Notes from the Trading Desk – EuropeApr 15, 2019

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

Notes from trading desk Europe

The Digest

US markets were higher last week, with dovish meeting minutes from the Federal Reserve (Fed) and a decent start to earnings season boosting sentiment. European equities were slightly weak overall, but equities in both regions saw bullish cyclical rotation as the year’s underperformers caught a bid. Asian equities were mixed amid what appeared to be profit-taking in Chinese domestic shares.

Last Week

Last week saw bullish cyclical rotation in both Europe and the United States, with the defensive sectors (and first-quarter winners) the clear underperformers. US health care names and their European counterparts were weak, while European utilities, telecommunications and real estate names also underperformed. It was a similar story across the pond.

Meanwhile, banking stocks (which have been recent underperformers), were at the top of the pile in both regions. Automotive stocks generally enjoyed a boost from continued positivity around US/China trade talks.

On the European side, European Central Bank (EB) President Mario Draghi offered supportive commentary after its policy meeting last week. The message was that the ECB will consider whether it needs to mitigate the side effects of negative interest rates, with the Council agreeing that it must be analysed. Tiered deposit rates were not discussed, but any move to ease the impact of the negative rate environment is helpful for the sector.

Some market observers did note that the conviction behind the move higher in certain names didn’t seem particularly high throughout much of the week as volumes were subdued. On Friday, however, things picked up on that front with more positive data from China buoying overall market sentiment further.

In the United States, while the March Federal Open Market Committee (FOMC) meeting minutes had a dovish slant; nonetheless, the door was left open for further tightening moves, causing the market to reduce the probability of an interest-rate cut this year.

Sanguine March inflation figures also supported the view the Federal Reserve (Fed) could be patient, but profit taking occurred in US Treasuries after their strong start to the year, bumping up yields.

The dovish FOMC and strength in yields played into the move higher in banking stocks. A strong start to US earnings season from several stocks in the space also helped lift sentiment.

Another point of interest continues to be the Growth vs. Value style debate. Some analysts feel value may be on the verge of a recovery, with the FTSE Russell Value index at its lowest level vs. the FTSE Russell Growth Index since 2000.1

Finally, we would note that in Europe stocks with a US exposure also generally underperformed as the spread between US and European growth stocks appears to be narrowing.

Europe

European equities were relatively unchanged last week with little in the way of key drivers either way. The emergency EU summit in Brussels was in focus whilst the ECB release also garnered some interest. Cyclical rotation drove sector moves and regional indexes were mixed with equities in France and Italy stronger on better data, whilst German equities were worse off on data and the UK’s FTSE Index was likewise weaker amid a stronger pound.

There were negative headlines out of Italy after the country lowered its economic growth forecasts for 2019 to 0.2% from 1%. This means the government’s budget deficit for the year would sit at 2.4%, vs. the 2.04% deficit set in December after a long-running battle with the European Commission (EC).

Economic growth for 2020 was also revised lower. This will likely rekindle tensions between the EC and Italy and is something to keep an eye on.

In terms of data, French, Italian and UK industrial production all beat expectations in February. The overall eurozone industrial production in that month also beat, down 0.3% on the year vs. a dip of 0.9% expected. German exports missed estimated in February, down 1.3% vs. an estimated dip of 0.5%.

Brexit Watch

Focus last week was on Wednesday’s European Union (EU) leaders’ summit in Brussels. The conference resulted in the EU27 granting the United Kingdom a Brexit extension until October 31. (We’ll save the Halloween puns for nearer the time.)

There was flexibility attached; meaning, should the UK agree a deal before that date then it can leave the EU earlier. However, if an agreement is not made by May 22 then the UK will be expected to participate in the EU parliamentary elections May 23-26.

Look Out For... (April 15-22):

Monday, April 15

  • Reserve Bank of Australia Meeting Minutes Published Link

Tuesday, April 16

  • UK March Employment Report Link
  • US March Industrial Production Link

Wednesday, April 17

  • Holiday in India, Early Close in Norway
  • Japan March Trade Balance Link
  • China First-Quarter Gross Domestic Product Link
  • China March Industrial Production Link
  • Italy March Consumer Price Index Link
  • UK March CPI Link
  • UK March PPI Link
  • Eurozone March CPI Link
  • Canada February Trade Balance Link
  • Australia March Employment Report Link

Thursday, April 18

  • Holiday in Norway and Sweden

Friday, April 19

  • Holiday – Good Friday
  • Japan March CPI Link

Monday, April 22

  • Holiday – Easter Monday

If the UK does not hold European elections, then the country will leave the EU automatically on June 1. The outcome was market-friendly as it took the immediate risk of a no-deal Brexit off the table, driving some relative sterling strength last week on Thursday.

The extension means the UK parliament has more time to come to an agreement on the country’s future outside of the EU. The latest indicative votes had suggested there was movement towards remaining within a customs union with the EU.

