Notes from the Trading Desk – Europe

The Digest

Last week was volatile for global equity markets, with indices see-sawing from headline to headline, whether it be comments from Federal Reserve (Fed) members or macro data releases. Overall, there was a sense that investor conviction was low, and that positioning, rather than any real confidence in the outlook, drove market bounces. The MSCI World Index declined 2.2%, its sixth week of losses and the longest run of weekly declines since the 2008 global financial crisis. Looking across regions, the S&P 500 Index declined 2.4%, the MSCI Asia Pacific Index declined 2.5% and the STOXX Europe 600 Index rose 0.8%.¹

Equity market volatile with conviction low

Last week was typified by low-conviction moves in equity markets, with several headwinds and themes for investor to navigate. To pick out a few key talking points from last week, investors focused on US inflation data, Fedspeak, crypto volatility, and COVID-19 cases in China. In addition, with global markets declining for six consecutive weeks, there is an increasing debate over how much bad news is priced in, and whether markets are now oversold.

Taking a quick look at some of these themes

US inflation data: The US April Consumer Price Index (CPI) release on Wednesday was the main macro data event last week. The headline reading came in higher-than-expected at 8.3% year-over-year (Y/Y), down from. 8.5% previously. The bulls argue the decline from the prior month suggests we are at peak inflation. That said, it was still higher than expectations, with one major reason being airfares, which were up 18.6% from March and alone added about 15 basis points (bps)² to the core print.

US gasoline prices also hit an all-time high, which will continue to add to inflation and squeeze the consumer ahead of the summer driving season. Ultimately, the number appeared to add to the overall air of uncertainty and, we really need to see more data before calling peak inflation.

Fedspeak: Last week, Fed Chair Jerome Powell reiterated guidance for 50 bp rate hikes over the next two meetings and said it will be “quite challenging” for the Fed to engineer a soft landing, adding that the process of trying to do so will include some pain. In addition, Fed Bank of Cleveland President Loretta Mester backed raising rates by a half point in June and July, but also said that 75 bp rate hikes cannot be ruled out forever. Overall, it was taken as positive that Fed officials seemed to rule out 75 bp hikes for now, but fears over a central bank policy error will likely remain a key narrative in to the second half of the year.

Crypto volatility: The crypto space was also a talking point, with some notable selling hitting the space.

Ukraine fallout: Energy prices remain volatile as the war in Ukraine continues, with Hungary vetoing a European Union (EU) ban on Russian oil and gas price volatility showing no sign of abating. Wheat prices have pushed back towards all-time highs as the supply disruption shows no sign of ending amid a Russian blockade of Ukraine’s remaining ports.

Chinese lockdown: There were some signs of an improving picture in China, as Shanghai reported a 58% drop in systematic cases, with less than 1,000 daily new infections.³ In addition, no cases were found outside quarantine. Cases also fell in Beijing. However, this morning we saw some poor Chinese macroeconomic data, with April Industrial Production down 2.9% Y/Y vs and retail sales down 7.5% Y/Y.

Where next: Given recent declines, there is much discussion around what is priced into market. Sentiment is certainly low, with the CNN Fear & Greed Index now in “Extreme Fear” Territory, a level we have often seen markets bounce from.⁴

Looking at technical indicators, some markets are beginning to flash oversold signals, which some say may have led to the bounce in European equities last week. The STOXX Europe 600 Index (SXXP) relative strength index (RSI)⁵ hit 27.7 on Monday, which seemed to help support the market. The last time the RSI was this low, it preceded a 14% rally in SXXP.⁶

Valuation: With the recent declines in markets, focus has also turned to valuations, which are looking less expensive. The price-earnings ratio (P/E) for the SXXP was back towards the pandemic lows, and while the backdrop is obviously poor, there is arguably more visibility than there was in March 2020.

The Week in Review

Europe

Last week was extremely choppy, but European equities managed to close in positive territory with slight gains. It felt like markets were at the mercy of positioning, given a broader lack of conviction. Familiar fears over inflationary pressures and stagnating growth remained front and centre due to macro data (US/German CPI and UK gross domestic product [GDP]). Volatility in the US technology sector and crypto added to the general sense of unease. However, calming comments from Powell, who reiterating the Fed isn’t actively considering a 75 bp move, helped boost risk sentiment, along with positive headlines out of Asia. The People’s Bank of China (PBOC) and Ministry of Commerce officials jointly said they are committed to fully boosting infrastructure investments this year. With that, we saw an unwind of some crowded trades into the end of the week, while some of the only sectors that have outperformed year-to-date (YTD)—such as energy/miners—were the worst performers last week.

Sector-wise, we saw a clear reversal of YTD trends, with the worst-performing YTD outperforming last week, and vice versa. As such, retailers were up, while basic resources/energy stocks were down. Health care also had a tough week.

