Global equities were weaker overall last week, with the MSCI World Index down 0.4%, after US equities gave up some recent gains.1 Rising yields started to bite risk assets, prompting some profit-taking with equities remaining at lofty valuations. At the moment, there is a clear push and pull in markets better-than-expected macro reports, unprecedented levels of stimulus and a potential end to COVID-19 lockdowns vs. stretched valuations and concerns of the impact of interest rate increases.
The reflation trade was evident once again, with basic resources, banks, and energy stocks strong again globally. Nonetheless, in terms of global fund flows, it was another big week for inflows into global equities, but European equities saw large outflows. Bonds also saw strong inflows last week.
In Bank of America Merrill Lynch’s (BAML) latest monthly Fund Manager Survey, a net 91% of investors now expect a stronger global economy in 2021, with the majority expecting a V-shaped recovery.2 Cash levels are now at an eight-year low, down to 3.8%.3
Meanwhile, equity and commodity allocations are at their highest levels since 2011. Interestingly, given how stretched we’ve seen valuations in certain areas of the market become, only 13% believe it to be a bubble.4 The latest report also showed that investors would rather companies focused on ‘increasing capex [capital expenditure]’ rather than ‘improving the balance sheet’ for the first time in over a year.
Reopening Plays in Focus in Europe
Governments across Europe are trying to keep a lid on reopening optimism for now. The extent of the second wave of COVID-19, especially in the United Kingdom, Belgium, Italy, Austria and most of Eastern Europe, serves as a reminder of how this virus can spread if governments fail to strike the correct balance between managing social interaction and enabling economies to function.
However, the difference between now and pre-second wave is the effective vaccination programme in motion across Europe. Looking at the bare facts, falling infection rates, hopsitalisations and deaths have brought about a sense of optimism that we may finally be through the worst of it.
COVID-19 patients still account for a large portion of intensive-care-unit bed occupants in Europe, with Spain’s capacity nearly fully occupied by COVID-19 patients, but infection rates in the eurozone and the United Kingdom are back at early 2020 levels and falling. On current trajectories, the United Kingdom is expected to have vaccinated 75% of its population by May 2021. The United States is expected to reach the same goal by September 2021. Meanwhile, continental Europe would not reach 75% vaccinated until at least summer 2023. However, we expect this to change dramatically in the coming months, with more vaccines being approved and produced and as rollouts are ramped up.
With that in mind, focus was on the February Purchasing Managers’ Index (PMI) reports, which came out on Friday of last week. Overall, manufacturing has been propping up activity, whilst services have lagged behind. Eurozone PMIs came in at 57.7 for manufacturing, 44.7 for services and 48.1 for composite. A strong increase in the German as well as the French numbers drove the sharp increase in the manufacturing PMI from 54.8 to 57.7, and the survey provider noted that ‘the rest of the eurozone enjoyed the strongest factory production gains since last August’.
There has been a sharp increase in external demand, which has supported manufacturing in the eurozone. Germany continues to be the shining light for the eurozone on manufacturing, reporting 60.6 following a previous read of 57.1 and reiterating impressive growth following the downturn.
Outside of the eurozone, UK PMIs also were released on Friday. The report handily beat expectations, with manufacturing coming in at 54.9, services at 49.7, and composite at 49.8. This follows a sharp downturn in January; for example, the services PMI in January dipped to 39.5. Despite the upbeat report, services activity remained severely subdued, with restrictions on travel, leisure and hospitality restraining output levels.
The improved sentiment around reopening fed through to European equity markets last week. Investors bought value names, which led to a strong finish for basic resources stocks. Banks, travel and leisure (including airlines), and oil and gas were all higher last week.
US Treasury Yields Rally
A hot topic in the last couple of weeks has been the recent rise in US bond yields. The rise in yields has been a little too quick for the liking of many, weighing on risk assets. The US 10-year Treasury yield is now through 1.36%, its highest level since February 2020, and showing no signs of retracement. The 2-year/10-year spread is now at its widest level for over four years. The longer part of the curve is even steeper, with the 5-year/30-year spread hitting the widest levels since October 2015. The move in yields hasn’t helped the US dollar, with the US Dollar Index still down at three-year lows.
It’s also important to watch the price of gold as real yields move higher. Gold is a zero-yield asset and is often used as a protection instrument in a negative-yield environment. Spot gold prices hit a seven-week low last week.
There has been a bigger discussion on inflation going on behind the move in yields. Datapoints continue to be supportive for the reflation trade globally. The better-than-expected PMIs out of Europe also showed that prices manufacturers paid for inputs rose at their fastest rate since 2011.
The US Empire Manufacturing Prices component grew, coming in at a reading of 57.8, the highest growth rate since 2011. The UK Consumer Price Index (CPI) was also up 0.7% in January. The incoming stimulus to the US economy via the recovery package is expected to get a further boost with the government’s US$4 trillion infrastructure programme being discussed last week, which will likely further support the reflation trade.
Week in Review
European equities felt a little less robust last week but the STOXX Europe 600 Index managed to finish higher. As equities tick towards February 2020 highs, it feels like some profit-taking has kicked in, which resulted in the largest weekly outflow for European equities so far this year.
In terms of key themes, economic reopening plays and Italian politics have garnered attention again amidst the backdrop of a steady flow of earnings. The French CAC 40 Index outperformed last week in Europe, but Italy’s FTSE MIB Index lagged. Italian equities pared some of their month-to-date gains despite Italian Prime Minister Mario Draghi easily winning a vote of confidence in the lower house of parliament on Thursday of last week. The exporter-heavy UK FTSE 100 Index performed relatively well considering the move in sterling; the UK pound (GBP) was up 1.3% vs. the US dollar.
