Notes from the Trading Desk – Europe

The Digest

Global equities generally ground higher last week as optimism grew that we may be through the worst of the coronavirus pandemic, with the MSCI World Index up 2.8% on the week. There were also hopes that, after favourable comments from trade officials on both sides, we may avoid an escalation in US-China trade wars—for now. The Stoxx Europe 600 Index closed up 1.1%, the US S&P 500 Index closed up 3.5%, whilst the MSCI Asia Pacific closed up 0.9%.¹ Sector performance was a clear indicator of sentiment last week, with basic resources outperforming in Europe, energy leading the way in the United States, and consumer discretionary on top in Asia. Oil futures were also better as hopes grew of a return of demand, with West Texas Intermediate (WTI) prices back around the US$25 level, whilst Brent traded around US$30.

COVID-19 Update

Across Europe, there has been a very gradual loosening of lockdown measures as governments try to get economies moving. Italy, Germany and Spain all saw their number of active cases continue to fall last week, whilst the United Kingdom saw an increase in active cases as it ramped up testing.

Italy, one of the worst-affected countries in Europe, began to ease restrictions on 4 May. This meant that Italians could leave their homes for the first time in around two months. Whilst some businesses began to reopen with strict social distancing applied, bars, restaurants, hairdressers and other commercial businesses have been prohibited from reopening before 1 June. The national newspaper La Repubblica reported that around 50,000 bars and restaurants are likely to close for good, putting 300,000 jobs at risk. Thus, whilst active cases trend lower, there remains a significant amount of economic risk in Italy, with many businesses unable to open and as supply chains remain constrained by stringent safety measures.

The easing of lockdown seems to be moving at a faster pace in Germany, where there have been much fewer deaths per head than other large European countries. All shops will reopen but strict social distancing measures will remain in place and masks must be worn. Schools have also began to reopen for older children, allowing more workers to return to employment. However, the national government has stated that they will apply an “emergency brake” if there is a surge in infections to over 50 people in every 100,000 in a district over a seven-day period. Note, over the weekend, we did see the “R number”² rise to more than one in Germany, so that will be a concern.

In the United Kingdom, the country does remain at least a couple of weeks behind its peers in terms of reopening its economy, as there is still some debate about whether the rate of infections and deaths has slowed enough to warrant loosening more restrictions. Nonetheless, we did hear from Prime Minister Boris Johnson as well as the other regional government leaders on their plans for the next few weeks. In Scotland, Wales and Northern Ireland, the message remained “stay at home”. For England, Johnson announced a slight loosening of lockdown guidelines allowing construction and manufacturing workers to go back to work, assuming social distancing is stringently maintained. He noted that this was the first step in the roadmap and any further easing would only take place should a fall in the rate of infection allow it.

In terms of a benchmark in Europe, Denmark has been seen as a beacon of hope by some. Denmark was the first European Union (EU) country to loosen lockdown measures. It has been more than 20 days since Denmark reopened some schools, without a notable increase in the number of cases. To some, this is seen as evidence that it’s possible to relax lockdown measures without causing a proliferation in cases through communities.

Meanwhile, the United States continues to take steps to reopen, championed by President Donald Trump. Data from the Financial Times showed that the United States continues to account for more than one-third of the daily global deaths. Whilst most of Europe has only taken steps on loosening lockdowns when the daily rate of infections has shown to be coming down over a number of days, the United States looks to be reopening earlier in its lifecycle as the priority shifts towards getting the economy going again, whilst continuing to manage the virus on a local level.

In Asia Pacific, lockdown measures continue to be gradually relaxed overall. South Korea, which has been praised for its approach over the last two and a half months, was due to reopen schools this week; however, the country saw a spike in infections in the last few days, thought to have centered on a nightclub in Seoul.

Bank of England on Hold but Further Easing Likely Over the Summer

The Bank of England (BOE) kept rates on hold on 7 April, as expected, but it did send a signal that further easing was likely in the future. The vote to keep rates on hold was unanimous; however, two of the nine Monetary Policy Committee members voted in favour of increasing the BOE’s planned asset purchases to £300 billion from the £200 billion announced on 19 March. Several commentators see further quantitative easing (QE) to come at the June meeting, potentially an extra £50 billion – £100 billion announced by the BOE. However, in the press conference, BOE Governor Andrew Bailey suggested the BOE did not extend QE because it wanted to gather more information over coming weeks.

