The Digest
Global equities moved higher again last week, despite a series of headwinds. The MSCI World Index closed the week up 0.3%, while regionally, the STOXX Europe 600 Index closed up 1.1%, the S&P 500 Index closed up 0.1%, whilst the MSCI Asia Pacific Index closed up 0.3%.1 Nothing really changed with regards to the major themes last week, as we were still at the mercy of continuing headlines regarding Ukraine, with optimism regarding a ceasefire outweighing the reality of continued violence and destruction by Russian forces. Inflation remained at record levels, increasing the likelihood once again of sharper-than-expected central bank tightening. Meanwhile, market volumes remained low on the move higher. The overall index moves last week continue to mask the sector performance divergence globally. Overall, a very mixed picture underneath what appears to be a slow grind higher.
An Eventful First Quarter in Europe
European equities closed the first quarter down 6%, which was hardly going to stand out in the record books. However, it is the journey of how we got here which is notable, as investors have endured a lot of uncertainty so far this year. Inflation is at record levels, with the latest eurozone Consumer Price Index (CPI) report in March jumping to 7.5% year-on-year (y/y) vs. 5.9% in February. Energy and unprocessed food prices have driven inflation to new highs, reflecting Russian President Putin’s war in Ukraine, as both Russia and Ukraine are major exporters of energy and agricultural commodities. Persistently high inflation has driven more hawkish central bank rhetoric, as bankers attempt to fight the effects of inflation. By late January, global equities were having their worst start to a year since 2009, with January itself the weakest month since the start of the COVID-19 pandemic in March 2020.
Added to that was the political uncertainty itself, derived from Putin’s invasion, as countries imposed strict sanctions on the Russian economy. Gross domestic product (GDP) forecasts were cut, with the Bundesbank predicting a recession. Meanwhile, equity strategists cut their index price targets as market sentiment hit levels not seen since the start of the pandemic. Some European equity markets traded in bear market territory at one point, meaning they traded down 20% from their highs. Also, European equities record their largest weekly outflow of all time at the start of March, shedding US$13.5 billion.2
Yet, despite the significant increase in market risk, the sharp spike in volatility at the start of March, and the exodus from European equity funds, European equities have held up remarkably well, closing the quarter down just 6% overall. However, sector performance divergence has been huge. Basic resources and energy stocks have held up well, tracking oil and commodity prices. At the other end, retail stocks in Europe really struggled during the quarter, as retailers face surging cost pressures and falling consumer sentiment. Technology stocks were also down on the quarter, driven by the huge rotation out of growth and into value. Market volumes were significant at the start of the year, but we have seen that volume taper off in the last few weeks as equities (at an index level) regained their footing.
In terms of credit markets, stubbornly high inflation and the prospect of higher fiscal spending have dented sovereign debt performance in Europe.
Limited Signs of a Ceasefire in Ukraine
Markets seem to be looking towards a ceasefire in Ukraine. Equities were buoyed at the start of last week on news that Ukrainian President Volodymyr Zelenskyy was ready to discuss Ukraine’s future neutrality. There was also a report last Tuesday that Russia would be scaling back its attacks in northern Ukraine. However, Russia’s attacks continued, with Ukrainian officials saying they saw limited evidence of a Russian retreat. Reports over the rest of the week showed little hope of any imminent de-escalation, with the crisis appearing to deepen in some areas of the country as Russian forces appeared to regroup, especially in the south and east.
Over the weekend, Russia’s chief negotiator, Vladimir Medinsky, said that peace talks had not progressed enough so far to grant a leaders’ meeting. The two sides have been holding talks for several weeks now. However, both remain far apart on the question of territory in southern Ukraine. Medinsky said that Ukraine had agreed it would be neutral, not have nuclear weapons, not join a military bloc and refuse to host military bases. However, on the question of Crimea and the two Russian-backed rebel regions in Donbas which Putin recognised as independent in February, Medinsky indicated there had been no progress.3 Ukraine had also accused Russian troops of a “deliberate massacre”, after hundreds of bodies were reportedly found in towns outside Kyiv in the wake of Russian troops’ withdrawal. Russia continued attacks on the cities of Odessa and Kherson.
Several reports over the weekend suggest that the European Union (EU) was planning a further round of sanctions on the Kremlin. Diplomats said that EU ambassadors are to decide on the measures this Wednesday. Among those discussed include punishing more Russian individuals, banning Russian ships from docking at EU ports, and further export restrictions and embargoes on energy. Lithuania has stopped importing natural gas from Russia and has urged other EU member states to do the same. The UK government has expanded its sanctions against Russia to 14 more people and organisations principally involved with information and media, whilst the US government announced sanctions on a global network of companies that are helping the Russian military evade multilateral bans on the sale of advanced technology to Moscow.
