The week ahead: Three events to watch

The markets are once again being driven by geopolitics, this time it’s the bond market. European bond yields have jumped at the start of trading on Monday, as the EU is set to announce an overhaul of defence spending after next week’s German election. This is good news for global defence stocks, and European markets have opened higher on Monday, but not such great news for bonds, as investors weigh up the impact on Europe’s debt pile.

European stocks had another strong performance last week, although the FTSE 100 lagged both Europe and the US on the back of some weaker than expected earnings data. Although the UK index managed to break to a fresh record earlier in the week. Mid-way through Q1, there is a clear investor preference for European equities over US equities, and within Europe, the FTSE 100 is the laggard. European stock market outperformance is impressive since it has happened at the same time as bond yields in Europe have risen so far this year. Higher bond yields do not need to be negative for European equities if yields are rising in the ‘right’ markets. For example, rates have risen in Germany and the Netherlands, while they have remained stable in France, Portugal and Italy. This is a sign of brighter economic prospects for Germany, and more fiscal largesse, which is needed to boost growth in the country.

The majority of monthly data is now out, bar a few key releases that will be released this week. The picture to emerge from the latest economic data is that there are signs that the global economy is losing momentum. The JP Morgan G10 economic surprise index has nosedived in recent weeks, suggesting that on balance economic data releases from the world’s biggest economies have surprised to the downside. However, this does not mean that the global economy is in danger, instead, there have been some notable economic data misses, especially the non-farm payrolls report and January retail sales for the US, which were down to seasonal factors, and they may pick back up again in the coming months.

In the US, weakness in the payrolls and retail sales data was mostly driven by weather related effects. The risk is that weather will continue to interfere with the February payrolls, since there are some large storms hitting the US in the coming week and flooding in Kentucky. However, from a market perspective, the seasonal weather distortions combined with Trump delaying any decisions on reciprocal tariffs are enough to help stocks to extend gains. For example, the best performers in the Eurostoxx 50 index last week included some of the embattled German car makers like BMW and Mercedez Benz. Stellantis also did well. The anti-tariff trade could have further to run, since stocks like Stellantis are down more than 40% in the past year.

Earnings update

Earnings season continues to help stock indices to defy weaker than expected economic data. At this stage of Q4 earnings season, the S&P 500 is reporting strong results that are better than expected, and the magnitude of earnings surprises is above the 10-year average, according to FactSet. Interestingly, the strong performance is broad based, with 9 out of 11 sectors reporting YoY earnings growth for Q4. Sectors with the strongest revenue growth include healthcare, financials and consumer discretionary. Earnings growth has been broad based; however, US stocks remain highly valued. For example, the 12-month forward P/E ratio is 22.2, which is above the 5-year average level. High valuations have not been a major worry for US stocks in recent years, however, after last week’s strong US CPI print, the US 10-year bond yield is hovering close to 4.5%. Although the correlation between the S&P 500 and US Treasury yields is not particularly strong over the long term, stocks have historically tended to stall when yields rise above 4.5%. If this is the new neutral rate for the US, then this could be an issue down the line.  

Three events to watch this week:

UK: Labour market and CPI data

Economists are expecting CPI to pick up for January, in line with the US. Headline CPI is expected to rise to 2.8% from 2.5%, and the core rate is expected to jump to 3.7% from 3.2%. The services rate of inflation is also expected to rise back above the 5% handle to 5.1% from 4.4% in December. The increase in prices is likely to be driven by education costs (VAT on private school fees), energy price rises and airfares. This has been expected, and it is unlikely to deter the BOE from cutting rates in May. Although service prices are expected to rise sharply in January, if they come in at 5.1%, this will still be below the 5.2% forecast by the BOE. Service prices are not forecast to fall to a sustainable level until after April, so a series of high prints may have no impact on bond yields or UK interest rate expectations in the near term.

The pound has been in recovery mode in recent weeks, as the dollar weakens broadly. This is driven by weakness in the dollar, rather than UK economic data, and it is defying the decline in UK yields and expectations for lower interest rates. Thus, the future outlook for GBP depends on what the dollar does next. The dollar index fell below its 50-day moving average last week, the next key support level is the 100-day sma at 106.25. The path of least resistance could be lower for the dollar, especially if it falls to this level in the coming days.

European PMIs: February rate to give key economic update

European flash PMIs for February will be released on Friday. This reading will be crucial to see how the Eurozone economy is holding up in the face of tariff threats from Donald Trump. The headline reading rose in January, and is crucially above the 50 level, at 50.2. This is higher than the 3-month average from October to December, suggesting that the Eurozone economy is experiencing some upward momentum. The biggest uptick to January’s PMIs was the manufacturing index, especially in Germany, however, for Q1 GDP to extend Q4’s gains, the service sector will need to extend further into positive teritory. The market is expecting the composite service sector reading to rise slightly to 51.5 from 51.3. The euro has rallied in recent weeks due to the decline in the dollar, and we think that the future direction of the euro will also be dependent on what the dollar does next.

Earnings and FOMC Minutes

The focus this week will be on Alibaba earnings along with Walmart. Alibaba could give us a valuable insight into consumer demand in China and whether the economy will experience an upswing in Q1. Analysts are expecting a big pick up in revenue growth for the last quarter, and a pickup in net income. President XI is also meeting Jack Ma, the founder of Alibaba, this week, which is seen as a softening in the stance of Beijing towards business, which could boost Chinese equities.

Walmart is also reporting earnings on Thursday. The market is expecting a strong report for Q4 2024, with revenues expected to top $180bn and profit to top $5.2bn, better than the $4.68bn in the prior quarter. It’s worth noting that the average move in Walmart’s share price in the 1 day following an earnings release over the last 8 quarters, is more than 4%. Walmart will be a good indicator of consumer strength in the face of Trump’s tariff threats and rising inflation, after inflation in the US was stronger than expected last month.  Thus, the market’s reaction to Walmart’s results could depend on their future outlook, since Walmart’s share price has had a strong start to the year. Its share price is higher by 14% YTD, which is stronger than the overall market’s performance, however, it also suggests that a lot of the good news for Walmart is already priced in.

The FOMC minutes released on Wednesday, are expected to show that the Fed remains firmly on hold for the long term. US inflation was stronger than expected last month, and the Fed expects Trump’s tariffs to drive up prices in the coming months. The minutes are unlikely to have a big impact on the market, as they may not tell us anything about Fed thinking that we do not already know. The dollar is unlikely to stage a rally, regardless of the Fed minutes, and in our view, stocks will be more impacted by earnings this week.