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UK stocks drag European equities lower in 2020

European equities extended their monthly rally into the final month of 2020, marking the end of a volatile year, and while an eleventh-hour post-Brexit trade deal was welcomed, markets entered the new year with concerns over a new coronavirus variant first detected in Britain.

The S&P Europe 350 index, which tracks equities from 16 developed markets on the continent, climbed 2.29% on a monthly basis in December 2020, slowing from the previous month's record 14% rise.

Despite the monthly rally, the S&P Europe 350 closed the year in negative territory, dragged lower by British stocks, which have the largest index weight.

"The S&P Europe 350's total return this year would have been a 2% gain were it not for the negative contribution of British stocks," S&P Dow Jones Indices said in a note.

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An eleventh-hour post Brexit trade deal "prevented immediate cliff-edge risks to materialize but it has not improved the long-term prospects for European economies," Sylvain Broyer, chief economist for Europe, the Middle East and Africa at S&P Global Ratings, told S&P Global Market Intelligence by email.

Trade deal negotiations between the U.K. and the European Union, which had been stuck over issues including fishing rights, concluded on Christmas Eve, but the skinny nature of the deal meant crucial sectors such as financial services barely took up any space in the 1,246-page document.

The "agreement itself was welcomed, rather than celebrated," by markets, Craig Erlam, senior market analyst at OANDA, told Market Intelligence by email.

FTSE 100 underperforms

Growth in the U.K.'s FTSE 100 eased to 3.1% in the final month of 2020 from 12.4% in November 2020. The index lost 14.3% in 2020.

"[T]he FTSE 100 has barely gone anywhere in the last 20 years, so the fact that the U.K.'s benchmark index has underperformed is not entirely down to the 2016 Brexit vote," said Michael Hewson, chief market analyst at CMC Markets UK, in a note.

The coronavirus pandemic also had a sizeable impact on British equities due to its unprecedented effect on the economy, Hewson added. The sectors hit hardest by COVID-19, such as travel, retail and banking, make up a significant proportion of the FTSE 100, further weighing down an index that was already dragged by uncertainty surrounding the U.K.'s future relationship with the EU.

"So, while the FTSE 100 has clearly struggled this year, it also stands to reason that it could also be the most susceptible to a strong rebound, if the U.K. and global economies see a normalization in 2021," Hewson said.

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In the eurozone, Germany's DAX logged a monthly gain of 3.2%. France's CAC 40 and Italy's FTSE MIB edged up 0.60% and 0.78%, respectively, in December 2020.

Stocks in 16 of the 19 countries tracked by Market Intelligence logged monthly gains. Spain's Ibex 35 slipped 0.04%, while Belgium's Brussels BEL 20 ended 1.25% lower.

Challenging months ahead

The Stoxx 600 and the FTSE 100 have risen so far in the first trading week of the year, despite continued COVID-19 restrictions in a number of major regional economies. However, market observers believe that the coming months could be challenging, mainly due to the rapid transmission of the new coronavirus variant, even as vaccines are being rolled out.

The "first couple of months may effectively be a write-off but I'm optimistic that countries can bounce back from the spring," Erlam said.

Vaccine effectiveness and the pace at which herd immunity is reached would play key roles in driving investor sentiment this year. Meanwhile, key elections in Germany, the Netherlands, Portugal and Scotland are scheduled for later in 2021, as discussions on the equivalence for U.K. financial services continue.

"2021 will not be boring!" Broyer said.