Beyond Bulls & Bears


Notes from the Trading Desk – Europe

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.

The Digest

The MSCI World Index traded up 0.2% last week, but this doesn’t tell the full story of what was an unsteady week for equity markets. Angst over familiar themes of inflation and central bank policy remains a key focus, thanks to the mid-week release of the Federal Reserve (Fed) minutes. Volatility in a number of asset classes, including cryptocurrencies, also unsettled investors at times. Looking at the regions, the S&P 500 Index lagged, down 0.4%, while Europe’s STOXX Index traded up 0.4% and the MSCI Asia Pacific Index outperformed, up 1.6%.1

Transitory Inflation?

The debate around rising inflation and the potential impact on central bank policy has been the key driver for financial markets of late, and last week was no exception.

In the United States, the latest Federal Reserve (Fed) meeting minutes showed members felt the economy remained far from the committee’s maximum employment and price stability goals to make any policy changes. Risks to the outlook were no longer elevated as in previous months. On inflation specifically, policymakers said that after the current transitory effects of factors fade, generally expected measured inflation would ease.

Looking further ahead, the Fed expected inflation to be at levels consistent with achieving the Committee’s objectives over time. A number of members suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases. Some felt concerned about the upside risk to inflation should underlying drivers be more “persistent than expected”.

In Europe, European Central Bank (ECB) President Christine Lagarde played down talk of the ECB tapering its asset purchasing programme, stating it was “far too early and it’s actually unnecessary to debate longer term issues….policymakers need to provide the right bridge across the pandemic, well into the recovery”.2 She also played down current inflationary pressures, saying they are “of a temporary nature” and she feels inflation will “return to lower levels” next year.

Aside from central bank commentary, there was some inflation data last week, which saw increases. These included the Japanese April Producer Price Index (PPI) +3.6%; US Empire manufacturing prices paid hit 83.5 month-over-month (M/M) (record level); the Philadelphia Fed Index’s prices paid index hit the highest in 41 years; UK Consumer Price Index (CPI) +1.5% M/M, and house prices +10.2% year-over-year (Y/Y); Canadian April CPI +3.4% Y/Y.

Commodity prices declined last week (iron ore -5%, copper -3.7%, aluminium -4%, wheat -4.7%, soy -3.8%) with China vowing to curb “unreasonable” price increases. This helped ease some fears over input costs and with that, we did see some respite for growth stocks, which started to see some outperformance versus value, also a sign of easing inflation concerns.

Europe in Focus

It was quite interesting to see Europe’s equity benchmark (STOXX Europe 600 Index) has now sneaked ahead of the US S&P 500 Index, as well as the MSCI Asia Pacific and MSCI Emerging Markets Indexes as the best-performing year to date; this is the first time European equities have outperformed US equities over the first five months of a year since 2017.3 Signs of easing lockdowns, economic reopenings and a ramp-up in vaccination programmes have all helped boost sentiment for European equities.

The monthly Bank of America (BofA) Global Fund Manager Survey came out last week, and amid some decent performance vs. other regions, investors remain positive on European outlook. Of the respondents, 93% expect European growth to improve over the next 12 months, with fiscal policy deemed the most stimulative since 2010.

Inflation is seen as the biggest tail risk: inflation expectations remain elevated, with 82% of respondents believing inflation is set to rise over the coming 12 months, only moderately below the record 94% reached in March.

Investors polled in the BofA survey do not expect a peak for European equities until next year: only one out of 10 investors expect European equities to reach a peak this quarter, with a plurality thinking a peak is unlikely to be reached until next year.

We also saw some investment banks pushing European equities again, with drivers including positive economic momentum, more attractive valuations, stronger earnings growth and economic support from the EU Recovery Fund.

Week in Review

European Markets

A choppy week for European equity markets as the STOXX Europe 600 Index stalled after making all-time highs at the start of the month. As has been the way recently, it felt like we really took our lead from events in the United States rather than European- specific catalysts. Focus remains on inflation after the US data last week—last week, we had inflation data points from the European Union (EU) (CPI at 1.6% YoY) and the United Kingdom (CPI at 1.5% YoY).

With investor nerves rattled on Wednesday (19 May) after a global de-risking and a meltdown in cryptocurrency, it’s not surprising to see defensive names outperform in Europe (health care +1.7%, utilities +1.4%). Automobiles also fared well after positive commentary from Daimler.

The laggards were the basic resources (down 3.6% on the week) amid comments out of China on stabilising the market. Crude oil declined a bit as easing restrictions bring Iran came back on tap. Having said that, the sector is still a strong year-to-date performer.

European Data: Another Upside Surprise

Monetary stimulus, fiscal measures, and a pickup in demand globally continue to drive the recovery from the COVID-19 recession in Europe.  Outside of the inflation data, which was less exciting from Europe, the Purchasing Managers’ Index (PMI) for May were the focal point last week. Readings in the eurozone showed a speedy recovery in the services sector as well as impressive growth in manufacturing, with the manufacturing PMI remaining close to the record level hit in April.

