Despite the month-end selloff on Friday, global equities put in a strong performance last week. The Stoxx Europe 600 Index and S&P 500 Index both closed the week up 3%, with rotation into value the key dynamic.1 Markets in the Asia Pacific (APAC) region were also broadly higher, with Japan the clear outperformer. The European Commission’s (EC’s) announced recovery package, further hopes over lockdown easing and fiscal stimulus in Asia drove equity market moves.
Lockdown: Measures Continue to Ease Across the Globe
We’ve seen further steps towards European economies reopening. France has relaxed travel restrictions within the country and is now allowing schools, cafes and restaurants to reopen. Tighter restrictions will remain in force in regions yet to show enough progress. Germany’s measures are now in the hands of the 16 federal states, with shops of all sizes now allowed to reopen (with social distancing measures). Border controls with Austria, France and Switzerland are set to be lifted on 15 June. Increased travel is to be permitted in Italy, with travel between regions and to and from the country to be allowed from 3 June. In Spain, from 1 July people travelling from abroad will no longer have to spend two weeks in quarantine upon their arrival to the country.
The positive rhetoric on the potential for easing of travel restrictions played into the equity market rotation dynamic, supporting the travel and leisure industries.
In the United Kingdom, Prime Minister Boris Johnson relaxed measures further for England, allowing more social interaction. The “track and trace” scheme also came into action. Both of these moves were faster than expected, likely in an attempt to distract from the Dominic Cummings scandal dominating headlines and putting the government under a lot of pressure. These moves come alongside studies from the Financial Times showing that the United Kingdom now has the highest excess death rate amongst countries producing “comparable data”, and also fares badly on other metrics.2 Whilst it is likely too early to draw too many conclusions, it is highly likely that the relative level of deaths in the United Kingdom will come under further scrutiny in the future.
From a purely economic standpoint, however, there are some positive signs coming from UK data. Since the reopening of the economy, the housing market has surged and the decline in spending has eased. That said, Bank of England (BOE) Governor Andrew Bailey gave a downbeat assessment of the economy and reiterated his earlier guidance that the BOE was prepared to provide further economic support.
Rotation: Momentum -> Value
Outside of the pandemic and geopolitical backdrop, rotation out of growth/momentum into value stocks (and from recent winners to losers) at the global level was a feature of last week’s action as individual stock fundamentals took a back seat to factor/basket moves. Positioning in cyclicals was at multi-year lows, with extreme concentration in certain equities, making the conditions ideal for such a move on the right catalysts. The catalysts came in the form of the following:
- The EC’s recovery fund.
- Fiscal stimulus/expansion from Japan/China.
- A wealth of headlines regarding economic reopening/restarting driving hopes for economic recovery.
- Fears of policy action from US President Donald Trump on social media have put big US technology companies under pressure.
The momentum unwind did start to reverse towards the end of last week, with Trump’s rhetoric towards China growing more aggressive. The US president seems to become emboldened as markets rally, as he continues to use index performance as a measure of his efficacy. As this year’s US national election draws closer, Trump is trying to balance being seen as tough on China, whilst also not damaging the fragile market recovery. China’s increasingly aggressive approach to Hong Kong is now also very much part of the narrative. However, even with this later reversal, the continuously beaten up travel and leisure, auto and bank stocks remain the week’s clear winners, whilst the recently favoured health care sector was the week’s underperformer.
With last week’s move, global equities have now rallied more than 31% from the low on 23 March,3 but it’s important to look at this in the context of fund flows. Despite the rally, we’ve seen sizeable redemptions from equity funds, both active and passive. This suggests that a significant amount of the move higher has been driven by the closing of short (sell) positions, rather than real buying of equities.
European Commission: Fiscal Solidarity Comes Through
We’ve talked a lot about the need for fiscal solidarity within the European Union (EU) in these Notes, and it does look like it is finally coming through. Last week the EC unveiled a rescue package of €500 billion in grants and an extra €250 billion in loans, higher than had been anticipated. It is not the size of the package that is so significant, however, it is the large-scale joint issuance, transfers, and joint tax revenues—all of which seemed far off just two weeks ago. The plan will be financed by the issuance of a common bond, pushing the message of solidarity.
The high proportion of grants also carries a strong political message as it amounts to fiscal net transfer. Under a new allocation key, the support will mainly go to the European South (which has been harder hit by the pandemic) and to Eastern countries where the “Green Transition” (which directs members to transition to climate neutrality) could be more costly. This move should help to calm some of the risk of a North vs. South narrative, which had the potential to play into the hands of populist political parties.
