Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what their 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

As in recent weeks, concerns over the coronavirus weighed on investor sentiment globally. In addition, US markets traded lower on Friday after weak manufacturing data put the brakes on the relentless march higher in the technology sector.

Global Spread of Coronavirus Shakes Investor Confidence

As we head into the new week, markets have declined sharply as coronavirus outbreaks in Italy and South Korea bring fresh concern about the spread of the virus outside of China. In summary:

• An outbreak in Northern Italy has seen more than 150 confirmed cases (and several deaths), with the Italian authorities still unable to pinpoint “Patient Zero”. Several towns have been put on lockdown in what is a key industrial hub in Italy.
• South Korea have seen the number of cases balloon to more than 800 in recent days, with an outbreak in the city of Daegu (population 2.5 million).
• The situation in China does appear to be more controlled, with the number of new cases potentially plateauing.

Market Reaction: Markets have traded lower today, with the two countries at the centre of new outbreaks most severely impacted. In Asia, the Korea Composite Stock Price Index (KOSPI) closed down 3.9%, while Chinese equities outperformed, closing up slightly as the situation seem more stable there and further talk of stimulus.

In Europe, markets have had their biggest fall since the Brexit vote in 2016. Italy’s equity benchmark, the FTSE MIB, declined more than 5% Monday, while the STOXX Europe 600 was down more than 3%. As you would expect, investors were flocking to so-called “safe havens” such as gold and US Treasuries. Outside of gold, other commodities are getting smashed, particularly oil. Sector performance is predictable, with the defensive names outperforming and global growth plays lower at the start of the trading week.

What next: Whilst the impact of the coronavirus is still hard to quantify, it was surprising that even last week that the MSCI World Index continued to trade at all-time highs. Whilst the Chinese authorities are committed to offsetting as much economic impact with stimulus as possible, most observers believe the impact on China’s economy will no doubt be stark.

As we progress through corporate earnings season, we continue to receive more insights from European companies on the impact, or potential impact, of coronavirus. Of note:

• Adidas: On Tuesday, Adidas had suffered a “material negative impact” from the coronavirus with business activity in China -85% year-over-year (Y/Y).
• Maersk: The company stated it was a weak start to the year and lowered their guidance. However, the CEO, Søren Skou, stated he felt the numbers of new virus cases was slowing and that it could be set for a peak within the next two weeks and a sharp rebound in April.
• Covestro: The company told analysts sales to China halved in February, though there are likely to be some signs of improvement in March, with an impact assumed in the second quarter.
• Airliners: Air France announced it will take an EUR €150m-200m hit February-April 2020 on the back of the coronavirus outbreak, stating fewer Chinese visits may hurt Europe short haul. In addition, the International Air Transport Association (IATA) expects the first annual decline in global passenger demand in 17 years.
• Accor: Said “practically no activity” in Chinese hotels.

Despite the concerns over the virus impact, European Purchasing Managers Index (PMI) data released on Friday did show a small uptick, but various analysts examining the report noted that we may need to brace for worse news in the next few months. That said, some suggest we could see a U-shaped recovery after the crisis if central banks offer support via stimulus measures.

Comments from the People’s Bank of China (PBOC) suggest it stands ready to do what’s needed to spur growth in light of negative coronavirus impacts, and it would not be a huge surprise if to see the European Central Bank (ECB) and US Federal Reserve (Fed) easing.

The Week in Review

Europe

European equities finished near the week’s worst levels on Friday following weak US and Asian economic data throughout the day. As noted already, the coronavirus remains a key market concern and continues to weigh heavily on the market. Luxury stocks were particularly weak. It was the defensive sectors which outperformed on the week, with utilities continuing their strong start to 2020. They were closely followed by telecommunications and health care, both of which closed higher. Meanwhile, the banks and technology stocks declined.

Last week marked another week of outperformance for European momentum vs. value stocks, a trend which doesn’t appear to show signs of reversing as of yet. Corporate earnings season in Europe is now beginning to wind down and numbers appear better-than-feared overall, with companies surprising on average to the upside.