Services hit a new 35-month high of 55.1, and as the vaccination effort continues to ramp up, we would anticipate further gains in the coming months. Demand is strong, with the increase in new orders accelerating to its highest reading since June 2006. The employment index was also better for the fourth consecutive month. The flash composite output PMI for the region came in well ahead of consensus, hitting a 39-month high at 56.9.

The UK picture was even better, with the composite output PMI for May hitting 62.0, its highest level since January 1998. This was from an already-elevated 60.7 in April and has benefited from a huge gain in the Manufacturing PMI, which hit a record 66.1 in May.

We also saw an impressive bounce in UK April retail sales. It will be interesting to see how central banks react, especially since there are signs that the recovery is creating capacity issues and causing disruption to supply chains, adding to pricing pressures. However, inflation pressures in the eurozone remain less severe than in the United States, meaning the ECB should still be able to move cautiously. As mentioned above, Lagarde again dismissed concerns over inflation, saying that inflationary pressures driven by the economic rebound were of a “temporary nature”.

United States

Volatility crept back into US equity markets last week with a variety of factors providing the push and pull. Inflation, COVID-19 case trends, economic reopenings, commodity price moves and the infrastructure bill have all been cited as drivers of market moves.

April Federal Open Market Committee (FOMC) minutes showed the Fed talked about tapering, though economists don’t seem to be changing their tapering timeline. Despite the volatility, the S&P 500 Index closed last week down just 0.4% after rallying in the latter half of the week and recovering most of its losses.

The CBOE VIX Index, a measure of market volatility, nearly hit 26 on Wednesday (19 May).4 US equities saw their smallest inflow in seven weeks of US$1.2 billion. On a sector basis, the defensives were among the outperformers last week with real estate investment trusts (REITs) up 0.9%, health care up 0.7% and utilities up 0.3%. At the other end, industrials and energy lagged, down 1.7% and 2.8% respectively, as commodity prices dipped.

The selloff in cryptocurrency also garnered attention, with Bitcoin -23% last week.

Potential tax increases to pay for US President Joe Biden’s US infrastructure plan remain a point of contention in the United States, with gaps between corporate rates across the globe also causing some friction.

The US Treasury Department stressed importance of multilateral cooperation to end the pressures of global corporate tax competition and corporate tax base erosion, underscored that 15% is a floor and that discussions should continue to be ambitious and push that rate higher.

Looking at the CNN Fear & Greed index as of 21 May, it suggests underlying market sentiment is not great and deteriorating, with a stronger FEAR reading versus the prior week.5

Asia and Pacific

Asian equities were higher last week, with the MSIC Asia Pacific Index closing up 1.7%. Cryptocurrency, commodity prices and COVID-19 cases were the key themes for investors. In terms of sectors, consumer discretionary stocks were strong, up 3%, followed by technology, up 2.7%. Like in the United States and Europe, basic materials were weak and the only sector to close in the red in Asia, down 0.7% as commodity prices fell.

On Wednesday (19 May), the People’s Bank of China’s (PBOC) comments around the use of cryptocurrency garnered attention, sending the crypto market into a spiral. The PBOC issued a statement on its WeChat account reiterating digital tokens cannot be used as a form of payment. The Chinese government also warned financial institutions and payment providers against offering cryptocurrency services such as registration, trading and settlement. This marks the latest attempt by China to crack down on cryptocurrencies after shutting down its local exchange in 2017, and in 2019 blocking access to all domestic and foreign crypto exchanges.

Iron ore prices fell last week as China intensified efforts to rein in surging raw material prices. Chinese steel prices extended declines amid further government curbs.

The Week Ahead

Monday 24 May

  • Bank holidays in a number of European markets (including Germany and Switzerland).
  • European Council leaders’ summit in Brussels
  • Key speakers: Fed’s Loretta Mester, George and Raphael Bostic; Lael Brainard

Tuesday 25 May

  • German gross domestic product (GDP) and Institute for Economic Research (IFO) Survey
  • Key speakers: Fed’s Randal Quarles gives semi-annual testimony before the US Senate Banking Committee; Bank of England’s (BOE) Silvana Tenreyro; Bank of Japan’s (BoJ) Haruhiko Kuroda; ECB’s Philip Lane

Wednesday 26 May

  • French Consumer Confidence

Thursday 27 May

  • US GDP
  • Bank of Korea policy decision
  • Chinese Industrial Profits

Friday 28 May   

  • French CPI, PPI and GDP
  • G7 finance ministers and central bank governors meet
  • US President Joe Biden’s fiscal year 2022 budget request is scheduled for release

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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: Reuters, “ECB’s Lagarde Says Too Early to Discuss Life After Emergency Support”, 21 May 2021.

3. Source: Bloomberg. 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. See for additional data provider information.

4. The CBOE Market Volatility Index measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. 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 performance.

5. 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.

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