The BOE’s economic outlook raised a few eyebrows, as it sees a sharp V-shaped recovery, with growth recovering to 15% in 2021 after a drop of 14% in 2020. Some observers have suggested this could be overly optimistic, particularly if Brexit isn’t smooth.

Finally, the BOE does not expect any major damage to long-term growth potential from the coronavirus recession.

German Court Ruling

On 5 April, we saw the German Constitutional Court rule on whether the European Central Bank’s (ECB) QE programme, introduced in 2016, violated the country’s constitution. The claim was that the ECB had overstepped its mandate and infringed the prohibition of monetary financing. As we noted last week, if the German court rules against the ECB  could potentially raise a political crisis, but this ruling stated the ECB would have three months to complete a proportionality assessment on its QE programme, known as the Public Sector Purchase Programme (PSPP). If that requirement was not met, then the Bundesbank would be prohibited from participating in the ECB’s QE programme.

Effectively, whilst the German court has no jurisdiction over the ECB, should it not be satisfied that the ECB has demonstrated that the objectives of the PSPP were proportionate “to the economic and fiscal policy effects resulting”, then the Bundesbank could be forced to cease its Bund purchases.

The reason why this is in focus is because it comes at a time when the ECB would like full flexibility in using its Pandemic Emergency Purchase Programme (PEPP). The ruling has an indirect impact on PEPP in that it could set a precedent for future action if the ECB proceeds with limitless purchasing under PEPP. In that case, the ECB may find it easier to argue that this response to the global pandemic was “proportionate”, but it could be a significant overhang on European monetary policy as it works its way through the courts.

Week in Review

Europe

European equities moved higher last week as lockdowns have been very gradually relaxed. Economies are starting to move again, albeit at a very slow pace. That optimism over a potential kickstart to economic growth can be seen in the outperformance of the basic resources stocks last week. Meanwhile, bank stocks were under pressure on the back of some dovish central-bank rhetoric. Automobiles were also one of the week’s laggards as new car registrations across Europe took a fairly substantial hit in April. Exporters were leaders in the UK FTSE Index, with these stocks outperforming on the back of weaker Sterling after the BOE kept monetary policy unchanged and stated that the currency is “vulnerable on a trend basis”.

In terms of corporate reporting in Europe, so far, first-quarter (Q1) earnings have been down nearly 22%, with forecasters anticipating an even greater impact in Q2. In terms of the STOXX Europe 600 Index, 75% of companies in the index have reported, with 55.2%, beating earnings estimates—albeit from a very low base. Some companies have suspended their fiscal year guidance, while many others predicted a sharp deterioration in performance in Q2 and Q3. Companies in the STOXX Europe 600 Index are now expected to report a decline in earnings of 44.9% in Q2.³

In terms of data, the Eurozone manufacturing Purchasing Managers’ Index (PMI) came in at 33.4 vs 33.6 expected, whilst the services PMI stood at 12.0 vs. 11.7 expected. Eurozone Retail Sales in March were down 11.2%. Meanwhile, French Industrial Production was down 17.3%, whilst German exports in March were down 11.8%. As noted, car registrations for the United Kingdom and Italy were near non-existent in April, both down nearly 100%.

Corporate capital raisings continue to be a theme, with another busy week of placings and rights issues last week in Europe.

United States

US markets put in another strong performance as the nation took steps towards reopening, seeing the S&P 500 Index close the week +3.5%. Momentum lead the way and growth outperformed value as part of this dynamic, with market structure the main catalyst here. The narrow concentration of indices is key as we continue to see the top five stocks by market capitalization (namely technology-focused companies) drive the US markets higher.

On trade, there were plenty of headlines and mixed messages, but overall tensions between the United States and China appeared to ease over the past week, adding fuel to the risk-on move we saw reflected in equity markets. Whilst commentary from Trump remained fairly aggressive, trade negotiators from both sides said that they expect to meet their obligations under the terms of the “phase one” trade deal. Chinese Vice President  Liu He and US Trade Representative Robert Lighthizer pledged to create favourable conditions for implementation of the bilateral trade deal and cooperate on the economy and public health. Trade tensions issues are no means completely resolved, however, and we can expect rhetoric to continue to provide headlines, with the potential to unsettle markets.

