of companies topping projections, although below what we saw in the second quarter 2020 through the third-quarter 2021. Apple, Microsoft, Tesla, J&J, Mastercard and Visa are all due to report earnings this week.

In terms of data, supply-chain issues still continue to be felt following the Omicron wave, with the US Empire Manufacturing Index coming in at -0.7, much lower than expected. New orders and shipments stalled too, coming in at -5.0 and 1.0, respectively.

Europe

European equities have outperformed their US counterparts this week, but still closed the week down 1.4%. Market volumes improved, up 25% on recent levels. Volatility climbed again last week, up 17% in Europe on Friday. Note, European equities haven’t closed higher on a Friday in over two months. The value rotation which we have witnessed so far this year pulled back a bit last week, with value stocks in Europe closing the week down. There was no real update in terms of market themes, and the focus remained on the rate trajectory and the velocity of it. The latest earnings season will be a clear focus for equity markets, and it kicks into gear this week in Europe when 10% of the companies that make up the Stoxx Europe 600 Index are due to report.

Despite the weakness, Europe saw another week of inflows to make it three in a row, eclipsing the regions net cumulative inflow for all last year. Whilst equities continue to see inflows, matching the same trend we saw at the start of 2021, the same cannot be said for bonds, which have seen outflows.

Although the value rotation stalled last week, the UK FTSE 100 Index continues to outperform, the only one of the major indexes in Europe to be up year to date, at 1.5%. Sector performance divergence between best and worst remains wide. There was an apparent defensive skew to sector performance, with cyclicals selling off overall. Personal and household goods stocks outperformed, with luxury stocks better off following some earnings beats and subsequent short covering. Telcomms were another relative outperformer, benefitting from their defensive profile. Basic resources also closed last week higher despite Friday’s selloff. Recall, the sector is trading at an all-time high. In terms of the laggards, Autos closed the week down 3.9% following a strong start to the year as investors now await earnings. Bank stocks, another year-to-date winner, were also worse off.

Asia-Pacific

Another mixed week for Asian markets, with Hong Kong’s equity market the clear outperformer last week, alongside China, while Australia’s market closed down 2.9%.

Hong Kong was the standout performer globally, bucking the trend to make year-to-date highs and ending the week up2.4%. The respite came as we saw improving sentiment in credit markets and the China Property situation has greatly improved after a number of People’s Bank of China (PBOC) rate cuts. This follows comments from PBOC Vice Governor Liu Guoqiang said that China will roll out additional policy measures to stabilise the economy and pre-empt downward pressures.

In Japan markets drifted, with the Nikkei Index down 2.1%, as global concerns weighed but also as a number of fresh COVID-19 restrictions were put in place in response to rising case numbers.

Of note, the Bank of Japan did meet last week and, in contrast to many other central banks globally,  stuck to its dovish stance and kept rates unchanged. It did adjust some of its economic forecasts, raising the fiscal year 2022 GDP forecast to 3.8% (vs. 2.9% projected in October 2021).

Korean equities slumped, trading down 3% last week as the global tech selloff weighed on Korean tech stock names.

The Week Ahead

It’s been a tough start to the week for European equities as they catch up with the US move lower on Friday. Looking ahead, all eyes will be on the Fed meeting on Wednesday and a number of bellwether corporate earnings reports in the United States. US GDP and global PMI data will also be in focus.

Key Events

Monday 24 January:  Italy Presidential Election; Euro-Area Flash Composite PMI; UK Flash Composite PMI

Wednesday 26 January: US FOMC statement

Thursday 27 January: US GDP & Jobless claims

Friday 28 January:  France GDP; Spain GDP; Germany GDP (Quarter-over-Quarter)

Monday 24 January

• Italy Presidential Election
• Euro-area Flash Composite PMI Survey
• UK Flash Composite PMI Survey
• US Markit Manufacturing PMI

Tuesday 25 January

• UK Public Finances (PSNCR)
• Spain PPI

Wednesday 26 January

Thursday 27 January

• Spain Unemployment Rate
• Italy Industrial sales
• US GDP & Jobless claims

Friday 28 January

• Spain 4Q GDP
• Germany 4Q GDP
• France 4Q GDP & Consumer Spending
• Italy PPI

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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. 
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