Should Investors Underweight Euro Area Equities Given Trade Wars, Elections, and the Weak Growth Outlook?

No. All three factors have weighed on euro area equity and currency markets to some extent in recent months. That has ranged from directly, by crimping economic activity; potentially dragging down future growth, by weighing on domestic economic confidence; or simply by denting the sentiment of fearful investors towards the region. However, a material degree of negativity is now baked into euro area asset prices, potentially tilting the balance of risks towards upside surprises. Nonetheless, catalysts for sustained improvement in euro area corporate fundamentals versus their peers are hard to find, so we recommend continuing to hold euro area equities at benchmark weights.

The threat of trade wars has weighed on sentiment towards the euro area since before the US election, when the odds of a Trump victory were rising. At that stage, a 10% universal tariff was pushed as the policy of the incoming administration. European assets were understandably underperforming in the face of that proposition, given the United States is Europe’s largest trading partner. Post election, a softer position was touted, with the idea of a universal tariff seemingly sidelined, allowing euro area assets to outperform in January. However, we have since witnessed President Trump ordering a 25% tariff on Mexican and most Canadian goods (now delayed until March), an incremental 10% tariff on Chinese goods, and stating his intention to impose tariffs on the EU. With Europe having retraced approximately half of the election-period underperformance, the balance of risks surrounding trade war developments may therefore be more evenly distributed again. What seems clear is that this facet of the European macro story is likely to keep volatility elevated, with performance subject to significant headline risk.

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