There was also a report this morning that French President Emmanuel Macron is calling for sanctions on oil and coal imports. It is notable that Macron never mentioned Russian gas, which accounts for about 40% of the EU’s natural gas imports.4
We also continue to watch for the ripple effect from the Ukraine crisis. Of note last week, automobile manufacturer Volkswagen’s truck and bus subsidiary, MAN, furloughed 11,000 staff on shortage of wiring, which comes from Ukrainian factories. Germany took the first formal step towards gas rationing, entering their “early warning phase”. This means the government will increase monitoring on import and storage. The EU aims for 80% gas storage by November and they are currently at 26%, close to a four-year low.5 Also, a further Russian bond, held by domestic and international investors, is due for repayment 4 April and Russia has indicated it will pay it.
Week in Review
Europe
Last week was interesting for European equities, with markets steady going into quarter-end comfortably back above pre-invasion levels. Last the week, the STOXX Europe 600 Index rose 1.1%. Last Tuesday saw some exuberance in markets following peace talks, and we saw a squeeze in recent underperformers such as auto parts and food delivery names, suggesting positioning was behind a lot of the move. Last Wednesday saw a reversal of much of that move, as a dose of realism kicked in and there was little evidence of a de-escalation in Ukraine. It is notable that despite the bounce in the second half of March, European equities saw their seventh week of outflows last week. That, combined with the low volumes, suggests the move higher was not driven by much conviction and more a case of positioning.
European credit markets remain calm, with the Markit iTraxx Crossover also back to pre-invasion levels and the credit default swaps (CDS) of European financials also tightening once again.
European Credit Back to Pre-Invasion Levels
On macro data, we saw the German CPI at a fresh post-unification high, up7.3% y/y. This is the highest y/y print since November 1981. In addition, Spanish inflation reached 9.8% y/y. European Central Bank President Christine Lagarde said last week that Europe is “entering a difficult phase” and “the longer the war lasts, the higher the economic costs will be.” The market now sees the ECB raising twice by year end. In the United Kingdom, the Bank of England (BoE) warned of a “historic shock” to household incomes because of soaring inflation and rising energy prices.
United States
US index performance last week suggested a rather subdued week, with the S&P 500 Index up 0.1% on-the-week and the Dow Jones Index down 0.1%. Positioning was a theme through the week, as markets navigated the first quarter end, with the S&P 500 Index dropping sharply in the last hour of trading last Thursday, 31 March before stabilising somewhat on Friday 1 April. The S&P 500 Index is now down 4.6% year to date (YTD), having recovered from early March lows post the Russian invasion of Ukraine, when the Index was down as much as 13.7% YTD. Looking at sector performance last week, the outperformers were the rate-sensitive real estate investment trusts (REITs) and utilities. In terms of losers, the financials declined as the flattening curve is seen as a negative for the sector. With crude oil’s sharp fall, it was no surprise to see energy stocks decline as well.
Aside from quarter end, other talking points last week included the aforementioned sharp pull back in crude oil, which fell 12.8% to US$100.32 per barrel (bbl) after US President Joe Biden’s administration announced plans to release 1 million barrels per day (mpd) from strategic reserves for the next six months to ease the pressure on US consumers. With mid-term US elections looming large later in the year and the impact of inflation, this will no doubt be a key issue.
Last Friday saw the monthly US employment data, which was somewhat hawkish. The headline was the nonfarm payrolls, which came in slightly lower than anticipated, at 431,000 jobs added. However, the previous month’s reading was revised up to 750,000 vs. 678,000 originally reported. Unemployment ticked lower in March to 3.6%, and average hourly earnings continued to rise faster than expected at +5.6%. With that, the market now sees about an 80% probability of a 50 basis points (bps)6 interest rate hike in May. The market has also priced in 8.7 additional 25 bps hikes by the end of the year.
Another talking point was the US Treasury yield curve’s inversion. The upward pressure on short-term rates on the back of rising interest rate hike expectations caused the US two-year/10-year curve to invert and finish the week down 6.9 bps.
An inverted yield curve has generally been seen to be a strong harbinger of recession. The two-year/10-year curve has inverted ahead of every single recession, bar one, in the past 60 years.
Asia-Pacific
Last week was decent for Asian markets overall, excluding Japan, with the MSCI Asia Pacific Index closing just in the black, up 0.28%. Equities’ attractiveness as an inflation hedge was cited as a factor behind recent market strength, while corporate activity has been a driver following Hong Kong tech results and buyback announcements. However, inverting yield curves continue to drive talk about the potential for a recession, and there are thoughts stock markets are not properly pricing in economic, inflation and monetary policy risks.
Japan ended its nine-day winning streak on Monday, and this weakness continued over the course of last week, with the Nikkei Index closing the week down 1.72%. Focus was on the weaker Japanese yen, which was trading at its lowest level since December 2015 versus the US dollar (positive for exporters but negative for households). The government announced it would step in to support the bond market after the 10-year JGB yield crept up to a six-year high of 0.245%. This highlighted the Bank of Japan’s resolve to keep rates ultra-low, even as other central banks such as the US Federal Reserve (Fed) move towards rate hikes.