UK Prime Minister Theresa May and Labour Party Leader Jeremy Corbyn are reported to be closer to finding some consensus as it’s thought that May has softened her stance. However, all options remain a possibility.

The events of last week heighten the uncertainty over the longevity of Theresa May’s reign as leader of the Conservatives.

We are still unsure whether May will remain in position until the end of the new negotiating period. Should the government continue to fail in their quest to secure a deal then it will inevitably result in questions over who is best to lead the country forward as Conservative Party leader. A more ardent Brexiteer, such as Boris Johnson, would represent a risk to markets in our view. There is also the risk of a general election.

The UK parliament is now in recess until April 23.

Interestingly, we did see a rebound in some UK macro data last week. The UK economy grew 0.2% (month-over-month) in February, more than the flat reading expected. The pickup was broad based, but Brexit related stockpiling may have helped drive the positive surprise. According to some sources, some companies may have brought forward orders before the original March 29 deadline for leaving the EU. We did see evidence of investor interest returning to UK equities last week.

Overall though, UK growth remains sluggish and as negotiations are drawn out further, we are unlikely to see a convincing rebound in data any time soon as uncertainty continues.

Americas

US equities were higher last week overall and the focus was again on central bank commentary with the March FOMC meeting minutes released on Wednesday. There was also some rhetoric around US trade talks with China and the EU.

The FOMC minutes continued the recent dovish theme with the majority of members preferring to keep rates on hold for the rest of 2019.

The minutes noted that the “appropriate response of the federal funds rate to signs of labour market tightening could be modest provided that signs of inflation pressures continue to be limited.” It is these inflationary pressures which have been a key factor in how participants review current policy.

Also in the release, there were notes given on balance sheet normalisation, but little that hadn’t already been communicated before.

On trade talks, we came in on Monday to reports of progress between the United States and China. US Economic Advisor Larry Kudlow stated that the two sides were getting “closer and closer” to a trade deal following talks the previous week. Chinese President Xi had also appealed to his negotiating team for substantive progress as soon as possible.

Signs of US-China progress have clearly provided support to equity markets in recent weeks; however, just as tensions with China appear to be easing, the US has turned its attention to Europe.

On Tuesday of last week we saw reports that the US Trade Representative was proposing tariffs on €11bn worth of goods and services in retaliation for EU subsidies. The list of goods which the tariffs could apply to includes food and drink, clothing, motorcycles and aircraft parts.

Meanwhile, the EU and China released a joint communique on trade where they stated they will “work together for peace, prosperity and sustainable development and their commitment to multilateralism”. The tone was one which suggested they would work together to fight the impact of US trade policies.

Asia

Asian equities were mixed, with gains in markets in Japan and Australia offsetting a decline in the Shanghai Composite Index in China.

There was actually a decent pick up in Chinese macro data, with month-on-month inflation data improving and a better-than-expected trade surplus thanks to a jump in March exports.

Positive commentary on trade talks failed to stem the domestic market weakness, but we would note the Shanghai Index was up 5% the prior week and approximately 30% year-to-date. With this, it seems clear to us that some profit taking might be occurring.

Japanese equities made small gains, although macro data from the region remains soft. The March consumer confidence reading was below estimates and preliminary machine tool orders for the month fell a shocking 28.5% year-on-year.

Australian equities were strong last week. Strength in the miners drove the market amid trade hopes as well the current prime minister’s announcement calling a general election on May 18.

Week Ahead

Investor focus will likely shift to first-quarter earnings season, which continues in both the United States and Europe. It’s a holiday shortened week for developed Europe, with most markets closed on Friday and Monday for the Easter holiday.

Politics

  • UK parliament is in recess until April 23, but further cross-party talks are expected to be held and so we can expect further headlines.
  • Two-day trade talks between the United States and Japan will commence Monday April 15. Last week Japan finalized the topics it aims to discuss, which included a trade agreement on goods, as well as some services, but officials plan to rebuff any request for automobile quotas or foreign exchange provisions.

Monetary Policy

  • We hear from several central bank speakers throughout this week, with a Fed speaker expected every day apart from Friday. We also hear from Bank of England Governor Mark Carney on Wednesday, with focus likely to be on any commentary around the impact of Brexit.

Economic Data

  • European flash purchasing manager reports (PMIs) will be the main macro event as they will give the first indication of how the economy has started the second quarter. We also get February trade balance data from the region on Wednesday.
  • UK labour market data and inflation data are due out on Tuesday.
  • US retail sales on Thursday are likely to show the beginning of an uptick following the recent dovish Fed rhetoric.
  • We expect trade balance data, manufacturing PMI and inflation data from Japan this week, which will be important given last week’s disappointing releases.
  • From China, industrial production, retail sales and first-quarter gross domestic product data are due out on Wednesday. It will be interesting to see if the recent improvement continues here.

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