Political risk in Europe still remains, however. The recovery fund forms part of the EU budget, which means entering a long negotiation process. The final agreement is likely to look very similar to the package discussed this week, but negotiations will seek the unanimity of all EU member states and the endorsement of national parliaments. Legacy problems like fiscal rules and debt sustainability remain, but for now the fragmentation risk has declined significantly. Peripheral spreads continue to be a key indicator of sentiment/risk, and they continue to tighten. We also saw an aggressive move higher in the euro following the release.
Capital Raisings: The Deals Keep on Coming
It was another bumper week for capital raisings in Europe, with US$6.9 billion raised in primary placings and the hot ticket that was the initial public offering (IPO) of coffee company JDE PEETS. The JDE PEETS deal size was around US$2.8 billion and multiple times oversubscribed. On this theme, there was an interesting article in the Financial Times last week about the future of the IPO and how “IPO ‘roadshows’ from home” may cause bankers to question old ways in this area.4 Deals such as JDE Peets have been successful despite the lack of a traditional roadshow, casting doubt on the need for all the hobnobbing in a post-COVID-19 world.
Whilst the market largely seems to be ignoring it for now, we can’t ignore the situation in the United States where protests sparked by the death of a black man, George Floyd, at the hands of police in the city of Minneapolis reached a 6th day. Mass protests leading to clashes between police and citizens have swept across the country as anger builds over the response from authorities over the man’s death.
The scenes have become increasingly violent as multiple police forces have been recorded using various levels of force, including rubber bullets and tear gas, on peaceful protestors. After using inflammatory language in a tweet last week that Twitter removed, Trump has failed to formally address the situation, instead just repeating calls for “law and order” on the social media platform.
We do not see this situation calming any time soon, with further escalation likely. It is also unclear just now what kind of impact the mass protests, large numbers of detainees, and gatherings would have upon the ability to manage COVID-19 in communities. For now, equity markets have not reacted to this crisis, but if prolonged we could see further uncertainty around US economic recovery.
Week in Review
As discussed, European markets were broadly higher, with rotation out of momentum and into value the key theme. Alongside the catalysts we have already discussed, we are seeing more signs that macro data has bottomed, raising hopes for the start of a recovery as lockdowns continue to ease.
In Germany, the expectations component of the May ifo Business Climate Index (which is a good predictor of future growth) improved to 80.1 versus 69.4 prior. The consumer confidence data across the region also improved month-over-month, with German and Italian figures showing significant upticks last week. In addition, the negative earnings revision estimates we had been seeing for Stoxx Europe 600 Index companies are starting to slow down.
Brexit Talks Resume
The latest round of Brexit talks begin on 1 June and continue throughout the week. There is usually a press conference on the Friday after the talks have concluded, so we expect most headlines to come on 5 June. This round of talks is important—indeed EU negotiator Michel Barnier said this week’s Brexit talks with the United Kingdom are crucial for whether a free-trade agreement can be reached because this is the last round before the high-level stock-taking meeting in mid-June, whereby the two sides will assess progress before the end-of-year deadline. Prime Minister Johnson has warned that the EU must give ground by June if there is to be a UK-EU zero-tariff, zero-quota trade deal this year, or run the risk of a breakdown in talks that would mean the United Kingdom leaving on World Trade Organization terms with tariffs imposed.
If there is no progress on issues like a level playing field, protection of fundamental rights, governance and fisheries, then we see a risk of going into July with a stalemate.
US equity markets rose last week, displaying reasonable resilience amidst rising political tensions and social unrest. The S&P 500 Index traded through the 3,000 level for the first time since the broad market selloff at the start of March, a level which had provided some resistance through May.
Investors appeared to shake off headlines around further strains in the relationship between the United States and China, as well as reports of widespread social unrest in the last few days in the former. The same equity rotation we saw in Europe was also evident in the United States too with financials, one of the year’s key underperformers, leading the way last week. Industrials were also strong as confidence grows that the United States may be through the worst of the virus.
In terms of the week’s laggards, communication services were weak, whilst the year’s winner so far, technology, was up moderately. Energy stocks were under pressure as inventories continued to rise.
US-China relations were in focus at the start of the week, triggered by an announcement from the Chinese government advising of new national security legislation in Hong Kong. Critics, such as the US government, claim that the new law infringes on the freedom-of-speech rights of Hong Kong citizens.