Looking at other asset classes: In foreign exchange markets, the trend was continued weakness vs the US dollar. The Swiss franc hit parity vs the dollar for the first time since 2019.⁷ Bloomberg noted: “Risk aversion usually favours the Swiss franc, but the dollar has emerged as the key haven in a more inflationary environment. Traders have been eyeing the rift between the Swiss National Bank, seen as a laggard when it comes to raising interest rates, and the more hawkish Federal Reserve, leaving the franc struggling in recent weeks”.

In bond markets, there was some respite from rising yields as European yields tightened last week. The German 10-year Bund ended the week at 0.94% (-15 bps) and the Italian 10-year government bond ended at 2.84% (-30 bps), a move which some attributed to an unwind of extreme positioning and talk of peak inflation.

United States

US equities saw their sixth consecutive weekly decline, with the S&P 500 Index closing last week down 2.4%. This represents the index’s worst run since 2011.⁸ Much of the focus for the week was on the April CPI. Price action was choppy through the early half of the week in anticipation of the report, but we did see volatility drop into the end of the week as Fed officials largely pushed back against a 75 bp interest-rate hike. The CBOE VIX closed the week below 29.⁹ The energy space remains a key focus for markets, with US gasoline hitting an all-time high last week as rising pump prices have increased the squeeze on the consumer. Cryptocurrency has been another focus over the last few weeks amidst a selloff; however, Bitcoin did seem to stabilise last week.

There was a clear risk-off theme to markets last week, with investors seeking safe havens. The US dollar rallied after the inflation data. The risk-off theme can be seen when we look at sector moves last week. Defensives largely outperformed, with consumer staples higher last week.  While still Communication services, health care and utilities were all slightly lower, while real estate investment trusts, financials, and tech stocks posted the largest losses. The US 10-year Treasury yield pulled back from recent highs to close the week back below 3.0%.

Asia Pacific

Asian equities were weaker overall last week, with the MSCI Asia Pacific Index closing the week down 2.5% despite a late rally on Friday. Similar to the United States, defensive sectors also outperformed in Asia. Despite that, all sectors closed in the red. Communication services was the relative outperformer, while energy and materials stocks saw the largest losses last week.

Despite the overall weakness, Chinese equity markets rebounded last week on signs that the spread of COVID-19 is beginning to ease again, bringing hope of an end to recent lockdowns. Shanghai has managed to wipe out COVID-19 cases outside of quarantine zones. The government is rolling out measures to open Shanghai and targets to restore normal order of life in June. Chinese authorities repeated pledges to boost policy support, and the Shanghai Composite Index closed last week up 2.8%

On Sunday, the PBOC cut the lower-bound range of mortgage interest rates for first-time homebuyers in response to weak macro data. The latest macro data out of China was poor, with industrial output falling unexpectedly by 2.9% in April from a year ago. Retail sales also contracted 11.1% in the period, weaker than anticipated. The unemployment rate rose to 6.1%, with the youth jobless rate hitting a new record.

The Week Ahead

Expect familiar themes to dominate this week, with eurozone and UK CPI data out mid-week. With that in mind, we expect the scrutiny of European Central Bank comments ahead of its next meeting (June) to be a driver for sentiment around European equities. Russian GDP data will also garner attention for obvious reasons. In the United States, retail sales and industrial production data will likely to be the main talking point. As with last week, Fedspeak will also be a focus.

Monday 16 May  

• US: Empire Manufacturing (May)
• China: Industrial Production Y/Y (April), Industrial Production YTD Y/Y (April), Retail Sales Y/Y (April), Fixed Assets Ex Rural YTD Y/Y (April)

Tuesday 17 May

• UK Labour Market Statistics
• EU: GDP SA (first quarter)
• US: Retail Sales Advance month-over-month (M/M) (April), Retail Sales Ex-Auto M/M (April), Industrial Production (April), Capacity Utilisation (April), NAHB Housing Market Index (May)

Wednesday 18 May

• UK CPI Inflation
• Euro-Area Final CPI Inflation
• Russia first-quarter GDP
• US: MBA Mortgage Applications (May 13), Building Permits (April), Housing Starts (April),
• China: Producer Price Index Y/Y (April), CPI Y/Y (April)

Thursday 19 May

• US: Initial Jobless Claims (May 14), Continuing Claims (May 7), Philadelphia Fed Business Outlook (May), Existing Home Sales (April), Leading Index (April)

Friday 20 May

• UK Retail Sales
• EU: Consumer Confidence (May)

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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. One basis point is equal to 0.01%.

3. Source: South China Morning Post, 16 May 2022.

4. CNN’s Fear & Greed Index tracks seven indicators of investor sentiment. 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.

5. The relative strength index is a momentum indicator, which measures the speed and velocity of price changes to evaluate overbought or oversold conditions within a particular asset or index.

6. Past performance is not an indicator or a guarantee of future results.

7. Source: Bloomberg, 12 May 2022, “Swiss franc hits parity with US dollar for first time since 2019.”

8. Source: NY Times, “After a year of steady gains, the stock market has become a roller coaster,” 5 May 2022.

9. The CBOE Market Volatility Index measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Often called the “fear gauge”, lower readings suggest a perceived low-risk environment, while higher readings suggest a period of higher volatility. 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.