Beyond Bulls & Bears

Equity

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

There were some notable moves in equity markets last week following a spike in bond yields as concerns rose over a more hawkish Federal Reserve (Fed). The minutes from the latest Federal Open Market Committee (FOMC) meeting revealed that the Fed was growing more confident that the US economy was ready for a broad-based removal of monetary accommodation, and the Omicron variant was unlikely to slow it down. COVID-19 continued to be a key focus for investors, and last week, attention shifted to the trends in hospitalisations following the surge of Omicron cases over the last few weeks. The initial decoupling of cases vs hospitalisations in Europe gave investors hope that recently enforced economic restrictions will be temporary. Outside of Europe however, Omicron cases continue to surge in the United States and China locked down a further two cities on relatively very low case numbers.

FOMC Minutes and the Credit Markets

The key focus for markets last week was the release of the minutes from the latest FOMC meeting. Investors were on the lookout for any hints around whether the committee still viewed inflationary pressure as transitory and for further reasoning behind the accelerated tapering decision. The minutes were released last Wednesday and the thoughts among board members were that interest-rate hikes may need to start earlier or at a faster pace than previously anticipated. Some also flagged the possibility of shrinking the Fed’s balance sheet relatively soon after raising rates. Assessment of Omicron risks were focused more on the potential for exacerbating inflation pressure rather than hampering economic growth. Many saw full employment as not far off and suggested the labour market needs to be monitored for inflationary pressures. Equally important is how the US Treasury adjusts its issuance in response to reduced Fed reinvestments and until all of this is clarified, it will create significant bond/equity negative uncertainty for the market. With all said and done, consensus on the minutes is the Fed recognises it is behind the curve on inflation and now is the time to play catch up.

Bond yields were on the move after the FOMC minutes suggested it could be appropriate to begin to reduce the size of the Fed’s balance sheet relatively soon after beginning to raise rates. Given the size of the Fed balance sheet, there is concern for risk assets when it begins to contract. Last week’s events saw the US 10-year Treasury yield rise 16.7 basis points (bps)1 to 1.76% and above the 1.75% resistance level which held over the course of 2021. Also, five-year real yields reached pre-COVID-19 highs last week. Bond yields spiked in Europe last week, too. December’s Consumer Price Index (CPI) print came in at a new high of 5% and triggered a notable backup in rates. European credit markets made an all-time high on Tuesday. The German 10-year Bund yield rose 13.6 bps to -0.047%, the highest level since 2019.

Rotation, Rotation, Rotation

As a result of the move in credit markets, we saw a global derating in growth stocks, which naturally weighed on broader indices. In Europe, the Morgan Stanley Value Index closed last week up over 10%, with the equivalent Momentum Index relatively flat overall.2 This rotation into value stocks was dovetailed by a clear push into cyclicals. Cyclicals in Europe closed the week up 6.2%. Sector dispersion between best and worst was over 11% last week. The banks outperformed in Europe, closing higher with the rate rhetoric improving rising. Automobiles weren’t far behind, having benefitted from that rotation into value. Basic resources also moved higher last week, having benefitted from a headline suggesting China may ease policy in the first quarter 2022.

Outside the broader sector beats, it is worth noting that European airlines enjoyed an early 2022 reprieve, closing the week sharply higher. Technology stocks were the key laggards last week given weakness in the United States. Health care stocks also had a tricky week, closing lower. As investors engaged on the reopening trade to start the year, it appears some of the outperforming pharma stocks were sold to fund these moves.

Most of the moves in Europe were driven by moves out the United States. US technology stocks finished the week lower, and that and the underperformance from technology heavyweights weighed on broader US indices. The S&P 500 Index closed the week down 1.9%, whilst the Nasdaq closed the week down 4.5%, its worst week since February 2021. Like in Europe, last year’s health care winners were sold last week to fund the move into value stocks, and the sector saw losses last week. Real estate investment trusts (REITs), one of last year’s outperformers, also lagged last week.

At the other end, given the strong rally in cyclicals, energy stocks closed the week higher, as West Texas Intermediate crude oil moved back above US$80 for the first time since November. Financials were also strong.

The big question from here is: will the rotation continue? Some argue that last week’s move should have taken place in the fourth quarter of 2021, but was delayed due to the spread of Omicron. The big picture does continue to improve on the COVID front though.