The National People’s Congress of China also stated a new bill would be proposed to “establish enforcement mechanisms”. President Trump said that his administration is “not happy” with the Chinese government, whilst Trump’s top economist, Larry Kudlow, said that China would be “held accountable” for this “huge mistake”.
It wasn’t just the United States displaying condemnation of China’s actions regarding Hong Kong—many countries throughout the West displayed their disapproval. However, it was the potential for further tariffs or sanctions from the United States which markets were focussed on. Hong Kong is a key trading partner for the United States, but with the autonomy of Hong Kong becoming more compromised, the US government has stated it may remove the former British colony’s special trading status, a move that would undoubtedly shake up markets in the Far East.
Data was in focus too last week. US gross domestic product (GDP) shrank 5% in the first quarter (Q1), a larger decline than was estimated one month ago. As the country began to re-open, we saw improvements in personal consumption as well as personal income data. Initial jobless claims continued to trend lower, whilst continuing claims also started to ease. We note the monthly non-farm payrolls will be in focus this week, within the employment report out on 5 June.
As discussed already, the main focus for Asian markets was fresh war of words between the United States and China on a number of issues (trade, COVID-19, Taiwan, and Hong Kong). With that, market performance was muted in Hong Kong +, and Shanghai. Elsewhere, Korea’s equity benchmark traded +3% as the Bank of Korea cut interest rates by 25 basis points (bps) to 50 bps. Australian equities traded +4.7% as the lockdown continued to ease there; Reserve Bank of Australia Governor Philip Lowe noted signs the Australian economy is bottoming amidst better-than-feared health outcomes.
The stand-out performance came from Japanese equities last week, with the Nikkei trading +7.3%. A number of factors spurred sentiment. The government ended the COVID-19 state of emergency and Prime Minister Shinzo Abe suggested this was a victory for the “Japan model” as the number of new cases fell from 600-700 a day a month ago to 20-30 a day at this point. Abe doubled Japan’s stimulus measures on Wednesday of last week, approving a ¥117 trillion (US$1 trillion) set of measures, including help for small businesses. Japanese equities also likely benefitted from the global rotation into value names last week, with banks and autos doing well. However, challenges remain; Japanese retails sales and industrial production figures both came in weaker than expected last week.
Looking at other macro data, over the weekend we saw Chinese purchasing managers indices (PMIs) rebound, with the China official May Composite PMI at 53.4, and the Manufacturing PMI at 50.6.
The European Central Bank (ECB) meeting on Thursday is the main focus this week. The ECB seems almost certain to increase the size of its Pandemic Emergency Purchase Programme (PEPP) at the 4 June meeting. The present pace of buying, government financing needs and brewing trouble in Italy suggest it needs to be increased to over €1 trillion from a current €750 billion. In addition, we think the severity of the coronavirus crisis calls for the Governing Council to err on the side of a larger figure.
Monday 1 June: Austria, Denmark, Hungary, Norway, Switzerland, Germany, Romania (Whit Monday)
Friday 5 June: Denmark (Constitution Day)
Monday 1 June
- Economic/Political: Brexit negotiations resume
- Data: Global: (May) Manufacturing PMI; Stoxx Europe 600 Quarterly Index Review announcement, rebalancing on close of 19 June 2020
Tuesday 2 June
- Data: Japan: (May) Services PMI; Hong Kong: (May) composite PMI; Australia: Q1 GDP
Wednesday 3 June
- Economic/Political: Anti-government protests in Rome
- Data: Global: (May) Services & Composite PMI; Eurozone: (April) unemployment rate; Germany: (May) unemployment rate; US: (April) factory orders, (May) ADP employment change
Thursday 4 June
- Economic/Political: ECB interest-rate decision and press conference (expect more on emergency stimulus)
- Data: Euro area: (April) retail sales; UK: (May) new car registrations; US: (30 May) initial jobless claims
Friday 5 June
- Data: Germany: (Apr) manufacturing orders; Swiss: (May) foreign currency reserves; US: (May) employment report
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1. Source: Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance does not guarantee future results.
2. Source: Source: Financial Times, “ UK suffers second-highest death rate from coronavirus,” 27 May 2020.
3. Source: Source: MSCI World Index. 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 guarantee of future results.
4. Source: Source: Financial Times, “IPO ‘roadshows’ from home cause bankers to question the old ways,” 24 May 2020.