PMI data reported in Europe on Friday was surprisingly positive overall, with manufacturing and services both ahead of expectations. Eurozone composite PMIs ticked up to 51.6 (reflecting expansion) and manufacturing was also better at 49.1 (although remaining under 50, still marking contraction). Within the results, German manufacturing also saw a slight pick up and manufacturing new orders were likewise also better.

Despite these sanguine readings, Eurozone PMI results for February already show a clear impact of the coronavirus, with a marked increase in the length of delivery times as well as a sharp decline in export orders. Given the news over the weekend out of Italy in regards to the virus, we can expect the data could be in the coming weeks. The UK flash PMIs for February held at 53.3 for February.

United States

It was a macro-driven week in the United States as well last week, with impacts of the coronavirus as well as Federal Open Market Committee (FOMC) meeting minutes garnering the most attention. All sectors traded lower, and like Europe, the defensive sectors were among the outperformers. Real estate stocks outperformed, finishing near flat on the week, with consumer staples and utilities seeing small declines. Technology stocks were the most notable laggards. Financials were also weak, as were telecommunications stocks. US PMI data announced Friday was particularly weak, causing a late market selloff.

The FOMC minutes were not much of a surprise as members generally judged the current stance of monetary policy as appropriate for a time given the economic backdrop. The minutes noted that participants saw the distribution of risks to the outlook as somewhat more favourable than the last meeting, though the FOMC flagged coronavirus, which was described as a new risk to the global growth outlook. Many participants also said the Committee should not rule out using monetary policy to mitigate financial stability risks.

The ongoing policy review was also a focus, with several different concepts for an inflation target range discussed, including a modest inflation overshoot as part of an inflation makeup strategy. The Fed’s balance sheet and repo operations were again key items, with members believing that Treasury bill purchases and money market operations could diminish as reserves approach durably ample levels.

In US political developments, Bernie Sanders (one of the more progressive candidates) is in pole position to win the Democratic party nomination after another win in the primary vote in the state of Nevada. Sanders is now considered a firm favourite to go on and win the party nomination, and it comes after a fairly negative reaction to candidate Michael Bloomberg’s debut in his first televised debate.

However, it’s still early going in the presidential race and focus turns to South Carolina for the February 29th primary there. If Sanders performs well again there, equity investors should keep an eye on financials, health care and energy stocks, all of which may come under pressure.

Nonetheless, many expect President Donald Trump will go on and beat Sanders in the general election in November, with it being the generally held consensus that Sanders (a self-described “Democratic socialist”) would struggle to attract the more centrist US votes needed to oust Trump.

Asia Pacific Region

Asian equities were mixed last week as coronavirus fears remained front and centre. Chinese equities avoided further weakening following the PBOC’s announcements around further stimulus measures. That said, all sectors were broadly lower, with utilities the relative outperformer with the smallest decline. Like in the United States and Europe, technology stocks were particularly weak.

Poor macro data didn’t do Japanese stocks any favours. Annualised gross domestic product (GDP) was down 6.3% and represents the worst decline in over five years. Japanese PMIs were also soft, with manufacturing still in contraction territory and services at their lowest reading since April 2014. These two reports raised fears that the country is heading for a recession.

Elsewhere, Australian equities were better off after a surprise rise in the country’s unemployment rate raised expectations that the Reserve Bank of Australia may look at further monetary easing as the Aussie dollar fell to its worst level against the US dollar in over a decade.

Week Ahead

 

A quiet start to the week, with a US bank holiday and school holidays in England impacting volumes on Monday. Looking ahead, coronavirus news seems likely to be a market driver, and in terms of macro data, Friday’s global PMI stands out.

Politics

• US Democratic debate on Tuesday ahead of South Carolina primary.

Key economic data

• Monday: US Chicago and Dallas Fed Manufacturing; German IFO
• Tuesday: US Consumer Confidence
• Wednesday: US New Home Sales
• Thursday: US Durable Goods and Initial Jobless Claims; Eurozone Flash CPI; Japanese Industrial Production
• Friday: US Wholesale Inventories; German Unemployment;

Monetary Policy

• ECB President Christine Lagarde speaks on Monday
• Bank of England Chief Economist Andrew G. Haldane speaks on Monday
• Bundesbank President Jens Weidmann speaks on Friday

Holidays

• Japan closed Monday

 

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