Week in Review

Europe

European equity markets emerged from the festive holiday season with some gusto last week. A variety of themes, some new and some existing, were evident as investors returned. Omicron continues to be a focus. Reopening stocks were bought and some of the “Stay-at-Home” stocks were very weak as optimism rose over the improving picture of Omicron in Europe. Goldman Sachs’ “Going Out” basket closed the week up 5.2%, whilst the equivalent Stay-at-Home stocks were down 5.5% last week.

Investors in Europe had one eye on the minutes from the latest FOMC meeting. On the political front, the protests against fuel price rises in Kazakhstan in the past week have garnered attention in the region. Meanwhile, the Italian presidential appointment and the French presidential election should become more of a focus in the weeks and months ahead. There was a clear rotation into value as noted, with hedge funds shifting out of last year’s outperformers and into last year’s underperformers.

The first half of 2022 brings a couple of European political events to keep an eye on, with a new Italian President due to be appointed and French presidential elections upcoming. The seven-year reign of Italian President Sergio Mattarella ends on 3 February 2022. The public does not elect his successor; rather, he or she will be appointed by an electoral college comprised of the members of the Parliament and regional councils.

While the presidential role is largely ceremonial, this election is important as technocrat Prime Minister Mario Draghi could be a candidate, and if he were to run and be elected, we could see a period of uncertainty with fresh elections possible. Draghi has been a calming influence on the volatile Italian political landscape and has successfully implemented various reforms. The Italian stock market performed well last year, up 22%, so his departure for a more passive role would be seen as a negative for markets. In addition, polling in Italy suggests a right-wing, Eurosceptic government is a possibility should elections be held, with the Northern League and Brothers of Italy polling around a combined 40% of the vote. A return to a more combative Italian government could create tensions within the European Union (EU)—another potential headwind for equity markets.

A bit further out, in April, we have a French presidential elections. As it stands, this could be a more benign event than some may have anticipated. The right wing, Eurosceptic Marine La Pen has been nudged into third in polls by the centre right candidate, Valerie Percesse. If this remains the case in April and the second-round vote was between Macron and Percesse, it would appear the outcome for markets is far more favourable for Le Pen not being involved. A lot of water to go under the bridge yet—but encouraging signs from a market perspective at this stage.

Las week was very turbulent for Kazakhstan, with initial protest demonstrations occurring due to the doubling of liquefied petroleum gas (LPG) prices on 2 January. Despite the authorities very rapidly agreeing to cap LPG prices at below pre-increase levels, protests continued, and demands became more structural. On Wednesday, President Tokayev accepted the resignation of the cabinet and declared a state of emergency (including closing the Kazakhstan Stock Exchange) as a result of these wider protests.

Russia sent in what it calls “peacekeepers” to support President Tokayev in his efforts to quell protests and restore order. This Russian move supports the idea that there is little risk of a major threat to the long-standing, authoritarian political system.

Assuming no additional deterioration in the coming days, the main consequence would be a further consolidation of power for President Tokayev and possibly some faster steps towards democratisation. However, if things go the other way, then concerns around the involvement of Russian troops, the wider Russian market, uranium and the price of oil, etc. will come under much more scrutiny.

United States

We saw an eventful start to the year with some notable moves on the back of changing expectations regarding Fed policy (as discussed above). The S&P 500, Nasdaq 100 and Russell 2000 indices all lost ground last week. Underneath the hood, we saw a huge rotation out of growth and into value.

Given the move lower, the S&P 500 Index is once again testing its 50-day moving average, a key support level in recent times.

Looking to the bond market, last week’s events drove the US 10-year bond yield up 16.7 bps to the 1.76% area, and above the 1.75% resistance level that held over the course of 2021.

In terms of sector performance, the move in rates caused a shock in the tech sector, as noted. Last week, energy and financials were higher as value names surged higher in the new year.

Looking to US macro data, last Friday’s December employment report was the main focus, with the US unemployment rate falling to 3.9% (the first time it has been sub 4% since February 2019). In terms of jobs added, the number actually missed expectations, coming in at 199,000. December jobs data also showed that average hourly earnings growth continues to exceed expectations at +4.7% year-on-year. Overall, the impression was that there was nothing in the data to change the Fed’s new hawkish path.

