Three things you need to know about European markets

clock • 3 min read
  1. Trade-war rhetoric coming from the US appears to be heading for a boiling point—and that could impact European markets

Following his focus on tax reform, another of US President Donald Trump’s campaign promises reared its head in the second quarter. Initial outbursts against unfair trade practises were directed against China and the steel trade, but the rhetoric and action are now widening. Europe and European companies, along with other close partners of the US, are at risk of tariffs. Europe has already retaliated by introducing tariffs on some iconic US brands including Harley-Davidson motorcycles, Bourbon whiskey and Levi’s jeans. The US administration has subsequently threatened to extend the tariffs to autos, particularly from Europe.

Tariffs on autos would clearly be painful for Germany, and hence for European growth, even though growth is now broader and has a stronger domestic element than it did a few years ago. Tariffs will no doubt result in higher prices and put upward pressure on inflation. While this may initially be welcomed by central banks, which have struggled with deflation for years, it will accelerate interest rate rises.

No economic theory supports the notion that starting a trade war will increase the wealth of anybody participating or affected by it. It is neither good news for the world economy, nor for European growth or corporate earnings. We are concerned though that the current US administration is not basing its decision on economic theory, but is pursuing another, more political agenda. We keep our fingers crossed and hope the current unstable situation does not escalate further. In general, we are not invested in commodity-related companies, but tariffs can result in higher input prices, for instance in manufacturing. Potentially, more widespread tariffs could disrupt the global supply chains many companies rely on, and affect production as goods become stuck or delayed at customs. In our view, investing in companies with a strong franchise, which gives them the power to raise prices if required, is the best way to protect investments.

  1. The European Central Bank is ending quantitative easing (QE), which could bolster valuation of financial markets.

In June, the European Central Bank (ECB) signalled it will end its bond-buying programme by December 2018. This decision came after the Eurozone achieved 2.3% growth in 2017, although more recent indicators suggest the figure for 2018 could be lower due to limited demand growth. The ECB takes a slow approach to raising its deposit rate, which is now at -0.4%. Any negative developments in Italy (the ECB has been the largest buyer of Italian government bonds for some time) may delay this further.

We welcome the decision to normalise monetary policy, which should correct some of the misallocation of capital caused by the policies introduced post-financial crisis. In the meantime, a gradual retreat from QE will lend support to valuation of the financial markets.

  1. Europe’s second quarter earnings season should be positive, which may offset potentially negative developments in Italy.

In the coming weeks, companies will start to report Q2 numbers. Earnings for the second quarter should continue to improve. Purchasing Managers’ Index (PMI) numbers have generally been positive and the strong currency headwind in the first quarter should have eased. Revenues should continue to develop positively and earnings revisions by analysts have also been positive. While news headlines are dominated by politics, earnings have supported equity valuations in Europe. There are indications the investment cycle is improving, with some of the strongest PMI increases seen in France. A stronger French economy will be positive not only for France but for Europe more widely, as a strong France will support the pull made by Germany and would enable the EU to better counter any potential negative developments in Italy.

Tom Stubbe Olsen, Fund Manager of Nordea 1 – European Value Fund and founder of Mensarius AG