Value outperformed momentum in Europe in a further signal that investors were taking profits and looking towards reopening plays once again. Value stocks finished the week higher whilst momentum stocks were down. Naturally, that fed into broad sector performance over the week. Basic resources outperformed, with commodity prices continuing to break higher overall as the US dollar remains near three-year lows. There were also some favourable earnings reported in the space last week.
Banks were also well-bid last week, with the rhetoric around interest rates a little more supportive. Travel and leisure stocks were also strong on the reopening trade, whilst health care and utilities were lower.
In terms of data, the focus was on the PMI reports later in the week, which came in better-than-expected overall. Also of interest was the bounce in consumer confidence in the United Kingdom. With household finances in reasonable shape thanks to generous government schemes which have kept employment and incomes high, could this point to the pent-up demand which has been spoken of so often as we emerge from the pandemic?
Although last week was shorter due a bank holiday, there was still plenty of moving parts for investors to get to grips with. On the week, the S&P 500 Index drifted lower, along with the NYFANG Index, whilst the Dow Jones Index made small gains. Whilst familiar themes of fiscal stimulus, Federal Reserve (Fed) policy, and COVID-19 recovery all resonated last week, it felt the main driver for markets seemed to be the discussion around the moves in Treasury yields and inflation.
Last week, the energy sector and the financials traded higher, whilst pharmaceuticals and utilities were lower.
Despite the renewed focus on inflation, Fed meeting minutes released mid-week were dovish as policymakers saw taper conditions not being met for ‘some time’. Participants generally viewed the risks to the outlook for inflation as having become more balanced than was the case over most of 2020, although most still viewed the risks as weighted to the downside. Note, this will be a big week for Fed speak, as Fed Chair Jerome Powell testifies before Congress on 22 and 23 February.
Last week, US Treasury Secretary Janet Yellen reiterated the benefits of a large coronavirus relief package. She said recent strength in retail sales and stock values doesn’t change her view and highlighted that she believes the unemployment rate is closer to 10% than the 6.3% officially reported.
The extreme cold weather across many parts of the United States saw volatility in energy markets; oil output was severely impacted in Texas. West Texas Intermediate crude oil is trading just below US$60 per barrel, having traded as high as US$62 last week on production outages.
Last week was quiet week for Asian markets amid market holidays for Chinese New Year. The MSCI Asia Pacific Index was essentially unchanged last week. Given the noise around inflationary pressure/yield moves, focus was very much on basic resources, with copper in focus, up 9% over the past five days. Commodities moves will likely be a key focus for Asian markets in coming sessions.
Japan’s Nikkei Index outperformed last week, moving higher with value names doing well globally.
The important Chinese New Year retail sales data was a focus, with sales of major Chinese retailers and restaurants jumping 29% year on year to 821 billion yuan (US$127 billion) during the Lunar New Year break, CCTV reported. Online retail sales topped 120 billion yuan.
Focus remains on the relationship between China and the new US administration. It was interesting to see China pushing US President Joe Biden’s administration to take steps to ‘build up goodwill’, including removing tariffs and sanctions. Foreign Minister Wang Yi told a forum in Beijing that the two sides should reopen opportunities for dialogue cut off under former US President Donald Trump.
On Monday 22 February, the German Institute for Economic Research Business Climate Index for February came in better than expected at 92.4. On 23 February, the UK unemployment number will be released. We assume the furlough scheme will end in April 2020. There have been media reports suggesting that the programme may be extended in the budget announced on 3 March.
Finally, we have a raft of consumer price index (CPI) data out, including euro-area, France and Spain, and gross domestic product (GDP) data from Germany and France will also be released this week. In the United States, we will be looking to the GDP report on 25 February as well as the personal consumption expenditures (PCE) inflation report on 26 February.
Monday 22 February
- Data: Germany IFO Survey.
- European Central Bank President Christine Lagarde speaks.
- The UK government is due to publish a road map for ending its third lockdown.
Tuesday 23 February
- Data: UK Claimant Count & ILO Unemployment Rate; Eurozone CPI; Italy Industrial Orders; US Consumer Confidence.
- US Fed’s Powell testifies before Congress.
Wednesday 24 February
- Data: Germany GDP; France Manufacturing Confidence; US Mortgage Applications, Home Sales.
- Bank of England’s (BoE’s) Andy Haldane speaks.
Thursday 25 February
- Data: Spain PPI; Germany Consumer Confidence; France Consumer Confidence; Eurozone M3 Money Supply; Italy Consumer Confidence; Manufacturing Confidence; Eurozone Economic Sentiment; US GDP annualized, Durable Goods Orders, Initial Jobless Claims, Pending Home Sales; Japan Industrial Production, Retail Sales.
- EU leaders will hold a video summit through 26 February. They are scheduled to discuss the rollout of vaccines and travel restrictions.
Friday 26 February
- Data: Spain CPI, CA Balance; France GDP, CPI, PPI; US Wholesale Inventories; Personal Income & Spending, Personal Consumption Expenditures Core.
- BoE Deputy Governor Dave Ramsden speaks on a webinar for the Institute of Chartered Accountants in England and Wales.
- G20 finance ministers meet.
- European Central Bank’s Executive Board Member Isabel Schnabel speaks.
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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. Source: BofA February Fund Manager Survey, BofA Global Research.