Elsewhere, Democratic Senator Joe Manchin remains at loggerheads with the White House over President Biden’s proposed US$1.8 billion “Build Back Better” stimulus bill. The bill remained stalled due to Manchin’s opposition.

Asia Pacific

2022 started with a mixed bag for Asian market performance. Hong Kong’s equity benchmark edged slightly higher last week, and Australian equities were essentially unchanged. However, equities in South Korea, Japan and mainland China all started the year with declines.

Focus in China remains on the COVID-19 situation with a hard-line approach seeing a number of regions in lockdown. The latest was Tianjin, with a population of 14 million, which went into lockdown in response to at least two cases of the Omicron variant discovered over the weekend. With the Winter Olympics looming large and an influx of competitors set to arrive, if cases rise there will be concerns over the threat to China’s economic plan and potential supply-chain disruptions.

There were a few other interesting headlines from China last week. China’s securities watchdog Chairman Yi Huiman told state television that it will adopt multiple measures to “firmly” prevent market volatility. On the property front, Chinese regulators have asked banks to increase lending to the sector this quarter and eased a key restriction that has held back acquisition activity.

Week Ahead

Monday 10 January

  • Italian unemployment rate
  • Eurozone unemployment rate
  • US wholesale inventories

Tuesday 11 January

  • Spanish industrial production (IP)/output
  • Italian retail sales
  • US NFIB small business optimism

Wednesday 12 January

  • Eurozone IP
  • US CPI
  • China CPI, Producer Price Index (PPI)

Thursday 13 January

  • Italian IP
  • US PPI (excluding food and energy)

Friday 14 January

  • UK monthly gross domestic product (GDP), IP, manufacturing production, construction output
  • French CPI
  • Spanish CPI, trade balance
  • US University of Michigan sentiment, retail sales (excluding automobiles and gas), import price index, IP
  • China trade balance

Views You Can Use

K2 Hedge-Fund Strategy Outlook: First Quarter 2022

With both the pandemic and inflation proving longer lasting than many had anticipated, what does that mean for central bank policy in the months ahead? The K2 Advisors team ponders the implications for hedge-fund strategies in its first-quarter 2022 outlook. Read more. 

PODCAST: A Tale of Two Real Estate Markets: US and China

Tracy Chen, Portfolio Manager with Brandywine Global, and Tim Wang, Head of Investment Research for Clarion Partners, join Head of the Franklin Templeton Investment Institute, Stephen Dover, to take a closer look at how the pandemic has has impacted real estate markets in the United States and China. Read more. 

The Supply-Chain Storm: Planes, Cranes and Automobiles

Supply-chain issues are often cited in the current debate about inflation—and aren’t going away as quickly as consumers and businesses would like. Our Franklin Templeton Investment Solutions team explores how supply chains became stuck, whether they will loosen up in 2022, and the implications for multi-asset investors. Read more. 

Where Are the Workers?

As the Federal Reserve debates its monetary tightening timeline, the labour market is an important factor to watch in the year ahead, according to our Franklin Templeton Investment Solutions team. Read their thoughts on the labour market’s implications for both monetary policy and risk assets. Read more. 

Emerging Markets: A Constructive 2022 in Sight

2021 has been a challenging year for EMs, but there are several reasons to be constructive about the outlook for 2022, according to Franklin Templeton Emerging Markets Equity CIO Manraj Sekhon. Read more. 

Important Legal Information

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.

Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data.  Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.

Issued in the U.S. by Franklin Distributors, LLC, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com – Franklin Distributors, LLC, member FINRA/SIPC, is the principal distributor of Franklin Templeton U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.

What Are the Risks?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.  Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

Links to External Sites

Franklin Templeton is not responsible for the content of external websites.

The inclusion of a link to an external website should not be understood to be an endorsement of that website or the site’s owners (or their products/services).

Links can take you to third-party sites/media with information and services not reviewed or endorsed by us. We urge you to review the privacy, security, terms of use, and other policies of each site you visit as we have no control over, and assume no responsibility or liability for them.

____________________________

1. One basis point is equal to 0.01%.

2. Indices are unmanaged and one cannot invest in an index. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.

 

Get Content Alerts in My Inbox

Receive email alerts when a new blog is posted.

Leave a reply

Your email address will not be published. Required fields are marked *