Global equity markets exhibited a mixed performance last week. US equity markets outperformed equity markets in Asia and Europe thanks to signs of progress on US tax reform throughout the week.
Hopes Build Around Brexit Talks
After months of talks, hopes are growing that the United Kingdom and the European Union (EU) are finally making some progress on Brexit negotiations.
Crucially, it was reported last week that the UK government had agreed upon a divorce payment of around €50 billion euros (£44 billion) for outstanding liabilities to the EU to be paid through the transition period. Talks are ongoing around remaining issues such as the future nature of the Irish border and role of the European Court of Justice. So, the potential for a last minute “spanner in the works” remains real. The EU has to deem sufficient progress has been made on the UK’s liabilities to the EU before talks can progress to future trade agreements. An EU summit is scheduled for December 14-15, where negotiators hope trade talks can begin in the presence of 27 other EU leaders.
The British pound strengthened on optimism around the talks, gaining against the US dollar last week, while the yield on 10-year gilts widened. Large-cap, export-oriented UK stocks generally suffered back of the currency move, while some smaller, more domestically focused stocks didn’t fare quite as poorly.
Overall sentiment on UK equities has been very cautious in recent times, so we think any signs of progress on talks could prompt some unwinding. This will be an interesting dynamic for us to keep an eye on.
Sector Rotation in Focus
Last week, there were some notable moves lower in sectors that had outperformed significantly so far this year.
Stocks in the technology sector had their biggest weekly selloff since late June.
On the other hand, telecoms stocks—still the worst performing sector year-to-date—outperformed. Stocks in telecoms are seen as beneficiaries of US tax reform proposals.
These contrasting performances suggest to us there has been a shift in investor appetite from the best-performing to the worst-performing (year-to-date) sectors.
It remains to be seen whether this was simply month-end profit-taking or whether we are seeing the beginning of a more significant unwinding in so-called momentum stocks.
European equities were mostly flat before dropping lower on Friday to close last week down. UK large-cap stocks underperformed, weighed upon by the stronger pound.
The best-performing sectors in Europe were retail, utilities and oil and gas. Technology stocks sold off sharply, while resources and chemicals stocks lagged. The moves seemed to be part of a large sector rotation dynamic in Europe and the United States, as investors sold year-to-date outperformers.
The German political situation remains in focus as the potential for a grand coalition comes back into play. The next key event should be the Social Democratic Party (SPD) conference on December 7-9. We expect this to approve the party’s involvement in further coalition negotiations and it should provide more clarity on what the SPD will demand from any deal.
There may be exploratory talks before the end of the year. These would, however, still need to be followed by formal coalition talks and a vote from the SPD party members, meaning a new government could be formed towards the end of the first quarter of 2018. European equity markets are taking these most recent headlines well and the situation looks more positive for Chancellor Angela Merkel, but uncertainty remains.
The European macro calendar was fairly busy last week. We saw the preliminary eurozone flash inflation reading, which saw a small creep higher in November but remained tepid. We also saw the Bank of England banking stress tests come back with no failures (unlike last year), meaning we will not see capital actions for any UK banks.
US markets had a slightly more volatile week as the sector rotation theme drove divergence. As we saw in Europe last week, technology stocks came under pressure, while telecommunications stocks outperformed despite a defensive leaning. Investors seemed to react positively to US tax-reform hopes. Bank stocks were also generally strong last week.
On Saturday (December 2), the US Senate passed its sweeping tax-reform bill. Media reports continued to highlight some difficulties Republicans will face in merging the Senate and House bills, but overall hopes for a resolution remain elevated.
Elsewhere, former National Security Advisor Michael Flynn plead guilty to lying to the FBI about his conversations with Russian Ambassador Sergei Kislyak.
As rumours about Flynn’s cooperation with the authorities circulated, there was a knee-jerk selloff in both US and European equities. However, US markets showed resilience, recovering much of the lost ground before the end of trading on Friday.
Finally, there was increased attention on the imminent expiration of the US government funding agreement on December 8. The budget impasse has seen no progress so far. However, such events tend to get resolved in the short term with minimal impact on the US economy given that the US Treasury can use extraordinary measures to extend government funding. It is nonetheless worth keeping an eye on this story.
Performance in the Asia-Pacific region was mixed, with Japanese equities outperforming on the back of a weaker Japanese yen, while Chinese equities ended the week lower as risk appetite remained subdued.
Concerns over deleveraging and regulatory tightening in China continued to weigh on stocks. There was notable movement out of larger companies to smaller companies in China as it seemed investors had listened to government concerns about the outsized pace of gains in certain outperforming stocks.
South Korean equities underperformed as the Bank of Korea raised interest rates for the first time since 2011. North Korea came back into focus after a missile launch on November 28, but global equity markets appeared resilient and shook off this latest move.
Markets had largely priced in a dip in crude oil last week. The main takeaway from the Organization of the Petroleum Exporting Countries (OPEC) meeting was the extension to production cuts through to the end of 2018. On the back of this, there was a relatively muted reaction in the price of crude oil.
The market also saw some support on news that Nigeria and Libya, two countries previously exempt from the production cuts, seemed to be on board with future production caps.
- Key monetary policy meetings this week include Reserve Bank of Australia on December 4 and the Bank of Canada on December 6.
- In the United States, the Fed is in a blackout period ahead of the Fed meeting on December 13. The market has largely priced in a further interest-rate hike.
- In Europe, we expect the following macroeconomic data releases: Spanish industrial production on December 5; German industrial production and eurozone GDP on December 7; and French and UK industrial production on December 8.
- In the United States, October trade balance data will be published on December 5 and the November employment report is due out on December 8.
- In Asia, Japan’s third-quarter GDP will be published on December 7.
- German Chancellor Angela Merkel and SPD leader Martin Schulz continue to hold discussions over a potential parliamentary coalition.
- In the United States, discussions around tax reform will continue. In addition, the Senate debate on averting a government shutdown on Friday will be important.
- In Spain, we’ll continue to watch for news ahead of the Catalan election on December 21.
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