Japanese retail sales fell by more than expected on the Omicron variant wave, driving more concerns about an economic pullback in the first quarter. On Friday we had the first-quarter Japan Tankan Large Manufacturing Index, which came in at 14 amid supply chain pressures and high raw material prices. However, Japan’s final Purchasing Managers’ Index (PMI) report for March came in stronger than expected.
Last Monday, authorities in China announced a four-day lockdown of half of Shanghai. The sweeping restrictions came as China experienced its worst COVID-19 spread since the virus’s emergence in Wuhan, with more than 6,000 locally acquired cases reported nationwide last Sunday. This obviously had a knock-on effect to the markets and put crude oil under some pressure. However, we did see a rebound from lockdown-driven weakness on Wednesday.
On Thursday, the China Securities Regulatory Commission (CSRC) said in a statement that China is aware of the comments made by the US Securities and Exchange Commission (SEC) chair on auditing cooperation, and that talks between China and the US Public Company Accounting Oversight Board will continue. Nevertheless, US-China frictions still an overhang for markets, as the SEC added to the list of Chinese companies facing possible delisting from US exchanges, including technology company Baidu.7 Takeaways from major bank earnings guidance highlighted multiple headwinds ahead. Official China PMIs showed a synchronous contraction across manufacturers and nonmanufacturers, mainly reflecting lockdown effects.
Last week was better for Hong Kong’s equity market, which closed up 2.97%, with Meituan leading technology stocks higher following better-than-expected earnings. This morning, Hong Kong Chief Executive Carrie Lam said she wouldn’t seek a second term, ending a tumultuous five-year tenure that saw the financial hub become more isolated due to its twin crackdowns on COVID-19 and the democratic opposition.
Elsewhere, in Australia, the budget was released, and contained fresh one-off payments to relieve cost of living pressures. However, early takes also noted the potential to worsen inflation and encourage more aggressive tightening from the Reserve Bank of Australia.
Sri Lankan equities had a turbulent week, with the benchmark closing down 19% last week as the International Monetary Fund (IMF) said it will start talks with Sri Lanka on loan requests soon.
Note that both China and Taiwan are closed 4 April and 5 April, and Hong Kong is closed 5 April. Markets are therefore likely to be subdued at the start of the week before events pick up later in the week. The focus will continue to be on inflation, the conflict in the Ukraine, oil prices and interest rates.
Week Ahead
This coming Sunday (10 April) sees the first round of the French Presidential election. Incumbent President Macron and the right-wing candidate, Marine Le Pen, look likely to progress to the second round head-to-head on 24 April. Polls have tightened in recent weeks, with Macron losing some ground to the chasing pack.
Holidays
Monday 4 April: China
Tuesday 5 April: China, Hong Kong
Key Events
Tuesday 5 April: Russia CPI Inflation
Wednesday 6 April: US Federal Open Market Committee (FOMC) minutes
Thursday 7 April: Germany Industrial Production (IP); ECB monetary policy account
Friday 8 April: US jobless claims
Monday 4 April
- Turkey CPI Inflation
- The Eurogroup will meet in Luxembourg to discuss the impact of the war in Ukraine on the euro area.
- BoE Governor Andrew Bailey and Deputy Governor Jon Cunliffe are scheduled to speak at separate events. Cunliffe dissented against the March interest rate hike to 0.75%.
- Germany trade balance
- US factory orders
Tuesday 5 April
- Russia CPI inflation
- France manufacturing and IP
- UK new car registrations
- Italy YTD deficit to GDP
- US trade balance
Wednesday 6 April
- ECB Chief Economist Philip Lane is due to speak on a panel at the Delphi Economic Forum in Greece.
- Germany factory orders
- Eurozone PPI
- US FOMC minutes
Thursday 7 April
- German IP
- ECB monetary policy accounts
- BoE Chief Economist Huw Pill speaks at the bank’s International Conference on Sovereign Bond Market.
- Germany IP
- US jobless claims
- US consumer credit
Friday 8 April
- A second estimate of Russia’s 2021 GDP will bring the first official reading of fourth quarter growth. Expect Y/Y expansion of 4.9%, consistent with quarterly acceleration. After a bout of overheating before the war, Russia’s economy is now headed for a sharp contraction in 2022.
- Italy retail sales
Views You Can Use
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On My Mind: The Fed Takes the Red Pill
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As Rates Rise, Financials Can Shine
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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: Bloomberg, “Investors Exit European Equity Funds at Record Pace, BofA Says”, 11 March 2022.
3. Source: Reuters, “Russia says peace talks not ready for leaders’ meeting”, 3 April 2022.
4. Source: International Energy Agency, “How Europe can cut natural gas imports from Russia significantly within a year”, 3 March 2022.
5. Source: Reuters, “EU to require countries to fill gas storage 90% before winter,” 3 March 2022
6. One basis point is equal to 0.01%.
7. Source: Reuters, “China plans to remove hurdle to Sino-US audit cooperation”, 2 April 2022.