A recovery in the price of crude oil also helped fuel equity markets. The WTI June futures contract closed the week +25% as more production cuts came through, adding to hopes the market is moving closer to a more balanced state.  Several US producers including Exxon, Chevron and ConocoPhillips announced cuts of more than 600,000 barrels per day.

Trade balance data from China also showed that crude oil imports in the first four months of the year rose 1.7%, helping improve aggregate demand and increase expectations for a rebound in global demand as more lockdowns are eased.

The disconnect between the health of the US economy and market strength remains a theme, with last week’s economic data painting a grim picture. Unemployment data was dire, as the nonfarm payrolls figure in the April employment report showed 20.5 million people had lost their jobs, putting the unemployment rate at 14.7%. Despite the ugly headlines, the figures themselves weren’t quite as bad as had been feared and didn’t dampen the market’s bullish week.

Corporate earnings season is now around 75% of the way through in the United States, with the number of companies beating estimates (and the amount by which they have beaten) unsurprisingly coming in far lower than average. So far, 65% of reported companies have beaten their respective earnings forecasts, while the average company has surpassed expectations by only 50 basis points(bps).⁴ Over the past eight quarters, 74% of companies (on average) had beaten expectations and done so by an average of 5.2%.

Asia Pacific (APAC):

Markets in the APAC region were mixed last week, with equity markets in mainland China making gains as trade tensions eased towards the end of the week whilst Hong Kong underperformed after the economy registered a record contraction.

Japan’s Nikkei 225 Index was the top performer in the region, despite inflation data suggesting that the Bank of Japan (BOJ) may have a challenge on its hands. Tokyo inflation returned to negative territory for the first time since 2017. Macro data was more positive from China, with export data a positive surprise last week. Over the weekend, the People’s Bank of China (PBOC) published its Q1 monetary policy implementation report, and its tone suggests additional easing steps could be forthcoming, with more focus on growth and jobs.

Also over the weekend, Wuhan (the Chinese city at the heart of the outbreak) reported its first cases since lockdown was relaxed in early April. As noted, there has also been a sharp uptick in new cases in South Korea, leading to the reintroduction of social distancing rules in Seoul. Any further developments in these regions will be in focus this week as the rest of the world looks to those further along in easing lockdowns for guidance.

China’s economy has slowly restarted as their strict lockdown has eased, but data still show that activity levels in many areas, including real estate and energy consumption, remain well below pre-pandemic levels.

Last week saw the Reserve Bank of Australia (RBA) leave its key interest rate unchanged at 0.25%, as expected. The bank said it’s prepared to boost bond purchases again and will do whatever is necessary to ensure bond markets remain functional. Australian equities gained 2.8% on the week.

Week Ahead

Markets Closed: Russia (Monday).

Monday 11 May

• Economic/Political: Brexit talks between the United Kingdom and EU continue; BOE’s Breeden speaks.
• Data: Industrial Production (IP) in Italy; China Consumer Price Index (CPI).

Tuesday 12 May  

• Economic/Political: US Fedspeak from Bullard and Harker.
• Data: France – Bank of France Industry Sentiment; US CPI.

Wednesday 13 May 

• Economic /Political: German Chancellor Angela Merkel gives Bundestag an update on the coronavirus and answers lawmakers’ questions.
• Data: OPEC monthly oil market report (including demand forecasts and production estimates); UK gross domestic product (GDP), IP, trade; IP in the Euro area.

Thursday 14 May  

• Economic/Political: BOE’s Governor, Bailey Speaks; ECB Publishes economic bulletin.
• Data: International Energy Agency monthly oil market report released; UK house prices; CPI in Germany; France unemployment; China IP and retail sales.

Friday 15 May

• Economic/Political: Boris Johnson’s European Adviser, David Frost, and EU Chief Negotiator Michel Barnier discuss progress of Brexit talks; France debt to be rated by Fitch; ECB’s Christine Lagarde speaks.
• Data: Euro-area GDP, trade, employment; Germany GDP; CPI in France and Italy; Italy industrial sales and orders; US retail sales, IP, Job Openings and Labour Turnover Survey.

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All investments involve risk, including 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.

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1. Indices are unmanaged and one cannot directly invest in an index. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.

2. The “R number” refers to the effective reproduction number, which measures the capacity for an infectious disease to spread. It represents the average number of other people an infected person will pass the virus to.

3. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. There is no assurance any estimate, forecast or projection will be realised.

4. A basis point is a unit of measurement. One basis point is equal to 0.01%.